Chuck Akre: The 100x Hunter

Chuck Akre's performed better than the S&P 500 for over 30 years.

Plus, he's made a couple 100x investments.

In this post, we'll review key take-aways from a lecture he gave at Google in 2017.

Quick summary:

• Chuck built his career on trying to understand what makes a great investment

• He didn't have any background in investing when he started, but he's had tremendous success regardless

• His core focus is on compounding

• He invests based on value and avoids speculating on share price

Who's Chuck Akre?

Chuck's a professional investor.

In 1989, he founded an asset management firm called Akre Capital Management.

Since then, he's been producing exceptional returns for clients.

Here're some performance stats he shares for his firms' products:

• Separately-managed accounts:

  • Time period: 27 years

  • Compound annual return: 12.7% (vs 9.4% for the S&P 500)

• Private investment partnership

  • Time period: 23 years

  • Compound annual return: 15.25% (vs 9.2% for the S&P 500)

• Mutual funds:

  • Time period: 19 years

  • Compound annual return: 13.2% (vs 7.7% for the S&P 500)

• Akre Focus Fund:

  • Time period: 7 years

  • Compound annual return: 14.75% (vs 13.5% for the S&P 500)

Note: I wasn't able to find independent verification of these stats. But, it seems to match up with the "Yearly Returns" section of the Chuck Akre page on GuruFocus.

Let's take the smallest number: 12.7%.

In 10 years, a 12.7% compound annual return turns $10,000 into:

$10,000 × 1.127^10 = $33,055.15

Compare that to the S&P 500's return of 9.4% over the same period:

$10,000 × 1.094^10 = $24,556.88

What happens with a 12.7% compound annual return for 27 years?

$10,000 × 1.127^20 = $109,264.31

That's a 10.9x return.

Chuck must be a 10x hunter, like us!

Note: Actually, if you read more about him, you'll find he's really a 100x hunter!

Lecture Notes

Chuck didn't start out with a background in investing

• He went to college, but majored in English

• He started as a stock broker in July, 1968

• He had no background in investing: "I had the advantage of a clean canvas. That is, I knew nothing when I came into the business."

• His early goal was to understand: "What makes a good investor and what makes a good investment?"

We don't need a background in investing, finance, or mathematics to succeed as investors. 💪

Learn by reading

• "I read voraciously and still do."

• Important books:

  • The Money Masters, by John Train (published 1980)

  • The newest version is called Money Masters of Our Time (published in 2003)

  • The Intelligent Investor, by Ben Graham

  • 100 to 1 in the Stock Market, by Thomas W. Phelps

• Business biographies in general

His readings led him to the core concept in his approach to investing: Compounding.

And this focus on compounding led to his exceptional performance.

What makes a great investment:

• "Rate of return, we say in our firm, is the bottom line of all investing..."

• Public US companies produce higher returns than any other asset class

  • Chuck studied historic returns across asset classes (stock, bonds, art, real estate, etc.) and found that...

  • "...public companies in the United States have compounded at roughly between 9% and 10% a year. And that's better than all other asset categories, and it's unleveraged."

• Over time, a stock's rate of return roughly equals the company's return on equity (ROE) (more on this later)

• "...your opportunity for a higher rate of compounding is enhanced by a lower valuation at the start."

  • That is, you want to buy when valuations like price per earnings or price per book value are relatively low

A "simple" example (that's not so simple)

In the lecture, Chuck gives an example to show how a company with high return on equity (ROE) results in a high-returning stock.

He says, "it's just real simple".

I didn't find it just real simple.

I found it kind of confusing. 😂

So, I tried to break it down:

Note: Don't worry if you find the breakdown confusing. You can skip it. The key points listed after the breakdown are what really matters.

Example stock, year 1:

• Price per share (PPS): $10

• Book value per share (BVPS): $5

  • BVPS is basically the value of each share if all liabilities were cancelled

  • Book value is: Total value of assets - Total value of liabilities

  • And BVPS is: Book value ÷ Number of shares outstanding

• Earning per share (EPS): $1

This gives us:

• Price per earnings (P/E): $10 ÷ $1 = 10

• Price per book value (P/B): $10 ÷ $5 = 2

• Return on equity (ROE): $1 ÷ $5 = 20%

  • ROE can be thought of as the company's ability to create profits from shareholders' stake in the company [1]

  • The "Equity" in "Return on equity" refers to Book value

  • So, we can calculate ROE as: EPS ÷ BVPS

Year 2:

• EPS: $1 + ($1 × 20%) = $1.20

  • That is, earnings grew by the ROE (20%)

• BVPS: $5 + $1 = $6

  • That is, the $1 of earnings made in year 1 was retained by the company and reinvested in the business

Assuming constant valuations (P/E and P/B):

• New share price as a function of EPS and P/E: $1.20 × 10 = $12

• New share price as a function of BVPS and P/B: $6 × 2 = $12

• So, the stock has increased from $10/share to $12/share due to ROE and reinvested earnings

There're 3 key points here.

