HOW STEVE KNOWS THE GUEST

Steve was introduced to Jenny in Omaha by Chris Bloomstran, a previous guest on the podcast who has become a friend. Chris said that Jenny was a must-have guest. The previous year, Chris introduced Steve to Guy Spier – who will be next?

Steve subsequently caught up with Jenny in New York, where she was presenting at the Value Investing Conference and they decided to record over Zoom, not Steve’s favourite choice, but the only option given both their travel schedules.

And they will meet in Omaha where Jenny will be the moderator at the dinner in aid of Columbia Business School. Other speakers will include former guests Mario Gabelli and Beth Lilly.

Contents

00:02 – Introduction to value investing
15:24 – Focus on balance sheet strength
23:45 – Catalysts for stock performance
41:18 – Research and investment philosophy
55:11 – Performance and market outlook

Transcript

STEPHEN CLAPHAM: Hi, welcome to the Behind the Balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an unsuccessful one. Our goal is to inform, educate and entertain. We hope you enjoy this and every episode.

DISCLAIMER: Behind the Balance Sheet And Affiliates and podcast guests may own shares or have an economic interest in securities discussed in this podcast, which is aired for your education and entertainment only. Nothing in this podcast should be construed as investment advice or relied upon for investment decisions. Always do your own research.

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STEPHEN CLAPHAM: I’ve interviewed a number of people in this podcast who describe themselves as value investors. It signifies, I think, a mindset and a philosophy more than anything, as they all run their portfolios and choose stocks quite differently.

STEPHEN CLAPHAM: That philosophy includes a willingness to underperform one year in three, an acceptance that they won’t have the glamour of the growth investor in the boom years, but they’ll make up for it in the down years, and a focus on buying stocks cheaply, however they define that. My guest today, Jennifer Wallace, is definitely a value investor.

STEPHEN CLAPHAM: In this episode, she explains her investment philosophy, which is buying high-quality companies on the cheap, often when things have gone wrong. Jen finds these gems for her 30-stock portfolio by combing ValueLine, just as she did when she trained under famed value investor Bob Bruce. Her focus is on the numbers.

STEPHEN CLAPHAM: She talks here about CEOs and IR heads. Being great salespeople, promoting their stocks, and how she avoids being sold to by that solid focus on the numbers. She likes her portfolio to be net cash or with very low leverage, to have returns and equity of over 30%, and to be in a free cash flow yield of 10%.

STEPHEN CLAPHAM: She buys stocks which are overlooked, often because they’re not in passive indices, or where there are not enough active value managers to facilitate price discovery. But by requiring low cash flow multiples, she can rely on the cash flow to deliver the return. Either management will return cash to shareholders, or about 25% of the time, she receives a bid, often from private equity, attracted by the cash generation and a starting conservative balance sheet.

STEPHEN CLAPHAM: It’s easy to see from our conversation why Jennifer has delivered to her partners and an 8x return since inception in 2009, even while holding substantial cash balances. Another tenet of her philosophy. You’re sure to enjoy our conversation.

STEPHEN CLAPHAM: So, Jennifer Wallace, we met in Omaha, oh, almost a year ago, and I’m really pleased to welcome you to the podcast. We met in New York just a couple of weeks ago, and I don’t really know very much about you. But I always ask guests, did you always want to be an investor?

JENNIFER WALLACE: Well, first of all, Stephen, thank you for having me. It’s a pleasure to be with you today. And on the question of did I always want to be an investor, the firm answer is no, most importantly because I didn’t even know that this profession existed when I was young, certainly not in college. I went to a very liberal arts undergraduate school.

STEPHEN CLAPHAM: Which one?

JENNIFER WALLACE: I went to Columbia College, which has, you know, a world famous core curriculum, but it is humanities driven. And in fact, only recently have they begun to offer any kind of business or technical kind of courses to undergrads. And I worked in investment banking out of college, still shocked they hired me because I knew so little about anything finance or financial markets.

JENNIFER WALLACE: And then went to business school. And it was in business school where I learned even basic things like the math behind a discounting calculation on your Excel. You know, I sort of, lights went on for me about the work I had been doing for the past years, you know, kind of punching away at my computer and learning, you know, sort of realizing that. I was fortunate in business school to become…

JENNIFER WALLACE: Close with a professor by the name of Bruce Greenwald, very well known in Value Investing circles. And he is the person who is credited with bringing the Value Investing program back to Columbia Business School. He said to me, there’s a class called Value Investing that you need to take next semester. And I said, great, I’ll take it. What’s Value Investing?

JENNIFER WALLACE: And it was Only through that course that I learned, A, that this was as interesting a potential career as it is, and B, that there were all these famous, you know, kind of legends out there that I got to listen to. And the course spent about six weeks focused on Bruce Greenwald and Roger Murray teaching us the basics of financial analysis and understanding.

JENNIFER WALLACE: What evaluation means and what constitutes a value investment. And the last six weeks listening to legends speak from Seth Klarman to Mario Gabelli to Michael Price to Warren Buffett, you name it. We were really exposed to some pretty special people. And that for me was when the light went off. This is what I think I want to do.

STEPHEN CLAPHAM: And so Warren Buffett was one of the guest lecturers. I don’t know what you call him. Yeah. Adjunct professors or something.

JENNIFER WALLACE: No, he was just a guest lecturer for one course, one class.

STEPHEN CLAPHAM: And what was that like? I mean, did you know that this was, you were in the presence of somebody great?

