Mark Lamonica: All right. So, I'm sure everyone wants to hear about the list. But where do you get started? Because there's obviously a lot of shares that trade on the ASX. So, I guess, what criteria did you use? How did you narrow that down to get to the list in the article?

James Gruber: Well, obviously, in somewhere like the U.S., you have a lot more options. The U.S. is a much bigger place, it's got a bigger population. You can get more growth as a company in the long term in a place like the U.S. versus Australia. There are limitations in Australia.

And the other limitation is, is that frankly, that companies often don't last that long. I think there were studies out of the U.S. that the average company lasts about 20 years. So, a lot of companies won't make it to 50-plus years. So, you've got to really be confident that they'll make it that far as well. And it's not only about longevity, you also—you don't just want a company that's going to last, you want one that outperforms indices, otherwise, why hold it? So that's some of what I was thinking through when I made the criteria to come up with a list.

Lamonica: And then one way is obviously to exclude things. And you did talk about whether it's particular industries. What were the exclusions you put in there, I guess, just to eliminate certain shares that are trading in Australia from the list, or I guess from consideration, even to go on the list?

Gruber: Well, think about, for instance, we don't have a lot here, but pharmaceutical companies have drugs that expire. Miners have mines that expire. If you've got a miner that has expiries in 10 or 20 years, how can you be confident that they're going to be around in 50-plus years? That needs to be in your thoughts as well. It helps us if they are larger, and they've got a diversified portfolio like a BHP. But I really knocked out a number of sectors as part of my thinking. Number one, controversially, I knocked out the banks.

Lamonica: Every Australian is like groaning right now as their portfolios are filled with banks.

Gruber: It's mainly around growth. You need to be able to grow earnings consistently over a long period of time. Now, the banks have been able to do that historically, but I think it's been a bit of an anomaly. You've had 40 years of a credit boom, which has been fueled by an incredible property boom. That is really dying down as we speak. And share prices follow earnings. And if you can't grow earnings in a decent way, you're not going to be able to grow your share price in a decent way.

So, for instance, CBA, which everybody loves seemingly, has grown earnings by 2% per year over the past 10 years. That's not a lot. The reason it's done very well is because its multiple has expanded significantly. That is the only reason the share price has done decently over the past 5 to 10 years. It's not through earnings. And going forwards, I can't see that changing a lot. You're really not going to get much growth out of the banks. And you've got to ask yourself, are their multiples going to expand to give you a return that's going to be decent over the very longer term? Now, I just don't see that happening over the next 10, 20, 30 years. I think a lot of their growth is in the past.

The miners are a bit of a struggle because their mines do have those expiry dates. Now, you do have larger conglomerates, but overall, miners as part of the ASX have underperformed the all-ordinaries. And it's because they have to spend a lot of that money. And if you look at the bigger guys like BHP and Rio, they need to spend a humongous amount just to move the dial these days because they're so big. So, it's not only about the mining industry itself, it's about size as well. Size can be a limiting factor. There's only so much you can grow when you're so big. So, there are a couple of the big exclusions that were controversial.

Lamonica: Yeah, maybe if we think about an investor going out and buying some of these shares—and we will get into the shares in a second—how do you think about over this 50-year period, did you think about dividends in terms of ways that over that time period that you could actually get some cash flows to spend? Over 50 years most people will have started working and then retired. Or were you really just looking agnostic to dividends and just sort of looking at, I guess, overall returns, so both capital appreciation and dividends?

Gruber: The latter. So, it was more about overall returns. I have a different perspective on dividends than most probably in that I don't want high dividend-yielding stocks now. I want stocks that will be able to grow dividends going forwards. And dividends come out of earnings. So, if a company can grow earnings each year by 10% per annum over the next 20 years, they're going to pay out potentially 60%, 70% of that. You're going to get very decent dividend growth as part of that. And that will give you a larger dividend going forwards in the out years, as well as a better total return.

Lamonica: Yeah, it's interesting. I actually wrote an article this morning on BHP. Their earnings came out and I wrote why I would never buy it. And yeah, I was going through and talking about some of the same stuff you were that, yeah.

Gruber: So, you stole my idea.

Lamonica: I did steal your idea. I believe it's called collaboration when you work together. But yeah, if you look at like BHP's dividend, it almost looks random. If you go back 10 years, it's high, it's low, it's really low, it's high. Yeah, it's just interesting to think about that. But people are on here because of course, they want to see where you ended up. So, I guess overall, are there characteristics when you came up with this list that a lot of the list members shared?

Gruber: Yeah, look, I came up with seven criteria. I'll go through them quickly. And they're my criteria. You can disagree or agree with it. Number one criteria was the stocks had to be part of the ASX 300. The reason I did that was that I wanted to establish companies with a track record. And you could kind of argue with saying that smaller companies have more room to grow. And that's understandable. I can see that argument. But for this list, I said the ASX 300.

This one was an important one, the second criteria, a long runway of growth opportunities. That kicks out a lot of Australian companies. There are a lot of mature companies here. There are a lot that only operate in Australia and Australia is a relatively mature market. So, it leaned towards more global companies as a consequence of that because that gives you that long runway of growth that you can potentially go 50-plus years with.

The third criteria was that they had to have economic moats—that is competitive edges. And competitive edges gives you the ability to last over a long period of time. If you don't have a competitive edge, you won't last as a business. So that was important.

Returns on capital was another criteria. High returns on capital, whether you measure by return on equity or return on invested capital, is normally the sign of a good-quality company and one that can grow earnings over the long term.

