(1/n) Have been seeing quite a few of these types of questions recently: what stocks would you never sell?

To me, that begs the question: what would you need to see to make you confident that you wouldn’t need to sell a stock for a decade or two?

If you bring it back to first principles, you need a strong probability that the company will continually surpass expectations (not necessarily linearly) over a long period

What are some of the things that cause companies to continually surpass expectations?

Expectations might be ‘very low’ or ‘very high’ in absolute. But if they’re surpassed the stock outperforms.

Very low expectations usually occur with low quality companies. If expectations are surpassed, typically doesn’t happen for long (as destroy value over time, cyclical..)

& thus they don’t outperform for long - although magnitude of perf when they do can sometimes be significant depending on cycle/leverage (offset is hit rate is lower)

So low quality not the best idea. Seems obvious but took me time to really internalize in a disciplined way

If it’s quality, investors typically realize it & increase expectations meaningfully...so how can they continually be surpassed?

What we’re trying to solve for is future value creation vs assumptions. What drives that?

(re)investment x (ROIC-WACC) x competitive advantage period

So the company needs to do at least 1 of the following vs initial expectations:

- reinvest more capital (at attractive returns)
- improve returns on capital
- lower cost of capital
- Earn excess returns for longer

Companies that can do at least 1 of these better than initially expected will create more value than was initially expected & thus outperform.

You should have a view on which ones you’re playing. Also why expectations don’t match up and won’t for some time (for another thread)

That’s theory. How does this show up in practice & what drives it? I’m sure there are many factors and would enjoy hearing everyone’s experience

The most common in my experience are that 1/ there’s an emerging moat, & as it’s not fully established yet it’s not obvious in numbers

and thus isn’t appreciated enough, especially if/as it widens. Leads to more reinvestment opportunities, higher returns etc.

There’s typically debate on these situations, which leads to only gradual move up in expectations as the moat becomes clear...

2/ within an established moat there’s a biz transition or recent products/regions where the growth runway/magnitude/duration is not well understood eg AWS at Amazon, Azure at MSFT, Zyn at Swedish Match currently (typically because analysts cliff growth)...

It might also be that there are revenue streams that don’t yet exist but could be meaningful. There are often continuous revenue streams that 'don't exist yet' at companies that have the right culture & adaptable/creative management. This is the point of Phil Fisher’s question 2

These revenue streams might be new products/services, new regions, new channels, it might be gaining access to a new type of customer or application and thus expanding TAM etc. It might be from acquisitions...

Because they’re not known/obvious yet, these revenue streams aren’t included in analyst models, even if they’re probable. What’s important is that they’re continually replenished...

and so these types of companies continually surpass expectations, and outperform over long periods of time....

examples include Apple (when Steve Jobs rejoined, the iPod, iPhone, iPad etc didn’t exist yet, but became meaningful businesses)

Amazon (category/region expansion, prime, 3rd party seller, AWS, advertising etc),

Netflix (since the early days of streaming, they’ve launched substantially more owned content, and expanded globally in many countries)

Facebook (regional expansion, features/product launches helped take more advertising share from print/analog, they bought Instagram & monetized it, bought WhatsApp a are starting to monetize it etc). Googl is similar with YouTube, Cloud etc. You get the point. There's optionality

Why don’t more investors focus on this? Because these type of stocks aren’t particularly suitable to DCFs (at least initially), and thus are difficult to model, and thus most investors don’t ‘dig in’ the right way. Which is in part why these work so well

Also they often invest via the P&L in intangibles, and shortcuts like P/Es etc often don’t work well with these.

Also because part of this is about people. Continuously hiring the right people/teams at the right time, and those people hiring well etc.

It’s harder to judge people than it is numbers for most investors. But often it’s people that drive future numbers, and it’s future numbers that matter to value

This approach also requires creative/imaginative thinking...not taught in business schools/CFA (nothing against those)

In fact, it seems like those that do well in those areas typically have traits that don’t necessarily correlate with creative thinking, which might be why so many of the most successful investors come from atypical backgrounds...

They’re truly original/outside the box, are not formatted like everyone else, and thus genuinely approach things differently

This also makes them adaptable, which is why they succeed over long periods, and not just in particular cycles...

Another question is: can you identify the aspects of management and culture that predict lasting success? Is it possible beforehand?

I think with a lot of hard work & pragmatism, it is. WCM is a great example that’s done this successfully. What others are people are aware of?

What companies do you think fit this today? I still think FB, Alphabet, Tencent fit. Some of the media companies like Disney and certain video game companies fit. Also think some potential ones include SPOT & TWTR (realize not consensual). Interested to hear some other ones?

This might sound paradoxical, but I think it’s important to look for continuous change/adaptation as part of culture.

To conclude, to me it goes people/culture > emerging moat/continuous new revenue streams/expansion (at attractive economics) > surpassing expectations.

I used to do things the other way around... I made mistakes, have tried to learn from them, and have tried to adapt...

Are there really companies you never sell? Perhaps, but they’re unbelievably rare. Maybe once or twice in a decade finds. The rest of the time, a 10-20 year horizon is already significant, and very hard to do, both from an initial research standpoint and a ‘holding’ standpoint