JENNIFER WALLACE: By then, I was not so naive and clueless. So by then, I also realized what an incredible experience and opportunity it would be, or it was. But also even in the presence of like a Seth Klarman. You’re in the presence of an unusual. Intellectual intellect and somebody who is truly great.

STEPHEN CLAPHAM: There seems to be much more emphasis in America about having studied finance. Here, it’s very common for people to have liberal arts degrees and go into investing without any business school training. And you just learn, you know, on the job. I mean, do you think it’s necessary to study at a university? Or do you think it helps?

JENNIFER WALLACE: I often joke. I was a political science and psychology major, undergrad. And I think investing uses as much psychology as it does finance. That being said, if you don’t know how to read an income statement or a balance sheet, I think it would be very hard to do financial analysis. But the financial analysis that you do is not advanced math.

JENNIFER WALLACE: And certainly in the way I invest, it doesn’t involve complex. Options, straddles or butterflies or anything like that. So those kind of courses aren’t things that I use in my day-to-day life. And really it’s basic financial analysis in the form of understanding what the financial statements are telling you.

JENNIFER WALLACE: And then also for me, it’s psychology, managing your own psychology and human nature, and also understanding the psychology of markets to the best of my ability.

STEPHEN CLAPHAM: You spent some time at McKinsey, I think. What was that like? And did that help?

JENNIFER WALLACE: So I went to McKinsey very specifically to sort of broaden my scope and perspective. Having been an investment banker, I knew kind of. The experience of processing deals. Having been in business school, I knew the experience of sort of academically learning about investing. But what I felt I lacked was a perspective inside companies.

JENNIFER WALLACE: Because when I invest, I’m thinking about buying a share is really buying a piece of an operating business. So I think you, you know. There are plenty of ways to invest, but that’s the way I invest. And so having not had the inside exposure, I felt that was a piece that was missing.

JENNIFER WALLACE: So I spent from 94 to 98 in a consumer health care media group at McKinsey serving clients, you know, from pharmaceutical companies to HMOs to cable companies to retailers and was able to get. Kind of an inside view of how companies really work. And I think that has been additive to my investment approach.

JENNIFER WALLACE: I was fortunate to have the opportunity to kind of off-ramp out of McKinsey and into a buy-side role. I was hired by a man by the name of Bob Bruce, who was a very under-the-radar value investor. He called me at the suggestion of Professor Greenwald. Said, if you want to learn how to buy high quality companies at a discount, come work for me, which is a pretty compelling thing to say.

JENNIFER WALLACE: But what made him his offer particularly compelling is that he had worked for many years with Warren Buffett. He was the chief investment officer at Fireman’s Fund when Warren and Jack Byrne and a few other people got involved. So he, I joke, the red phone to Warren for many years. So that made his offer.

JENNIFER WALLACE: Substantive.

JENNIFER WALLACE: And so he was managing money for a family office, Bob Bass, out of Texas. And I got to go work for him. And it was sort of an old school apprentice style relationship. I sat at his elbow. We shared an office all day, every day.

JENNIFER WALLACE: And my first day on the job, he put me in a conference room with a glass door and he said, don’t come out. He left me with a pile of value lines and said, don’t come out until you have something interesting to talk about.

JENNIFER WALLACE: And he didn’t mean like, you know, with the best next next best investment idea. But what he did want me to do was learn how to let the numbers tell a story. The numbers will tell you if a business is interesting, if a business is good, and if the management team does smart things with the cash that they generate.

JENNIFER WALLACE: And so I have become quite addicted to value lines. I still use them today.

STEPHEN CLAPHAM: You still use it? They still print it? I didn’t even know it was still around.

JENNIFER WALLACE: It is. It’s online now and you have to print a PDF. They don’t send you the books, but I save all my old, you know, on the thin little newspaper kind of print. But, you know, I think it’s a great snapshot of a company and you could cover up the entire…

JENNIFER WALLACE: Make commentary and just look at the numbers and you will know the questions to ask and you will begin to start, you know, be able to make conclusions about the quality of the business and the management team.

STEPHEN CLAPHAM: Why do you think that’s not sort of standard? Because, you know, if you asked somebody outside investing and they would say, well, obviously that’s what you would do, but it doesn’t seem to be that common. You know, I mean, the people that I have in this podcast tend to be of that sort of genre. But I know lots of people who invest without paying much regard to the numbers.

JENNIFER WALLACE: I would find it very difficult to give capital to somebody who invests without regard to the numbers, A. And B, I don’t know what kind of investing that is, because all investing should be, quote, Value Investing. Value Investing is nothing more than the idea that you figure out what something is worth and you wait for an opportunity. To buy it for less.

JENNIFER WALLACE: And you hopefully have a margin. That’s your margin of safety in case you’re wrong about what it’s worth, recognizing that the future is uncertain and any kind of future projections will not necessarily be 100 percent accurate because nobody has a crystal ball. And so if you invest without regard for the numbers, I’m not really I’m sort of speechless. I don’t even know what to say about. That. Well, I mean.

STEPHEN CLAPHAM: I’m saying without regard to numbers. I mean, I don’t think people actually do that. I don’t think people place enough.

STEPHEN CLAPHAM: Emphasis on the numbers and i i noticed that quite quite a lot you know when i go around you know i do these this forensic accounting training and i go into clients i’ll usually go into a group of seven ten people and the different analysts well you know there will always be somebody who’s a bit of a numbers geek but there will always be others that are much less focused on the numbers obviously So it’s not surprising.