Point 1: The more profitable a company is, the more it's worth.

This seems obvious. But remember that price isn't the same as value.

The price of a stock depends on how much the market is willing to pay for it.

Price per earnings (P/E) and Price per book (P/B) constantly change based on how the market feels at any given moment.

Point 2: The price we pay for a stock has a big impact on our returns.

This seems obvious too. But, remember that:

1. We can't control the price multiples the market sets for a stock

2. We can control when we buy and sell

3. A seemingly small difference in price multiples makes a big difference in total return

To demonstrate point (3), let's say:

1. A stock normally has a Price per earnings ratio (P/E) of 10

2. The company's Earnings per share (EPS) is $10

3. We buy the stock when its P/E is a little elevated at 12.5: $10 × 12.5 = $125/share

4. The company's EPS doubles to $20

5. The market has now returned to pricing the stock at the normal P/E of 10

6. We sell the stock and get: $20 × 10 = $200/share

Nice! We gained $75 per share!

But, if we'd bought at a P/E of 10, we'd have paid $100/share instead of $125/share. In that case, we would've gained $100/share instead of $75/share. We would've done 33% better!

Lots of people tell us price doesn't matter.

Price matters.

Point 3: Reinvesting earnings produces compounding.

Each time a company reinvests profits in the business, it creates a bigger base for generating future profits. This is compounding.

This is how we get investments that return 10x.

How to identify businesses with above-average rates of return

Akre describes his approach as a "three-legged stool":

1. The business has a high rate of return

2. The management team are great operators and treat investors as partners

3. The management team reinvests profits back into the business

"[The third leg]'s what creates the compounding effect."

A couple notes on what it means for a rate of return to be high:

A company's rate of return is considered high if it's well above the average rate of return across companies.

We need to be sure to pick the correct average value to compare with because it can vary:

• Akre suggests that at the time of the lecture (2017) the average rate of return was "roughly [in the] high single digits"

• In Q1 of 2024, the average rate of return for the S&P 500 was around 11.5% [2]

• Different industries have different average rates of return

• Average rates of return change with interest rates, inflation, etc.

Investors, not speculators

• "We try very hard to be investors in the value of businesses, as opposed to speculators in the price of shares."

• Chuck aims for below average risk. He says low-risk companies have:

  • "more growth"

  • "higher returns on capital"

  • "stronger balance sheets"

  • "frequently, lower valuations than the market"

• Since he takes a long-term view, he doesn't consider volatility a risk

• Chuck's firm is located far from big cities to avoid distraction

  • "And the reason we're in a town with one traffic light, away from [interesting people in big cities], is that their stuff would be intellectually appealing to us and it would distract us from what it is we do well."

• Compounding requires time, which requires patience and discipline

  • "I think the most difficult thing to do in our business is to not sell if you're a long-term investor."

  • "[Warren Buffett] always has said, ...either you get [compounding] or you don't. And I wrote him a letter and I said, that was not my experience. My experience was, I didn't get it until I experienced it."

  • Media misleads us into thinking we should constantly be buying and selling. They're sponsored by brokerage firms. And brokerage firms make money through transactions. So, every day we hear: "They beat by a penny. You better buy it. ...They missed by a penny. You better buy."

  • "We try very hard to be investors in the value of businesses, as opposed to speculators in the price of shares."

Final words

"I've only had two [100xers] in my life... And I mean, and that's a really important issue as it relates to investing, is you really only need to have one great success... And so the quest is, for me, the search is trying to figure out what the characteristics of those are."

Maybe we should raise the bar and hunt for 100x. 😉

Happy hunting!

References

1. Franklin, M., Graybeal, P., & Cooper, D. (2019). Principles of accounting, volume 1: Financial accounting | Section A: Financial statement analysis. OpenStax. Viewed 2024-07-31.

2. Butters, John. S&P 500 Reporting Higher Net Profit Margin Quarter-Over-Quarter for Q1. FactSet. Viewed 2024-07-31.

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