Y H & C Investments June 2024 Update

'Nothing is more difficult, and therefore more precious, than to be able to decide. ' Napolean Bonaparte

I was asked to participate in the Lytham Partners Spring Conference so take a look below!

Fewer Decisions Made with Deeper Consideration-

Return figures in this section come from the May 31, 2024, edition of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research the investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

Many families enjoy the process of a dining experience. Today, a group can research any restaurant to find out all of the pertinent information which makes an establishment unique. The history, location, menu, specialties, signature meals, decor, famous patrons, and what has recently been given more credence, the online review section, are all readily available. What I find interesting is many single location, hole in the wall restaurants are often voted the best places to eat by the dining public. I would note that large chains are quite prominent, but sometimes the experience does not match their, call it, public reputation. Let’s dig into this a little bit, shall we?

There is one publicly traded restaurant group which has long been famous for its extensive menu. The locations are generally near public malls and often in areas where income levels are at the upper end of the economic spectrum. These spaces often run in the 5-10,000 square feet range. The bar area is extensive, as is the dessert display. When the chain opens a new location in a different country or city, the wait times can be over two hours. The company takes pride in its huge menu, so much so that management believes it is a big advantage versus the competition. I bring this up because the menu size is reflective of the dilemma patrons face when dining at these eateries. How does one decide what to order when there are ten pages of items to investigate? Even more to the point, why is this important?

When I say fewer decisions with greater consideration, I am referring to the process of learning and obtaining a thorough understanding of a topic. I mentioned the dining experience so let’s use this as an example. We will start with the establishment and the chef. What is their background in terms of their upbringing and family? What were the major influences in life that made them become a culinary artist? Where were they trained? Is there a particular emphasis in terms of the kinds of food they specialize in? Who are the closest team members to the chef and what are their backgrounds? Where were they trained and who were their biggest influences?

Next, we turn to the food itself. What kinds of ingredients does the establishment use? Are they sourced domestically or internationally? Are any chemicals deployed in their production? Are the foods all natural or are there special ingredients placed in their dishes? Are particular seasonings integrated in their prominent items? Are there any differences in how they make the meal versus their closest competition? Is there a particular palate which the food appeals to, and is there a notable taste difference in terms of flavor? How has the food changed over time, if at all? Have any of the changes been recent and if so, have they been minor, or extreme? Have they added new dishes recently or has the menu stayed the same? How does the food compare to similar regional or national establishments?

Finally, we investigate the business. Does the business have a long reputation of excellence, or did it recently gain prominence? How many locations do they have, and are they similar in terms of quality and public perception? Do the online reviews mention any service problems or poor reactions to the meals that were served? Are there any regulatory issues the business is faced with? Are they restricted to one jurisdiction, or are they occurring in multiple places? Are the challenges national or international? As you can tell, one can become quite thoroughly versed in any subject matter. Knowledge is power, and deeper detail usually is quite beneficial to the decision maker. Using the same thorough approach when investing capital in a specific company leads to a very complete understanding of what you own. At the very least, when the stock goes down (as it inevitably will), this knowledge helps give you the staying power to not sell during stressful market fluctuations.

Like an enormous menu with an endless number of choices, investing in the capital markets offer thousands of possibilities to choose from. Whatever you want to put your capital in, you can find. My own experience over the last few months is instructive of this reality. Attending the different investment conferences in New York and Las Vegas allowed me the opportunity to meet with quite a few management teams in a wide variety of businesses. It is a privilege to get invited to these events, and it makes sense to make as much of the available time as possible. The leaders of public companies are in high demand, and their time is valuable. My situation is common in that all investors are trying to earn the highest return relative to the assumed risk. It is distinct because my capital base is considered larger than the typical investor, but certainly we aren’t Vanguard (they are quaking in their boots don’t you know!). Narrowing down the field of candidates for investment is important. I am limiting the number of companies to add or invest new capital to fewer than five. You might be happy to know the vast majority will go into existing holdings. Fewer decisions made with a great deal of consideration is my approach. It might be useful the next time you eat out, too!

With respect to the broader financial markets, there are a few areas of the market I find interesting. The first is foreign exchange, where noteworthy themes include the weakness of the yen, Europe’s interest rate path, and the continent of South America. The leadership change in Argentina and upcoming national election in Mexico are potential secular shifts that can mean big economic changes in the future. The most obvious theme is the continued glorification of the artificial intelligence boom. From my perspective, an interesting area is going to be the potential for massive overinvestment and its commensurate capital destruction. With any boom, there is inefficient capital allocation, which usually results in disappointing returns and capital loss. Recently, I’ve been reading estimates of nearly $200 billion allocated for investment in AI by 2025. The flip side of the massive spending in artificial intelligence is a derivative, the related burden of providing energy sources to supply data centers, the grid, and other electricity transmission vehicles. It is an area where there will be beneficiaries and requires my attention.