STEPHEN CLAPHAM: But. I was going to ask you, you’re not what people think of when they think of Value Investing. You’re more of a quality investor. Let’s talk about your investment style and how you derive that.

JENNIFER WALLACE: I would actually say we’re deep value. We’re long biased. And at times we hold significant amounts of cash. We’re focused on public equities of generally global businesses. And at the end of the day, we come to work every day with one objective, which is to compound our partner’s capital safely.

JENNIFER WALLACE: And we do that by buying common stocks of what we believe are uncommonly good companies. So that’s where you get your idea that we’re very quality focused. But we are only interested in buying those companies when we can find them at bargain prices. So, you know, there’s GARP, there’s whatever. I would say we’re VARC, which is value at reasonable, even high, if we can find it quality.

JENNIFER WALLACE: But at the end of the day, I… I would argue that investing boils down to two questions. How good is something on one hand and how much do I have to pay to get a piece of it on the other? And in my experience, successful investing happens sort of in this effective tradeoff between quality and value.

JENNIFER WALLACE: But we are looking for major price dislocations. We’re looking, honestly, at stocks that have something wrong with them typically because they just don’t get cheap enough for us to be interested unless there is something wrong. Real or perceived. And so because of this, we avoid leverage.

JENNIFER WALLACE: Both our portfolio is an unlevered portfolio and the companies we invest in generally have low to no debt because the situations that attract us typically occur, as I said, when the company or even its industry or the economy broadly is facing headwinds and uncertainty. And it’s in those situations like now.

STEPHEN CLAPHAM: Yeah. I was going to say, so you’re enjoying yourself now then.

JENNIFER WALLACE: A little bit. So this is sort of the strength, though, of a company’s balance sheet is what we call kind of a runway for recovery. And that is what allows a company to invest incremental capital at high rates of return.

JENNIFER WALLACE: And at the end of the day, helps to separate truly attractive investment opportunities from stocks that might be cheap on a pure multiple basis, but deservedly so.

JENNIFER WALLACE: So I would argue that this sort of element of balance sheet strength is a very important aspect of quality in our portfolio, as is the fact that we’re looking for management teams whose incentives are aligned with shareholders and who’ve demonstrated that they’re good allocators of capital.

JENNIFER WALLACE: Because at the end of the day, if you’re looking at an unlevered company, maybe even one that has excess cash, you want to be certain that they’re going to use that cash well. Because from a mathematical standpoint, you’re sort of counting it as your own in a valuation sense.

JENNIFER WALLACE: So what I would say is we’re combining a very strict discipline about value and quality with a basically unconstrained mandate around industries and cap sizes. We’re benchmark agnostic. You know, we’re fairly concentrated, 25 to 30 stocks most of the time.

JENNIFER WALLACE: And then we don’t invest in certain areas of the market, including most financials, utilities, REITs, just because the leveraged nature of those business models don’t really meet our quality requirements.

STEPHEN CLAPHAM: But what happens if you’ve got the opportunity to buy a not very highly levered REIT at a massive discounted assets? Would you not be tempted by something like that?

JENNIFER WALLACE: I’ve never seen that. Reits use quite a lot of leverage in the basic. Business model and then they pay it all out. That’s not something that I’ve ever seen. Surely, if I saw something like that, I would look at it, but I’ve never seen that.

STEPHEN CLAPHAM: Financially, so you wouldn’t buy an asset manager or is that just banks and insurance?

JENNIFER WALLACE: It’s really banks and insurance companies. It’s companies that have leverage as their basic business model, right? We take in assets and then we make loans or we invest. I think particularly on the investment side of both financials and even insurance companies, it’s very hard to know from the outside what they own and how safe it really is.

JENNIFER WALLACE: I also, as we know and have seen, there is a duration mismatch in many cases between what they hold and what they, you know, their assets and their liabilities. And so, you know, I just think particularly banks have been poorly regulated and poorly run in many, you know, we find it out in many cycles.

STEPHEN CLAPHAM: No, absolutely. I mean, they. Well, the problem with these things is they’re black boxes, aren’t they? So you can do all the research you want, but you never really understand what’s going on. And the chances are…

JENNIFER WALLACE: Agreed. And even they don’t really know. I mean, as we saw in the financial crisis, there were a lot of companies that thought they had AAA investments and they were, you know, not.

STEPHEN CLAPHAM: And you’re prepared to hold cash. Why do you want to do that? Because, I mean, most of your…

STEPHEN CLAPHAM: Buyers, they’re paying you to invest their money. It means you’re making explicitly or implicitly a market call. Why do you feel comfortable doing that? I mean, do you think it’s helped your performance or hindered your performance?

JENNIFER WALLACE: If you simply took our performance and grossed it up for cash, you could make the argument that holding cash has been a drag.

JENNIFER WALLACE: But, by the same token…

JENNIFER WALLACE: We don’t hold cash with an explicit call on the market. We hold cash in the absence of an investment. I do believe in general in equally weighted positions in a portfolio.

JENNIFER WALLACE: And what we have found is that cash tends to accrue in the portfolio as markets go up or as, you know, I’ll say we had something like. 17% cash leading into Brexit. Now, who in the heck could have known that Brexit would end up the way it did?

JENNIFER WALLACE: And in fact, that morning I had planned to take the day off, but all of a sudden Brexit happened and came to the office and we were able to add to positions and buy new positions with cash. Why do we have so much cash? We had cash because two stocks in the portfolio just earlier had reached our estimate of value and one had been acquired.

