How Dev Kantesaria Invests in High-Quality Businesses
How to find, invest, and outperform by holding the world's best businesses.
Welcome to issue #002 of Invested Capital. Each week, I share one letter to help you invest smarter, think long-term, and build lasting wealth. My goal? To cut through the noise and bring you timeless lessons from great investors so you can make better decisions with your money and your life. Join 200+ readers learning how to compound capital and wisdom, one issue at a time.
In this week’s issue, I’m sharing my highlights from Dev Kantesaria’s interview with Value Investor Insight (2024).
Invest in businesses with high organic growth & predictability
"Judging business quality is essentially finding the perfect intersection between organic growth and predictability… we want companies with high organic growth rates but doing it in a predictable way.” -Dev Kantesaria
In the stock market, you will find young businesses growing 30-40% per year, but are unpredictable. You will also find mature companies growing at a predictable 3% rate. The sweet spot is to find great businesses that are growing fast, and doing so in a predictable way.
How to find a great business
Industries with strong secular tailwinds
Offer unique and essential products/services (pricing power)
Operating leverage (margins that expand over time)
Management with a prudent capital-allocation strategy
Concentrate your portfolio in 10-12 high-quality names
"We believe holding a concentrated portfolio of high-quality businesses is the best way to outperform the market over the long run.” -Dev Kantesaria
The more stocks you hold, the more difficult it becomes to track.
Many investors hold more than 15 stocks because it gives them “comfort,” but comfort can come with a cost, which is underperformance.
The key is to follow Warren Buffett’s “punch card” approach. If you had only 20 businesses (punches) to invest in your life, you would be very selective on the type of businesses you own and focus only on high-conviction ideas.
The FICO Standard
"FICO scores are the de facto standard and are cheap and ubiquitous, making it difficult for others to compete. Fair Isaac has over 90% dollar-share of the market… A FICO mortgage score that costs $3 today, could easily be $6, $9, $12, or even $15 in the future.” -Dev Kantesaria
Dev initially invested in FICO when he saw the business change its pricing strategy.
Previously relying on volume growth, FICO changed its pricing strategy to a royalty system, earning a higher fixed fee on each FICO Score produced. This gave FICO the ability to improve pricing power and become a toll collector.
What’s important to note is that FICO was a business that Dev has studied for years, but never pulled the trigger. Once he saw this change in pricing strategy, he took the opportunity and acted on it.
This is an example of acting on an idea when you believe there is an improvement of business quality.
Do nothing
"We expect to hold positions for 10-plus years. To us, constant churn is a telltale sign of a poor investment process that prioritizes short-term results.” -Dev Kantesaria
Buying and holding a stock for years is not emotional attachment but rather an assessment of business quality.
Dev could have sold Moody’s many times over when he first invested in it 17 years ago, but that would have been a costly mistake.
With great businesses, change happens slowly.
Keep studying the business. Take action only when you see movements in the rise or fall of business quality.
If you’re constantly trading in and out of positions, that means you don’t have a great investment process.
As Charlie Munger once said, “The big money is not in the buying or selling but in the waiting.”
Why Dev sold Adobe in 2023
"Over the long term, we see a future where Adobe is rendered obsolete except for very high-end use cases.” -Dev Kantesaria
Dev sold his stake in Adobe over 2 concerns he had on Adobe’s market position in photo and video editing
At the low-price end market, Adobe is being attacked by companies like Canva that offer free/low-cost photo/video editing services
The threat of AI and Generative AI to make images and videos keep improving each year
How Dev Kantesaria values businesses
"Great businesses will usually trade at a premium valuation, but if you’re picking long-term compounding machines, market timing your purchases becomes less important.” -Dev Kantesaria
3 Thoughts on valuation
Don’t market time your purchases
What matters most is finding the right business to invest in, not how much you pay for it
Compare a company’s forward FCF yield to the 10-year U.S. Treasury and buy when the FCF yield is better than the risk-free rate
Don’t invest in a business that depends on a rock-star CEO
"We don’t like situations where the success of the company depends on a rock-star CEO. If you need a Howard Schultz operating your business to be successful, it’s probably not predictable enough for us.” -Dev Kantesaria
In the past few years, consumer stocks like Nike and Starbucks have sold off, leading to a change in management. The lesson is that a manager can make a great business, but when there is no “great manager,” poor capital allocation decisions are made.
