California-based WCM do things differently. That's why their fund has grown from $500 million to $43 billion in two decades.

What are the principles that make a fund grow from $500 million in 1998 to $43 billion today?

Global Investment Specialist from J.P. Morgan Private Bank in Asia Tom Reid recently sat down with the Co-CEO and Portfolio Manager at WCM Investment Management Kurt Winrich for a discussion on business culture, competitive advantage–and how to avoid some of the common pitfalls of Wall Street. 
 



“Warren Buffet came up with the Moat metaphor 40 years ago. He talks about a business being a castle and the moat’s your protection against competitors … What’s your competitive advantage? That’s your moat.”

Thinking about your moat–your competitive advantage–has to be a rigorous process. Many investors will only think about moats as they currently are, and not how they might evaporate in a few years’ time. It is seductive to focus only on the biggest business in the market, and not how that market is changing.

“So, for us, the important thing is not how big the moat is, but how it’s changing.”

The best example of this kind of thinking was the Finnish cell phone company Nokia.

At the end of 2006, the company dominated the market and was the fifth most valuable brand in the world. But with the introduction of iPhone and Android products in 2007, Nokia’s moat rapidly dried up. By 2014, the brand had all but disappeared. There are many examples of similar circumstances in the tech world: Yahoo was once bigger than Google, eBay was once bigger than Amazon, and Dell was once bigger than Apple.

“All of these were cases where wide moats and low prices…really seduced people into buying the wrong investment and they weren’t paying attention to that growing competitive advantage.”
 


“The picks and shovels idea is that [in] … the 1849 Gold Rush in California, a lot of people came from our East Coast to California to strike it rich, right? But how many of them actually did?”

The truth is, the vast majority never saw the glint of gold. But the vast majority did buy the picks and shovels to dig for it. There are a lot of business sectors for which this analogy is particularly apt. None more so than the health sector. Biotech drug makers are constantly driving toward a gold mine, and with the costs and risks involved, the outcomes are very binary. A few are big successes, but most are big failures.

“So, who is selling the picks and shovels in that environment?”

For WCM, one great “picks and shovels” firm in the health space is Western Pharmaceutical. The former is considered by some as one of the best in the business for drug packaging. Many firms buy packaging from them, and while some firms succeed and others fail, Western doesn’t have to worry about striking gold. This same lesson applies to other sectors. Taiwan Semiconductor, for example, sells chips for Apple, Broadcom and NVIDIA products.

 


WCM is often asked why the price-to-earnings ratio of their portfolio is so much higher than the benchmark: just under thirty, versus a benchmark in the high teens. One key reason for this is that WCM avoids a ‘lazy fade’ in their forward price-to-earnings models for forward earnings. Many analysts use valuation models that are rigorous only for the first three years, then assume average performance beyond that: a lazy fade from an explicit projection to a nominal growth rate (such as GDP).

“We call it the lazy fade because it only accounts for a couple of years, and yet their models try to account for 10 or 15 years, and most of the value that the analysts think they see is in the lazy fade part where they don’t do a lot of work.”

WCM extends the explicit projection by looking at whether or not the company’s competitive advantage is growing, and if their culture is aligned with that advantage. If true, they assume that the earnings in the fifth year and beyond will be greater than the general consensus.

“We paid a hundred times earnings for Baidu back in 2008, a lot of people thought we were insane. Five years later Baidu’s earnings had grown by a factor of 100. So, we were paying a price in 2008 that was a multiple of about three times the earnings in 2012.”




Some businesses are run by a “genius with a thousand helpers”. These types of businesses can often be very successful, but the same reason for their success is often the reason for their failure.

“If the genius goes away it’s like a chicken with its head cut off, it doesn’t know what to do.”

Businesses in this position may have a healthy culture, good product and a great business model, but all these will suffer from a lack of depth in leadership. One telltale sign is an inability to get a meeting with anyone other than one particular member of the leadership team, such as the President or CEO. Worse, if you are not talking to this one particular person, you will not be able to get a complete picture of the organization. There is also the risk that this particular person decides to leave the organization. In almost every case, a thousand helpers do not add up to one genius.



“Culture is simply the set of values that animate the behaviors in an organization. Those behaviors need to be aligned with the competitive advantage of a business.”

Across the business world, different companies have as many different cultures as there are products and services. There is no “best” culture, but the best businesses are those that align culture with their competitive advantage. Amazon is a great example of where this fusion has led to tremendous success. Their competitive advantage is in price, and their culture focuses on reducing prices for their customers as much as possible. This alignment also serves to attract people with the characteristics and ambitions that in turn align with the company’s overall goals.

There is one common factor among the businesses that have this alignment: they all make sure their people are valued.

“What happens is that the people are valued in a real and tangible way, and that means they love their job and actually perform better.”

Look after your people and they will look after you. Remove hierarchy as much as possible. Be transparent about compensation. Let talented people be part of the decision-making process and give them a stake in their success. Happy employees create happy customers, in turn creating happy shareholders.



If you would like to discuss any of the ideas addressed in this article, please contact your J.P. Morgan representative.