JENNIFER WALLACE: So we had, you know, a lot of cash, more than average, and we were able to put it to work. And I would say that having that dry powder is a helpful and has been a helpful component of our performance. And I do believe that you should be disciplined. You shouldn’t just invest because you have it.

JENNIFER WALLACE: You know, cash, I don’t believe you should have cash burning a hole in your pocket. That said, we do have some clients who are, you know, particularly like university endowments, and they have cash in their central portfolio. So they don’t need us to hold as much cash, or in fact, don’t want us to hold as much cash.

JENNIFER WALLACE: And what we do for a client like that is that we’ll have slightly larger positions. They hold the same stocks that the fund would hold, but they’ll have slightly larger positions. And as a result, we’ll have slightly, you know. Probably 50% to 60% the amount of cash.

STEPHEN CLAPHAM: I mean, what’s the most amount of cash you’ve ever had? And what do you have now?

JENNIFER WALLACE: Well, we’ve been putting it to work. We’re down to about 7% cash now, I believe. And we’ve had as much as 30.

JENNIFER WALLACE: Very rarely. We’ve averaged about 12 over the last couple of years.

STEPHEN CLAPHAM: So that must mean you’re more positive today than you’ve been.

JENNIFER WALLACE: You know, it’s funny. If you think about… The things that we buy as humans. And you think about stocks. Stocks are like the only thing we like better when they get more expensive. If you found a pair of great looking expensive loafers in your favorite store that were $700 and then you went by one day and your size and your color happened to be on sale for 50 off.

JENNIFER WALLACE: You’d jump at the opportunity. However, if you have a great stock of a fundamentally great cash-generating business with an excellent management team, and one day you wake up and that stock is down 50% and your investment thesis is intact, people get panicked and they want to sell.

JENNIFER WALLACE: So stocks are the only thing that I’m aware of that people like better and are more inclined to buy. After they have gone up and conversely, like less and are more worried, frightened when they’ve gone down. What I will say is we have added to existing positions and we are looking very carefully at some new positions, adding a couple of new investments. And, you know, a market downdraft is good for us.

STEPHEN CLAPHAM: I’ve been rather aggravated by the amount of emails in my inbox saying, buy the dip. I mean, it seems to be a very fashionable policy, and it’s particularly in the United States. And obviously the uncertainties. You know, look, you know, the market’s down. I don’t know where…

STEPHEN CLAPHAM: Recording this on the 16th of April, the market’s down 10, 12% from the peak. And you could argue, I mean, it’s obviously a very bifurcated market and there’s lots of cheap stocks and lots of expensive stocks. So I think it’s very hard to draw general conclusions. But I would find it very difficult to go in and buy a Costco on 50 times or a Walmart on 35 times just because they’re 10% or 15% off their…

STEPHEN CLAPHAM: High because it seemed to me their highs are very high or in converses i mean there’s some cheap things but i’m just curious if you’ve got any sort of general perspective on what’s happened recently because this is the first recording i’ve done since the ill-named liberation day and i i i’ve frankly i’ve read some absolute nonsense being being written.

STEPHEN CLAPHAM: And I think people kind of aren’t working out that there’s an economic implication of all this. And there’s a significant implication for corporate earnings. I mean, what’s your take on it all? And what sort of things have you been looking at?

JENNIFER WALLACE: So I would step back for a minute and say, you know, there’s sort of like two concepts, buy the dip. What dip are we talking about? Right. Are we talking about the market? You buy the market in total. Are we talking about buying the high flyers, the Mag 7S, the Costcos, whatever?

JENNIFER WALLACE: It’s hard to argue that these stocks have been anything other than safe havens in times of volatility until just recently. Things work until they don’t work. But in my experience, buying a stock at 40 or 50 times earnings is not a great recipe for compounding capital safely. And if you think about it, you’re…

JENNIFER WALLACE: Buying something at, let’s say, a 40 times multiple of today’s earnings, that’s 40 years of earnings that you’re giving to the person you’re buying the stock from and that you’re going to have to wait before anything comes to you in just pure, what am I really doing here? So in order to justify that, you’ve got to assume.

JENNIFER WALLACE: One of two things or actually both. One is continued market dominance of that company. And if you look over the history of time, 40-year dominance is rare, certainly not a given.

JENNIFER WALLACE: You can look back at the nifty 50, less than I think 40% of them are still even in the S&P 500. If you look at the top 10 stocks at the internet, at the peak of the internet bubble, I think only one is still a top stock today.

JENNIFER WALLACE: You know, the assumption of perpetual market dominance, I do not think is a good one in most cases. So stepping back, I’d say like buying the dip, buying the market, not something I would argue for. But in a dip and in a broad-based market sell-off, especially if there is this sort of panic, if this…

JENNIFER WALLACE: Carting of things because people are nervous, you can find baby with the bathwater opportunities where the baby is tossed out with the whole bathwater. And there are great opportunities. There are companies that, you know, sort of smaller and mid-cap companies, not the Mag7, U. S. Companies, companies that will benefit from the onshoring of, or even if you just look at sort of global supply chain redundancy.

JENNIFER WALLACE: Across the world. That, as you point out, will be potentially challenging from a company’s margin standpoint. But from a national safety standpoint or security standpoint, you certainly can’t have the optimized single source supply chains that we had prior to 2020. So it’s interesting, but there are plenty of companies that we believe regardless of tariffs or even after tariffs, already have a lot of negativity now priced in.

JENNIFER WALLACE: Names that we have been looking at for a very long time that were just not quite cheap enough for us that have now gotten a lot cheaper.