Y H & C In May: Rodney Dangerfield Sums it Up Well- No Respect

As I was growing up, the most famous comedians were ever present. Richard Pryor, Eddie Murphy, Johnny Carson, Jay Leno, and Andrew Dice Clay were always in the news. Comedians from a prior generation, like Don Rickles, also were very popular. One such person was Rodney Dangerfield, who starred in the legendary film Caddyshack. His most well-known line was, “I tell you; I don’t get no respect, I don’t get no respect.” Currently in the capital markets, the vast preponderance of public entities receives very little respect from the investment community. In the latest earnings period, if a company met or exceeded earnings expectations, unless it was a tremendous report, the stock sold off. The drawdowns have been harsh, as many of the declines are over 10% or more of the stock value. Are they ever justified? Probably once in a while, but when a company grows its revenues in double digits, exceeds earnings expectations, and the stock still sells off hard, well, it is a sign investors are only willing to buy a few select companies they consider exceptional. So how does this apply to Y H & C Investments?

Last month, we had several companies report earnings and, in many cases, the results were solid. Our companies are cash generative, investing in their business, looking for accretive acquisitions, and buying back stock if the management team considers it cheap. One principle which has worked out well is the best place to invest capital is in existing positions. Owning high quality businesses is merely a starting point to wealth creation. It is also important to own as much of them as one can in order to benefit from their ability to grow. When markets present opportunities to buy what you already have benefited from, well, I consider it a gift. It may be a few years before the returns eventually materialize, but I am more interested in ‘if’ than ‘when’. Consequently, during these harsh periods, we have been buying more of what we already own. The risk with this strategy is the various biases which plague investment decisions- typically anchoring, confirmation, and recency bias. It may sound a bit arrogant, but I’ll take my chances, knowing these businesses and their competitive positions.

Y H & C Industry & Holdings Update: Making it Hard

Regular readers and clients are well aware of my participation in the recent investment conferences for smaller companies. One should understand many of these enterprises are not a good fit for client portfolios. As I explain to some of the management teams, from a fiduciary standpoint, there is a suitability requirement for each client in terms of what fits for their portfolio. As a result, quite a few of the companies I meet with are just for an introduction, learning, or a follow up from a prior meeting. It is a good idea to consistently add more possibilities to your watch list as one cannot have enough strong businesses in your portfolio. I already follow a great number of companies, so these conferences just widened the potential universe. The good news is there were plenty which have very attractive businesses. With the widest discrepancy on record between small company performance and the largest companies in the market, it is a very good time to look in this area. If the proven statistical law of reversion to the mean is accurate, and historically there is very little doubt of its reliability, again we get back to when, not if. It is a matter of making excellent choices on where capital is placed.

On that topic, many of the companies I met with made the task harder because of their interesting businesses. However, this is just a starting point, and having been involved in this space for a while, I’ve adopted a whole series of requirements which narrow down what I am interested in before investing capital for clients. In many respects, I am trying to find a needle in a haystack. Great businesses do not just pop up out of thin air. It takes a long time to build them, and the process plays out over years, not weeks or months. Most great businesses have challenging periods where they have to improve, adapt, and respond to competitive threats. A billion-dollar revenue business does not suddenly take place, so one has time to monitor what is transpiring relative to the stated plan. The ability to see the journey through is difficult, and just as many marathoners do not finish the race, many investors do not stay with an investment to reap the rewards of a profitable company. As a result, I find it essential to follow the progress of many candidates. In terms of allocating capital, there are about five to ten companies we own positions in where we met with their teams. The size and value of the positions vary but I feel confident all are worth owning. My message to each of them is all I want to do is own more of them. By having more capital, it means instead of a half a percent position, maybe we own 2 percent. Still, I had the opportunity to add to one of these situations over the past month and took it in big way. It is a company we’ve owned for a long time and have a lot of confidence in, but time will tell on how this plays out. Finally, I included a link to the Lytham Investor Relations panel I was asked to participate in. It is a wide-ranging discussion you may find interesting.  I appreciate your interest and if you have any questions or comments, please say hello at information@y-hc.com.  Thanks for your continued support!