Robert Luciano of VGI Partners spotted the enormous growth potential of Amazon back in 2013 when it was trading at ~US$250. At the time, there were two trains of thought. The first was the conventional wisdom of the day, the bearish tirades view that the company was an overvalued pit of “profitless prosperity”. The second was for VGI to do the hard work and get to really understand the e-commerce giant, the industry it operates in and take a different approach to valuing it. Luciano opted for the latter.

“You’ve got to recalibrate your thinking and look deeper than prima facie metrics.”

Luciano says that approach to finding companies has not changed through Covid-19. In this interview, he uses Amazon as an example of how he thinks about quality companies and discusses recent changes within VGI’s portfolios.

edited transcript

Has your definition of quality changed?

No, I wouldn't say it's been altered last 12 months. I'd go further back and say, over the last five, six, seven years… what meets our investment criteria changed a while ago.

The classic example is Amazon. When we built our position in Amazon at $260, $270 a share, it was deemed - and it was consensus in the market - that it was profitless prosperity. It had no earnings, it was on stratospheric metrics, people thought it would never make a profit. And you've got to recalibrate your thinking. You've got to look a little deeper than prima facie metrics. You've got to look at what's revenue doing, how has this business been able to consistently grow and fund itself if it's not issuing any equity? It's barely raising any debt. Well therefore, by definition, it's got huge amounts of internal cashflow, which it did have. So that now has become apparent six, seven years later, and the equity (trading at less than a few hundred dollars a share) is trading today at 10 times that amount, 11 times that amount.

That ability to recalibrate your thinking and that ability to look at a business and look at an industry, or the industry that it operates in, and take a slightly different perspective - that can put you in a position where you can extract very substantial outsized returns by having a variant perception. It’s about taking a view on an industry, or a business, and thinking about not where will it be in 12 months’ time, but where will it be in five years’ time, in 10 years’ time. How will this business look in the future? That is something that we've been doing now for a considerable period of time and, if anything, there has been an accelerant to some of the businesses we've had on our watch list as a consequence of this year and what's transpired, and the pull forward that that brings to a variety of sectors, a variety of industries and hence, a variety of businesses.

Have you recalibrated your portfolio more recently?

We've evolved the portfolio quite dramatically, in that we've shifted away from some of the positions we've held for a considerable period of time. A position we've held for over a decade, WD-40, has been a multibagger return for us. It really had got to a point where we saw some upside, but the upside was relatively muted. The fact that you own something for a decade - it’s delivered huge returns - you don't want to get emotionally attached to situations. We had found that holding positions for long periods of time has generated outsized returns, but you also need to sit there and say "What's the optimal return on capital and what's the incremental return on capital from here?"

So we've made a few decisions on situations where we think there's capped upside or the upside is relatively muted. It doesn't mean they're not good businesses, or they're not great businesses, we just feel like we've extracted a lot of excess return out of them. So WD-40 is an example of a position where we've exited. Colgate Palmolive – it’s a very high quality business - but we've exited and extracted what we think is an acceptable return. Linde, which is the old Praxair (Praxair and Linde merged), got to a level where the valuation, we believe, was fully reflected in the share price, in fact, well beyond.

So we've made a couple of transitions in the portfolio and that's really been underpinned by the fact that these businesses have reached full or fair value, or a premium to what we think is fair value. We’ve rotated into situations or positions where we think they are very high quality businesses, they meet our criteria for industry structure and secular growth and we can buy them at what we think are attractive prices.

There were some opportunities that existed a number of months ago. We took advantage of the sell-off in March and April and were able to build a couple of new positions there. One being Otis, which we've spoken about with our investors, which we built in the March, April time period. More recently in June and July, we built a position in Pinterest and we've built a couple of other positions that we would like to add to, so we're not actively talking about them at the moment.

Diversification preserves wealth. Concentration builds wealth

VGI Partners is a high conviction global equity manager, focussing on businesses with secular growth, attractive industry structures and where they believe they possess insights not appreciated by the wider investment industry. For further information, please use the contact form below.