JENNIFER WALLACE: And their business fundamentals have not gotten worse.

STEPHEN CLAPHAM: And at the year end, you said your portfolio has an average return on equity of 30%, mainly net cash, almost all paying a dividend, three quarters having recently done buybacks, and conclude that this combination of Value, quality and shareholder return is an excellent recipe for capital appreciation. Is that kind of the ideal combination that you look for? Is that the kind of the setup?

JENNIFER WALLACE: Absolutely. Yes.

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STEPHEN CLAPHAM: You’ve been around in the markets for quite a while. And not that you look like you’ve been around the market for a while. Oh, thank you. I know that you have. And I just wanted to ask you, I think it’s very interesting, the change in market structure, because it’s quite a different market from the market that we started in, right?

STEPHEN CLAPHAM: And I just wondered if, you know, David Einhorn. So I was talking about, you know, he used to buy the stocks that and wait for capital and fidelity to discover them. And then they would go up. And he said, no, you know, there’s nobody, nobody there. Capital or fidelity buying these stocks. If they’re there, they don’t have the same amount of money. And he gave up on that sort of traditional model. How do you how do you sort of look at it? You’re in a similar you’re doing a similar sort of thing. You’re trying to find these. All overlooked assets and they do need to be discovered for you to get the re-rating, right? How do you think about that?

JENNIFER WALLACE: Yeah, first of all, I think David Einhorn is 100% correct. I’ve read his analysis and perspective and I agree with it. I’ve also spoken to some of the same people that he talks to to inform my own perspective.

JENNIFER WALLACE: I would say in the tech bubble was the first time I became aware that It wasn’t just fundamentals and re-rating and sentiment that drove stock prices, but it was also supply and demand and asset flows.

JENNIFER WALLACE: Then it was sort of all the money going into the tech mutual funds. And you could see them come into the market every day at around 10 o’clock in the morning and start buying more of what they already owned. And then since the financial crisis, we’ve seen a market growth. In passive investing and index investing.

JENNIFER WALLACE: And that has created a set of supply and demand characteristics that has fundamentally changed market structure. If all the capital is flowing to passive investors and it’s coming out of active managers who presumably have undervalued stocks that they have to sell, making them more undervalued so that more cash can flow to passive, you can kind of get yourself into a rabbit hole of despair, thinking, what now can I do?

JENNIFER WALLACE: How can I ever make money? And my capital will also eventually flee. To passive. Knock on wood. We hope that is not the case. But what we have concluded, quite similar to what David has concluded, is that you cannot simply invest with the expectation of a re-rating because of capital coming behind you.

JENNIFER WALLACE: That is not the investment game, if you want to call it that, anymore. I used to sort of worry as I noticed this sort of risk on, risk off. And as I thought about this growth of passive, I honestly never expected it to get to the magnitude that it is today.

JENNIFER WALLACE: But I would think to myself, you know, when a tree falls in the forest and nobody hears it, did it really make a sound? Well, you could take the same thing and apply it to our portfolio.

JENNIFER WALLACE: You know, Jenny has found a great cheap stock, but there’s nobody else left to buy it. So how will Summit Street investors ever earn a return, ever get paid.

JENNIFER WALLACE: And I also used to think, well, so in a decade of, now it’s been a decade and a half of Value Investing, kind of underperforming so many other approaches, particularly, you know, mega cap growth, how has Summit Street done so well in that environment being a deep value investor? And again, the conclusion is that we focus on something ever so slightly different, and we are not solely waiting for a re-rating.

JENNIFER WALLACE: We are interested in companies that are cheap relative to the cash that they will generate. And when we’re right, they generate excess cash and do wise things and shareholder-friendly things with that cash.

JENNIFER WALLACE: So our companies tend to kind of be their own catalyst, right? They generate so much cash, they pay it to us in dividends, they shrink their share count, or they make strategic acquisitions that accrue to the benefit of shareholders.

JENNIFER WALLACE: In those cases, cash is its own catalyst and the company becomes its own catalyst. We are not waiting for, or, you know, the company becomes… An unlevered mid-cap company with cash-generating potential is a very appealing acquisition target for a financial buyer or a strategic buyer. Something like 25% of the stocks we’ve owned since inception are no longer publicly traded because they’ve been acquired.

JENNIFER WALLACE: So there are lots of ways that cash can be a catalyst, but it is important and has been a major contributor to our long-term returns. Because… We focus on price to cash flow as our primary valuation metric. And when we’re right about the cash flow we expect a company to earn, the cash becomes its own catalyst and the company’s cheapness becomes impossible to ignore.

STEPHEN CLAPHAM: There are two questions that arise from that. One is, you know, are there common characteristics to the companies that got taken out, that got acquired? Another is, I suppose that if… If that’s kind of the focus, then you’re unusually dependent on investing in good management. So I want to talk to you about the management in a minute. But have there been any common threads to the companies that have been acquired? Nope.

JENNIFER WALLACE: Across the board, no.

STEPHEN CLAPHAM: Because Mario Gabelli, he likes to buy things that will get taken over, right?

JENNIFER WALLACE: Yeah, I mean, he’s talking about that private market value. And I think that’s a great way to think about it. But No, I mean, the common thread is that they are bite size. The company, you know, they’re not so large. Right. We’ve owned Apple and Microsoft back in the day when they were cheap.

JENNIFER WALLACE: Neither of them have has been acquired. But mid size companies. So I would say the common thread is that they’re bite size. They generate excess cash and they tend to be unlevered and have excess cash. But the appeal has been from financial buyers and strategic… Buyers alike over the years.

