Chris Bloomstran – What Makes a Quality Company - [Invest Like the Best, EP.141]

Episode Summary

Executive Summary: Chris Bloomstran explains Semper Augustus's quality-first investing, emphasizing high incremental returns on capital, distribution control, and forensic accounting. He uses Ross, Costco, Dollar General, Richemont, Disney, Cummins, Microsoft, and Berkshire to show how durable businesses compound value.

Main Topics: The Ross Stores mistake and lessons on valuation (Priority: 5/5): Selling Ross too early taught him not to anchor on the entry multiple when a business can compound for decades. Defining quality as business durability plus management quality (Priority: 5/5): Quality means outstanding businesses run by outstanding people, with capital preservation and long holding periods. Incremental returns on capital as the key lens (Priority: 5/5): He prioritizes where each new dollar can be reinvested at high returns, especially in unit-growth businesses. Control of distribution as a durable moat (Priority: 4/5): Businesses like Richemont, Disney, Cummins, and Dollar General win by owning the customer relationship and channel. Berkshire Hathaway as a case study in capital allocation (Priority: 5/5): Berkshire evolved from textile to insurance, then used capital shifts into railroads, utilities, and other assets. Accounting adjustments and economic reality (Priority: 4/5): He adjusts for write-offs, pension assumptions, and other distortions to estimate true returns on capital. Growth, value, and why expensive compounders still matter (Priority: 3/5): He accepts growth as part of value, but still avoids paying extreme multiples even for great businesses.

Key Arguments: Selling Ross at ~20x was a huge mistake because the business became a 20-bagger after he left it. Quality is about strong businesses and managers; price matters second, not first. Incremental ROIC matters most because retained capital is where long-term value is created. Costco proved that low headline margins can still mean excellent economics if unit returns rise over time. Distribution control can justify lower margins if it protects brand, pricing, and customer access. Berkshire's capital reallocation from stocks into operating assets drove much of its long-run compounding. True earnings require adjusting for write-offs, pension assumptions, and hidden liabilities.

Data Points: Ross stores owned at outset: 350, 375 stores - He described Ross as a retailer still early in its store rollout Ross purchase multiple: 10 times earnings - Initial buy price for Ross Stores Ross sale multiple: high teens, call it 20 times earnings - When they trimmed/sold Ross after the early run-up Ross stock outcome after sale: more than a 20-bagger - What happened after they sold and never re-bought it Costco stores at purchase: 350 or 375 stores - Costco looked similar to Ross when first bought Costco unit maturity: six or seven years - Time for a new Costco store to become a mature unit Costco mature-store returns: mid teens returns on capital - Mature Costco stores versus new stores Costco returns on capital today: 21, 22% - Current system-level returns on capital Costco gross margin: 14 down to 11% - Margins declined as scale benefits were passed to customers Dollar General store count: 15,000 stores today - Approximate store count at the time of discussion Dollar General target store count: 24,000 or 25,000 stores - Management's long-term store expansion plan Dollar General rural mix: 70% - Share of business done in rural markets Dollar General store size: 7,400 square feet - Typical store footprint Dollar General average store count by town size: towns of 20,000 or fewer; opening in towns of 5,000 or fewer - Current format and expansion strategy Richemont gross margins: 65% - Luxury manufacturing margins Richemont higher-end watch gross margins: 90% - Very high margin at the top of the watch category Richemont sales growth base: 7 billion euros in sales to 11 billion dollars - Growth driven largely by Asian demand Berkshire stock portfolio share of book value in 1998: 115% - Stock portfolio value exceeded book value then Berkshire stock allocation in 1998: 65% of all assets - How much of Berkshire assets were publicly traded common stocks Berkshire stock allocation after Gen Re: 30% in stocks - Result of shifting capital away from common stocks Berkshire current stock allocation: 25% today - Approximate current share of assets in stocks Berkshire underwriting/investment mix: 45% of overall value tied to P&C insurance and reinsurance - His estimate of the current business mix Berkshire cash: $110 billion - Cash balance offset by debt in subs BNSF purchase price: $34, $37 billion - Berkshire's railroad acquisition in 2009 BNSF best-year return on capital: nine on capital - His estimate of railroad returns before the acquisition Market underperformance period: 2012, 13, 14, 15 - Years when his firm lagged badly Semper stock return: 10.5%, 11% for 20 years - Approximate long-term stock performance Cash drag: 190 basis points - Effect of client cash balances on performance Annual stock edge vs market: 500 basis points ahead of the market for 20 years - Portfolio-level outperformance claim Market median stock performance in 2015: down something like 20% - He cited broad weakness that year S&P performance in 2015: up 1 - Market benchmark that year General Mills bonus hurdle: 3 percent organic sales growth down to negative 1.4 percent - Proxy comp hurdle changes over time General Mills free cash metric: rolling three-year period - Compensation tied to free cash generation Comp split example: 132 percent of free cash metric paid pro rata as 66 percent - Illustrated incentive comp structure Annual write-off rate: almost 15% of annual profits every year - His estimate of annual operating profits written off over long periods Defined benefit return assumption: 4% - His standard assumption for pension assets Typical corporate DB assumption: 6.5% - Current market assumption, down from prior periods Prior typical corporate DB assumption: 9% - Earlier era assumption he judged too high

Pivotal Quotes: "I thought we could step away from Ross at what we thought was a very full price." — Chris Bloomstran: Explaining the mistake of selling a business too early because it looked expensive "We employ a dual margin of safety in the process." — Chris Bloomstran: How he frames quality and price in his investment process "We're going to pay you performance comp to slowly shrink the business." — Chris Bloomstran: Critique of incentive schemes that reward low growth or financial engineering

Implications: His framework favors businesses with long reinvestment runways and disciplined disclosures; investors should keep testing whether reported earnings reflect economic reality.