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Searching for New Compounding Machines

When looking for "compounding machines," there is no better place to start than the portfolio holdings of Akre Capital Management.

Akre Capital Management runs a 12 Billion dollar concentrated portfolio that has consistently beaten the S&P 500 index with low turnover. Akre's equity portfolio typically consists of around 20 (mostly large cap) stocks, many of which they have held for a decade or longer.


Investing process

Chuck Akre (Trades, Portfolio) refers to the company's investment selection process as a "three-legged stool." The first leg is an assessment of the nature of the business and return on owner's capital. They try to assess what is unusual about the business that causes it to produce the results it does. The second leg is an assessment of the people who run the business. Are they acting in the best interest of all shareholders on a per share basis? The third leg is the reinvestment of free cash flow in the business. Reinvestment of free cash flow enhances the compounding effect of an investment in the business.

The selection process is essentially a qualitative process where they assess the quality of the business and bring in their judgement as business analysts.

Looking at Akre's largest position, American Tower Corp. (NYSE:AMT), you can see the compounding at work. Akre correctly identified early on that cellular tower companies like AMT own the toll booth for the growth of wireless communication today, which requires denser and denser antenna population with each succeeding wireless generation from 2G, 3,G, 4G and now 5G. He has said that the rate of return per incremental tower for AMT (after its been paid for) exceeds 90% - a very powerful business model. AMT is now in 16 countries outside the U.S.

In addition to AMT, Akre also holds SBA Communications Corp (SBAC) in the portfolio, which is another cellular tower company. MasterCard and Visa are other long time holdings of the fund, which Akre thinks have long growth runways ahead of them as the world increasingly shifts to electronic payment solutions.

Concentration

Akre Capital Management leverages the power of concentration in their higher conviction ideas. Their concentration in fewer stocks has grown in recent years in spite of huge growth in their AUM (Assets Under management). The reason for their higher concentration is a reflection of their higher confidence in the stocks in their portfolio. Akre Capital maintains no sell targets on their stocks, just buy targets. After they have acquired a "compounding machine" at a good price, they just give the stocks time to compound over the long term.

Current portfolio

As can be seen below, Akre Capital maintains a concentrated portfolio with low turnover. Some of the established positions were taken almost two decades ago. This is remarkable as a typical mutual fund large cap growth portfolio has a turnover of about 75% over the same time period. The large size of these old positions indicate that Akre expects the stocks to keep compounding well into the future.

Ticker Company Price % portfolio in portfolio since
(NYSE:AMT) American Tower Corp 227.87 15.67 2001
(NYSE:MA) Mastercard Inc 299.2 14.26 2010
(MCO) Moody's Corporation 239.06 11.47 2012
(NYSE:V) Visa Inc 189.16 8.29 2012
(ORLY) O'Reilly Automotive Inc 439.09 7.41 2005
(MKL) Markel Corp 1123.65 5.98 2001
(SBAC) SBA Communications Corp 241.26 5.86 2014
(DLTR) Dollar Tree Inc 92.08 5.72 2010
(ROP) Roper Technologies Inc 353.82 5.51 2014
(KMX) CarMax Inc 89.03 5.45 2013
(VRSK) Verisk Analytics Inc 148.83 3.97 2012
(KKR) KKR & Co Inc 29.28 3.38 2018
(BAM) Brookfield Asset Management Inc 57.93 2.79 New
(DHR) Danaher Corp 152.82 2.36 2013
(NASDAQ:ALRM) Alarm.com Holdings Inc 42.64 0.63

2015,

Adding

(BRK.B) Berkshire Hathaway Inc 226.45 0.59 2003
(PRMW) Primo Water Corp 11.55 0.37 2011
(BRK.A) Berkshire Hathaway Inc 339650 0.13 2003
(NASDAQ:OLLI) Ollie's Bargain Outlet Holdings Inc 66.37 0.06 New
(GSHD) Goosehead Insurance Inc 41.42 0.05 2018
(LAMR) Lamar Advertising Co 88.81 0.04 2013
(NASDAQ:DSGX) The Descartes Systems Group Inc 42.13 0.02 New
(ESGR) Enstar Group Ltd 208.12 0.01 Sold
(BOMN) Boston Omaha Corp 21.38 0 Sold
(NYSE:CLNY) Colony Capital Inc 4.78 0 New
(AMTD) TD Ameritrade Holding Corp 50.77 0 Sold
(DHIL) Diamond Hill Investment Group Inc 142.37 0 Sold
(UI) Ubiquiti Inc 190.42 0 Sold



New ideas

Ollie's Bargain Outlet Holdings Inc (NASDAQ:OLLI) is a retailer of brand name merchandise at drastically reduced prices. It operates stores across the Eastern half of the United States. Its differentiated go-to-market strategy is characterized by a unique, fun and engaging treasure hunt shopping experience, compelling customer value proposition and witty, humorous in-store signage and advertising campaigns. Revenue and EBITDA have compounded at a rate of 13% and 20% over the last five years.

OLLI Annual Rates (per share) 10 yrs 5 yrs 12 months
Revenue Growth (%) N/A 13.10 14.00
EBITDA Growth (%) N/A 19.60 9.90
Operating Income Growth (%) N/A 21.60 9.00
EPS without NRI Growth (%) N/A 45.90 -9.30
Free Cash Flow Growth (%) N/A 38.80 -69.20
Book Value Growth (%) N/A 14.90 11.90



The Descartes Systems Group Inc (NASDAQ:DSGX) is a Waterloo, Ontario-based provider of software for the transportation and logistics, distribution, manufacturing and retail industries. As the table below demonstrates, its's a compounder par excellence.

DSGX Annual Rates (per share) 10 yrs 5 yrs 12 months
Revenue Growth (%) 13.50 11.70 15.70
EBITDA Growth (%) 18.20 17.30 25.80
Operating Income Growth (%) 18.70 15.70 25.40
EPS without NRI Growth (%) 6.20 24.10 8.40
Free Cash Flow Growth (%) 18.00 12.60 29.40
Book Value Growth (%) 13.30 14.00 43.4



Akre Capital has recently doubled its position in Alarm.com Holdings Inc (ALRM), a provider of cloud based security and automation solutions. ALRM recently hit a 52 week low due to conservative guidance. Looks like Akre thinks that this weakness is temporary. Revenue and EBITDA per share has compounded at a rate of 17% and 18% over the last five years and the company appears to have a long runway.

ALRM Annual Rates (per share) 10 yrs 5 yrs 12 months
Revenue Growth (%) N/A 17.90 16.10
EBITDA Growth (%) N/A 18.20 102.20
Operating Income Growth (%) N/A 3.50 172.30
EPS without NRI Growth (%) N/A N/A 242.90
Free Cash Flow Growth (%) N/A 37.10 -17.30
Book Value Growth (%) N/A N/A 25.50



Colony Capital (NYSE:CLNY) is a recent small position and it too early to say if it any more than an experimental speculative position. The stock is at an all time low and is trading below tangible equity.

Conclusion

Chuck Akre (Trades, Portfolio) says that:


"The three areas of analysis - business, management, and reinvestment - are the key components of what we call our "three-legged stool." When we find a business that satisfies all three of our requirements, we refer to it as a "compounding machine," and we seek to purchase shares at a modest valuation."



Akre Capital's new positions give us some good ideas to in our quest to find these compounding machines which we can hold for a long time.

Disclosure: The Author is long Moody's (MCO) stock

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