STEPHEN CLAPHAM: Interesting. And then on management, so if you’re buying companies that have got a lot of cash and are generating lots of cash, you’re Reliant on them doing sensible things with that. How do you, do you always meet the management before you invest? And how do you judge them? You’re a psychology major, so you’re probably quite good at that, right?

JENNIFER WALLACE: There’s a couple of thoughts I have. You know, look, I’ve been in this business so long, when I first started, regulation FD wasn’t even a thing. So you could actually go visit management teams and glean information legally that was not known broadly and that was valuable as an investor.

JENNIFER WALLACE: With Regulation FD, I’ve noticed a pretty big shift in the sense that management teams have become more charismatic, more likable. I’ve never met a CEO that didn’t think that their stock was undervalued. And, you know, part of being a CEO and part of being a head of IR is now being convincing about that concept. So it’s interesting over time that actually management teams have…

JENNIFER WALLACE: Meetings have become probably less valuable. What’s more valuable and what I have always focused on is what they do with the cash. And you can look at that over years. You can say the company generated this, they did this. They’ve made these seven terrible acquisitions or they’ve made two great acquisitions. They did a massive share shrink, special dividends. So you, you know, I don’t think. It’s as important to listen to what they say as it is to look at what they’ve done.

JENNIFER WALLACE: And if there’s a big break between what they say and what they’ve done, sometimes that’s a big red flag. And then every now and again, they’ll do something totally that surprises us. And we will revisit our thesis.

STEPHEN CLAPHAM: Will you sell the stock if they do something you don’t like?

JENNIFER WALLACE: Yes, 100%. People sometimes ask us if we are activists. I said, no, we don’t have to waste our time. That is not our job to tell a management team. First of all, it’s an uphill battle and you have to be willing to fight. But we’re not interested in telling a management team to run themselves differently. We vote with our feet. We move on. And there’s plenty of other things we can do with our capital. That’s interesting.

STEPHEN CLAPHAM: And do you just not bother meeting management when you think they’re just too…

JENNIFER WALLACE: I mean, listen, before we invest, we’re doing a lot of fundamental research, right? We’re looking at all of the financial statements and understanding how those flows of cash have gone. We read everything they write, their shareholder letter. I like to see a management team that says, these are our objectives.

JENNIFER WALLACE: This is what went well this year. This is what we’ve got to work on. And the next year, they said, you know, our objectives, we’ve, you know, worked on these things that we mentioned last year. What I don’t like is a management team that every year has a new set of objectives or never revisits what went wrong the year before.

JENNIFER WALLACE: You know, there’s you get all kinds. So we read every we listen to every conference call. We listen to every presentation. We read everything they write. And we typically either meet them in person or do calls with them before we would invest. So it’s very important to us. But I also am, you know, I have my…

JENNIFER WALLACE: You know, kind of antenna up. Because as I said, part of a CEO or an IR person’s job is to make the investment community like them, believe in them, value the company.

JENNIFER WALLACE: So, you know, this is not a business where you should, in my opinion, look to befriend a management team or have them think particularly specially of you. If you want a friend, get a dog. This is not the business for someone who’s desperate for friendship or approval.

JENNIFER WALLACE: This is a business for someone who can maintain sort of a cold and distant analytical view of a management team. And that’s important because as humans, we all like to be liked. We like to have positive interactions with people. We always try to have that, but we are also willing to ask the tough questions.

STEPHEN CLAPHAM: But you, I mean, you hold stocks for quite a long time, don’t you?

JENNIFER WALLACE: You know, it depends. If you look back in like 2009, 10, 11, 12, our turnover was higher. I would say since 2017, our turnover has been far lower. You know, there’s sort of two situations. And as we just discussed, the market was different then. There was a more active management community. And you Or, you know, I would say 15 years ago, you were more likely to see capital come behind a re-rating happen and you could move on.

JENNIFER WALLACE: And so there were, you know, that there was that was, I would say. A bigger component of our returns. And as that has declined in terms of just market structure, we have seen that it’s more that a company compounds in value and the price goes up. But as long as the company is still growing in value and we still have a large enough margin of safety we are willing to hold.

JENNIFER WALLACE: And that’s… You know, kind of the reasoning behind our longer hold periods now. I would say it’s just as much market structure as anything else. It’s not a kind of coming in and saying we’re going to own this for 10 years or we’re going to own this for five years.

JENNIFER WALLACE: That said, nothing really gets fixed quickly, right? If you’re buying something that’s got an issue or a company that’s got headwinds, it takes, you know, 12 to 24 months at a minimum, typically, for them to get there. Act together.

STEPHEN CLAPHAM: Do you not find that you get sort of drawn to people, you know, the longer you own the stock?

JENNIFER WALLACE: So I think human nature is maybe that you would. And I can’t say, you know, that we wouldn’t fall prey to the same issue. We do believe in a broadly defined equal weighted portfolio. So what that means is. It’s sort of a guardrail against what you’re talking about, which is human nature. As a stock dips, we revisit our thesis and we are more likely to buy more of it.

JENNIFER WALLACE: As a stock appreciates, we revisit our thesis. We try to understand how big that margin of safety is. And if the margin of safety is smaller, we will trim it. So that helps us, you know, to be more agnostic to the people and more analytical about the value.

STEPHEN CLAPHAM: But you, I mean, you wouldn’t really be equally weighted in that. You still have different weightings in the different positions, but they’ll all be different discounts to your estimates of volume, presumably.

