How a billionaire value investor picks winning stocks
Bill Ackman is a well-known value investor.
His fund, Pershing Square, manages around $10 billion.
His investment style is heavily influenced by Warren Buffett, and his performance is nothing to scoff at (despite a difficult stretch from 2015 to 2018):
Source: company report
He has achieved these results by following a simple set of principles.
He invests in companies that:
Are simple and predictable
Generate a lot of free cash
Are dominant and operating in industries with large barriers to entry
Earn high returns on capital
Have limited exposures to extrinsic risks
Have strong balance sheets, so they don’t need access to capital to survive
Have excellent management teams, and
Have good governance (systems, practices and processes directing the firm)
Ackman’s biggest position is Lowe’s Companies.
What type of company is Lowe’s?
It’s the second biggest hardware store in the U.S. - after Home Depot.
By studying Pershing Square's reports we can see Ackman’s rationale for buying Lowe’s, and gain an understanding of how he picks winning stocks.
Why Ackman Likes Lowe's
Ackman first invested in Lowe’s in 2018, and in that year’s report he explained that Lowe’s was a “high-quality business” led by a “high-caliber management team”.
Already we can see parallels to Buffett, who is famous for following the same principles.
Ackman went on to say that Lowe’s appointed a new and experienced CEO, who used to be a senior executive at Home Depot.
Management was now focusing on:
Enhanced merchandising (e.g. better variety of products, better product displays etc.)
Transforming its supply chain
Achieving operational efficiencies, and
Better engaging with its customers
Ackman is known as an activist investor, which means he invests in companies where he believes he can influence the board and management.
These types of companies are often experiencing some trouble, but are in the process of turning around.
This was clearly his strategy with Lowe’s.
The company was hoping to increase its operating margin from 9.2% to 12%, with its new initiatives.
That might not seem like much, but it’s a 30% increase.
If valuations stayed constant, it would lead to a 30% increase in the share price, which is not too shabby.
Ackman highlighted that Lowe’s traded at 17 times analysts’ estimates of 2019 earnings, which was a discount to Home Depot.
And this valuation did not account for the potential for improved profits in the future, which would also lead to a higher valuation multiple for Lowe’s.
A double whammy.
He finished off his analysis by stating that he believed there was likely further upside to the housing cycle.
But those who were nervous about the housing cycle could draw some solace from that fact that a meaningful portion of Lowe’s revenue came from less-cyclical repair and maintenance spend, which would do better in a recession.
Where are we Today?
That analysis was from 2018.
Fast forward to today, and Ackman just increased his position in Lowe’s. It’s now his biggest holding, at 22%.
Recent filings show he bought more shares during the second quarter of 2020, which was a savvy move considering how much the stock has bounced since then.
In Pershing Square’s 2020 interim report Ackman reiterates that there is still substantial potential for growth in the business.
Lowe’s did very well during the lockdown because consumers invested more in their houses as they were spending more time at home.
Beyond adapting to Covid-19, the company is making further progress to improve its business and they have expressed that they can go beyond the 12% operating margin goal that they set for themselves.
Today the company trades at approximately 19 times Ackman’s estimate of next-twelve-month earnings.
That’s compared to a multiple of 25 for Home Depot.
Ackman is a savvy investor who has proven himself to be a skilled stock picker. And he has been right about Lowe’s so far.
Looking at his simple and straight forward reasoning can teach us a lot about how to pick winning stocks.
We recommend that any aspiring investor listens to Ackman and learns from his analyses.
It can teach you a lot.
Lars and Roshni