Despite a positive turnaround opportunity in beloved names, Dev prefers to invest in businesses that don’t require a great CEO to run the business.
You want to have more confidence in a business rather than management.
3 reasons why Dev doesn’t own any of the Magnificent 7
"These companies must go after very large addressable markets for conitnued growth, which means they are increasingly encroaching on each other’s territories and competing for the same customers. New entrants largely compete on price, pressuring the margins of existing players.” -Dev Kantesaria
Price pressure driven by increased competition
Increasing CapEx spend will hurt profits and return on capital going forward
It will be difficult for the Mag 7 to monetize AI, which leads to unpredictability of who the winners will be
4 reasons why Dev just invested in ASML
"We think it’s preferable to own businesses that can significantly benefit from AI without the risk, which is what led us to ASML.” -Dev Kantesaria
ASML’s value prop: lithography machines that perform with fidelity and precision, and with no defects and waste
It’s hard to replicate ASML’s technology: “ASML is 20 years ahead of any competitor.”
New semi supercycle: “Entering a new semiconductor supercycle driven by AI, and we expect ASML to be a direct beneficiary of that.”
ASML is cheap: “This is our cheapest name, trading at close to a 4.5% free-cash-flow yield… we expect free cash flow to increase at a high-teens to low-20% annual rate over the next decade, we consider the valuation and the potential shareholder return today quite compelling.”
S&P Global dominance
"Today 90% of all debt in the world has both a Moody’s and a S&P rating. They are toll collectors making money from the initial rating as well as monitoring fees over the outstanding term of the debt.” -Dev Kantesaria
Hard to replace S&P Global & Moody’s: “Debt ratings is a natural duopoly, which means it’s extremely difficult to displace the two market leaders even if competing products are heavily discounted.”
Recurring revenue: While debt issuance is cyclical, “What matters to us is the amount of debt to be issued and rated over the next ten years, which we believe can grow at a mid-single-digit annual rate.”
Passive investing trend: S&P Global will benefit from the secular trend of passive investing
2 Thoughts on Intuit
"We own Intuit for its two core software assets, QuickBooks… and TurboTax.” -Dev Kantesaria
QuickBooks and TurboTax have high customer retention and switching costs due to the essential services they provide
The company needs to improve its cost structure and capital allocation, which Dev believes is a management issue.
Focus on the facts
"We don’t mind dissenting opinions- that’s what makes a market. We focus on the facts and have our own views of what they mean for our businesses over the long term.” -Dev Kantesaria
If a short report comes out on a business you own, or lots of bears call for the end of the business, focus on the facts rather than their subjective voice.
What’s important is to hear and understand a bear’s argument. You can’t only listen to confirmation bias.
Mastercard: the toll collector of global payments
"Mastercard and Visa sit at the top of the payments food chain as toll collectors on most of the electronic payments that occur throughout the world.” -Dev Kantesaria
Network effect is difficult to compete against
“The business has a tremendous amount of operating leverage.”
On Mastercard’s future: “We think this is a business that can deliver free cash flow per share in the high-teens over the next decade. The stock trades at a high-20s forward earnings multiple, which we view as an attractive business model of this quality, with secular growth, pricing power, operating leverage and consistent share buybacks.”
3 Essential qualities of a great equity investor
"Most investors get distracted by irrelevant issues that don’t affect the long-term health of a business. It’s far more important to focus on the few critical items that really matter.” -Dev Kantesaria
Focus: Focus on the few items that really matter, ignore everything else
Temperament: “It’s critical to remain disciplined and unemotional regardless of market conditions and let the facts drive your decisions.”
Be Frugal: “I also believe that great investors are inclined towards frugality. Being careful with money as a fund manager is no different than being cautious with purchase decisions in your private life.”
Tl;dr
Invest in high-quality businesses that are growing fast in a predictable way
Concentrate on a few great businesses
Market timing is less important
Do nothing, only act when there’s a rise/fall in business quality
Don’t rely on a rock-star CEO
Invest in businesses that can’t be replaced
Toll collectors are amazing businesses
Be focused, frugal, and disciplined
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Thanks for reading
Happy Compounding
Matt Harbaugh
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What a great read thanks a lot!
Good commentary