JENNIFER WALLACE: Yeah, look, I mean, I think if a stock is worthy of you buying it, you should buy a full position. Yeah. And a full position for us is like 3.3 to 3.5%. In some of the accounts, it’s like a 3.7% position. And then we begin to trim at around four and a half or 5%. Percent. Back down.

JENNIFER WALLACE: And then depending if it’s, we still love the name, we’re willing to hold it at a full position size and continue to hold it at a full position size. If we think that the company is still done well, but maybe the stock price has gotten ahead of itself, we might trim it to a slightly smaller size.

STEPHEN CLAPHAM: But you would never own a position with 7% or something like that.

JENNIFER WALLACE: I’m not a 10% position kind of person. That is not what you invest in Summit Street expecting to get.

STEPHEN CLAPHAM: And that’s from a risk point of view, a risk management point of view?

JENNIFER WALLACE: It’s from a portfolio management point of view. I think when you invest in Summit Street, you’re expecting to get 30 equally weighted, 25 to 30 equally weighted stocks, roughly speaking. I’ve seen enough of my peers focus on like their three best ideas.

JENNIFER WALLACE: If you knew what your three best ideas and you had a crystal ball, yeah, have at it. I don’t believe there is a crystal ball. I don’t believe our investment approach requires a crystal ball. And I think people, when you ask the questions about do you get attached to management or do you grow overconfident because you, you know, it’s your best idea.

JENNIFER WALLACE: I think it’s in those type of portfolio structures that that is more likely to happen. I’ve seen enough, you know, out of left field problems that can hit a company in my. Tenure that I just, I don’t believe that’s necessarily the safest way to compound capital.

STEPHEN CLAPHAM: No, sure. I mean, I remember when I first started in the buy side and I was asking somebody about, you know, how many positions was the right number and we were having the discussion and, you know, they said something like, well, you know, every year three stocks make us all money if we only knew which three Now, look, you’re a woman running a fund and you’re in the minority, really. Maybe less so in the United States than in Europe.

STEPHEN CLAPHAM: But there aren’t as many women running funds there probably should be, are there? I mean, women tend to be better investors than men, I think. Are you optimistic you’ll see more women come into the industry?

JENNIFER WALLACE: I’m not really focused on gender. As a thing. I mean, I do think there should be opportunities for women. Women shouldn’t be shut out because they’re women.

JENNIFER WALLACE: I’m not sure I really buy the analysis that says women are better investors. I sort of think that. The women who are in this business at my age or they’ve, you know, are similar to my age, they’ve kind of jumped through a lot of hoops in a period of time that finance was very, very male dominated.

JENNIFER WALLACE: Maybe they’ve had to jump through more hoops. Maybe the funnel’s been a little tighter. And that’s probably what drives the outcome of that analysis. That being said, I don’t believe anybody should be shut out of an industry based on their gender.

JENNIFER WALLACE: And so part of the reason I do things like this podcast is to show, you know, in case some young woman is out there thinking, you know, can I can I have a career, you know, seeing other women I had, you know, who’ve kind of been doing this for a long time is probably useful.

JENNIFER WALLACE: But I’m a big believer that there’s an approach. There’s a mindset. You either get it or you don’t. And maybe it’s connected to gender. I I can’t say I’ve read any research that convinced me of that.

STEPHEN CLAPHAM: Yeah, well, I don’t know if there’s any evidence. I mean, it would be quite hard to get that.

JENNIFER WALLACE: Well, it’s dead. I’m not sure where it comes from.

STEPHEN CLAPHAM: Well, I don’t know. I mean, it’s a feeling I have that, you know, I just find when I talk to women investors, they’re more calm. They’re more, they seem to be, they often seem to be more rational, less emotional. And, you know, I’ve… If I had the choice between two people that had identical performance and similar portfolios, and one was a man, one was a woman, I would probably give it to the woman.

STEPHEN CLAPHAM: I mean, I don’t have any analysis to back up my feeling, but it’s just an experience and a feeling. But I do get a bit frustrated because I’ve got an online school, and this podcast is far more. Has far more male listeners than female. I’ve got very few students at my school. And I think, well, why is that? And, you know, so, you know, I think it’s good to have women guests because that, you know, that encourages everything.

JENNIFER WALLACE: I would agree.

STEPHEN CLAPHAM: Even the best volume investors underperform one year in three. Is that fair?

JENNIFER WALLACE: Yes. I probably 15 years ago did some analysis on, I took the investors that, Uh… Warren Buffett had identified in his paper called The Super Investors Of Graham And Doddsville. And I got their performance track record over time for each of them and compared it to the S&P. And pretty consistently, the value managers underperformed the S&P about 30% of the time. And over time, the S&P… Earned something like 9% and value investors earned something like 18%.

JENNIFER WALLACE: As I sort of said about the crystal ball, I don’t think anyone can invest well with the expectation that they can see the future. But if you can invest consistently with a disciplined approach in stocks that are worth less than you buy them for, over time, the market is a weighing machine. And in the short term, as Warren Buffett says, the market is a voting machine.

JENNIFER WALLACE: So if you can take advantage of short term, you know, kind of fall from grace and disfavor and buy companies that over time become more valuable, over time you will earn a lot more money. And if you invest with a big enough margin of safety, when you’re wrong, you won’t lose that much money. So when you think about being an investor.

JENNIFER WALLACE: From a probabilistic standpoint, assuming that none of us have a crystal ball, what you want is a high hit rate and a long tail, you know, and a positive skew. So you want a high hit rate. So your winners, you have more winners than losers and you want a positive skew. So you earn more on your winners than you lose on your losers. If you can consistently do that, you will be able to compound capital safely for your partners.

STEPHEN CLAPHAM: And what you’ve done, an amazing rate. You’re up. Eight times since you started, something like that. But you didn’t have a good year last year. What did people say to you? And how do you answer their fears? Because it’s really difficult for clients, isn’t it, to trust you?

JENNIFER WALLACE: So it’s hard. And I do think it’s really important to have a great client base that knows you well and knows what you do.

JENNIFER WALLACE: Your partner should never be surprised by any move you make or by anything you say. And if you’ve done a good job, sort of narrowing down and selecting your partners. And if they’ve done a good job making sure, you know, Summit Street’s not for everybody, but if we’re for you and you’ve done a good job understanding us, even a year like last year won’t be an issue.

JENNIFER WALLACE: So what I could say about last year is we, you know, the good news is we compounded capital and we preserved capital. The bad news is the market did better. So I don’t think that… Compounding capital at 13% a year since inception is a record to apologize for. And last year, you know, look, 2022, the market was down, you know, mid-double digits. We were down mid-single digits, low single digits. So we have protected capital.

JENNIFER WALLACE: Then, you know, in 23.

JENNIFER WALLACE: We were up pretty close to the market. And in 24, I would say we had a great year until July. And then July, everybody became concerned about China.

JENNIFER WALLACE: A lot of our names came in. Thankfully, we had trimmed a bunch and were able to buy at higher prices and we were able to buy more. We were able to put some money to work.

JENNIFER WALLACE: And December was a bizarre month. I mean, if you tell me that… There was a huge fund liquidating, I’d believe it. I really… You know, Mag7 went straight up and even financials did pretty well, neither of which are in our portfolio. So it’s not surprising that we didn’t keep up.

JENNIFER WALLACE: But then you look at a year like this year, and we’re down a whole lot less than the market. So a partner of ours needs to be special, needs to be able to have a long enough investment horizon and mindset. That they don’t get too bothered when markets are going straight up and trading at 45 times earnings and we’re not keeping up.

JENNIFER WALLACE: Because it’s only with that long term investment horizon that you can then benefit when, you know, kind of idiosyncratic stocks recover or when these crazy multiples become compressed and our stocks can continue to accrue.

STEPHEN CLAPHAM: Your last letter said, we believe our best times are ahead of us. Why did you write that?

JENNIFER WALLACE: Natural optimist. Trust but verify.

JENNIFER WALLACE: On average, the market goes up and we’re long biased, long only, right? So on average, we will be up.

JENNIFER WALLACE: And I believe there will continue to be idiosyncratic investment opportunities that are cheap and high quality and will generate attractive returns. So I am a big believer in that. I sort of look forward and think the United States is a great place to do business, a great place to invest.

JENNIFER WALLACE: I do think we’re going to have some interesting times between tariffs and regulation and all kinds of things. And as we talked earlier, the future is unknowable, but the stocks in our portfolio and the names we’re looking at are genuinely attractive companies.

JENNIFER WALLACE: High returns on invested capital, excellent balance sheet and cash flow characteristics, trading at less than 10 times earnings, or 10 times, I apologize, 10 times cash flow.

STEPHEN CLAPHAM: I was very taken with the stocks that you presented at the New York conference, and they were very unusual and very distinctive. And you’ve obviously got a knack of finding these sort of overlooked areas, which I’m curious about, but it’s all down to the numbers.

STEPHEN CLAPHAM: So I, you know, I, I’m just not exactly what you’re saying. We normally ask people to recommend a book to a young person thinking of coming into the industry. So what would you, is there a book you would recommend to a young woman thinking about becoming an asset manager?

JENNIFER WALLACE: A couple actually that I think are very valuable. First, I would say many young people do not have an appreciation for market history and understanding market history as opposed to the last 20 or 40 years.

JENNIFER WALLACE: It’s very important. So there are books like Only Yesterday. Or Reminiscence of a Stock Operator, both of which are old and worth reading. A book that was very formative for me was Margin of Safety by Seth Klarman, but that’s a tough book to get your hands on.

JENNIFER WALLACE: And then a book by Bruce Greenwald called Value Investing from Graham to Buffett and Beyond, if you believe that you’d like to learn more about. The practical approach to Value Investing.

STEPHEN CLAPHAM: Jen, where can people find you?

JENNIFER WALLACE: So we have offices in New York and Florida. We have a website, www.ssvfunds.com.

JENNIFER WALLACE: And any information that you’d like about Summit Street, you can typically get from the website, including our contact phone numbers and address.

STEPHEN CLAPHAM: Okay. Well, we’ll link to that in the show notes. Jen, thank you so much for coming on. It was a pleasure talking to you.

JENNIFER WALLACE: This was fun. Thanks for having me.

STEPHEN CLAPHAM: Well, we didn’t even get on to passive investing, where Jen has strong views. But I loved her old-fashioned approach. Find good companies which are cash-generative and sensibly managed. Don’t get close to management. Focus on the numbers. Get out if things don’t go to plan. And manage the portfolio according to the margin of safety.

STEPHEN CLAPHAM: I’m looking forward to seeing her again in Omaha, where she will be moderating the panel at the Columbia dinner on the Friday night, along with two other former guests. Mario Gabelli and Beth Lilly. Let me know if you have questions for them by filling out the form on our website BehindTheBalanceSheet. Com. Thanks, as ever, for your support.