They also have to have sound balance sheets, which I think is important. Studies have shown that high indebtedness amongst companies leads them to underperform over the short, medium, longer term.

And this will cause a bit of controversy in that I don't want companies that rely on exceptional managers to perform. The reason is that you really want a company that's going to be able to grow with or without a good manager. That's a sign of a good-quality company as well. Good managers help, of course, but you don't want them to be the be-all and end-all.

Lastly, in our modern age, you want companies that are unlikely to be disrupted. That's really important and becoming more and more important as we go into AI and other things with companies. So, they're the criteria I came up with. They may not be perfect, but that's what I came up with.

Lamonica: Okay. And 16 companies, major less. Now, we're not going to go through them all because obviously, we can't have a six-hour podcast here, but we will put a link to James's article in the show notes. So, go read what James said and get all 16 companies. But maybe if you could pick a couple out and we can go through them. We've heard the criteria, but it will be interesting to see how these companies that you select fit into that.

Gruber: I'll mention one. First up is Auckland International Airport is one. Airports in general are exceptional assets and they make for good companies over the long term. Why is that? Because normally, they've got monopolies. Monopolies give pricing power and long-term pricing power and Auckland International has that. They have regulatory barriers that ensure that monopolistic characteristic as well. Over the long term, you've got to be confident in New Zealand's future, particularly with regards to tourism and visitors coming in. I think that I have a degree of confidence in that over a long period of time. They are some of the reasons why Auckland International Airport makes the list. It's relatively defensive, but the assets are fantastic. You've got a fair bit of growth there, I think, over the longer term. I just think it's one of the best to own. In general, Sydney Airport was a great asset as well. We don't have that anymore. This is the other one to go to in terms of airports on the ASX.

Another stock, well, I'll pick a less known one, Propel Funeral Partners. Again, funerals may not sound exciting, but you get…

Lamonica: It depends on whose funeral it is at the end of the day.

Gruber: That's true. You get 1% to 2% volume growth, which in English means growing number of people dying each year, which helps funeral services companies. Importantly, in this industry, there's a lot of fragmentation. That is, you've got a lot of mum and pup funeral directors out there. And these larger companies like Propel are consolidating that industry. That can be a very interesting and profitable arrangement for them because as you consolidate, you get more pricing power as well. So, if you get that volume growth plus prices increasing by more than inflation, you get decent revenue growth of mid to high single digit revenue growth, plus you get the acquisition growth on top and you get increasing margins, hopefully, over the medium term. That is a pretty compelling story for having earnings growth that's decent over a long period of time for these guys.

Again, it's a defensive industry, but a lot of my research recently has shown that defensives are pretty good over the long term. If you look at the U.S., tobacco and consumer staples have been the best-performing sectors over the past 100 years. You don't have to have spectacular growth to make a spectacular investment. For instance, you've had a lot of research from the respected Hendrik Bessembinder on the stocks that have returned the most over the last 100 years, Altria, the tobacco company in the U.S., tops the list. It's gone up 16% per annum over the past, I think it's 99 years. That doesn't sound a lot, but that adds up to a lot of money. I think $1 has turned into over $6 million U.S., something like that over that period. The magic of compounding over that period. You don't now have to have spectacular growth companies to make a story work for you over the long term. They're two pretty defensive companies, one larger, one small.

Lamonica: Yeah. I always think it's interesting. I used to own InvoCare. I actually used to own Sydney Airport too, and then they were both taken private, which I wasn't happy about. InvoCare was another or is another funeral operator that used to be publicly traded. I always thought what funeral was like, it's not exactly a time that a lot of people are out there bargain hunting and arguing about prices. It's obviously hopefully not a reoccurring thing. You aren't burying too many people. So, yeah, it's an interesting business.

All right. So, these companies obviously are standalone businesses. You talked about some of the characteristics, but how do you think an investor should think about what is right for them? So, whether they're looking at that entire list of 16 or just in general looking at companies in the share market.

Gruber: Well, we like to say in the financial industry that it depends on your risk requirements. It really depends on your appetite for risk and your time horizon. This podcast has been about a very long time horizon, much more than most people would think. But real wealth is built over the very long term. If you look at Buffett, the amount of money that he earned in the first 50 years of investing was a trickle of what he's earned since. That's the power of compounding. Now, you may not like it because you might be gone by the time it compounds, but that's the way it works.

The other thing is your risk appetite. You've got to want to get into the share market. First of all, you want to be able to sit on stocks even when there is a large downturn. That is really important. You've got to be able to know yourself to be able to own these stocks. That is the key to owning stocks longer term. You've got to be able to sit through them through thick and thin. How do you know whether you're going to do that? Well, if you're young, you may not know, but if you're older, how you reacted to 2021, how you reacted to 2008 gives you a pretty good clue about how you handle risk. You want to own stocks that you're sure that you'll be able to hang on to for that longer term. Otherwise, there's not much point.

Lamonica: Yeah. Is this the approach that you take? In your personal investments, you're looking for similar or perhaps the same name, similar companies to these as a long-term investor?

Gruber: I do. I'm on the conservative end of the spectrum. So, I will look for more probably defensive companies with moats that can still grow. They're the ones that I like over the longer term. I have a long-term horizon. I look at stocks at 10-plus years. That's probably unusual. In this case, it's 50 years, so it's even further. That's the way I like it. The way I like to think about it is, if you own an Auckland International Airport or another—the list includes The Lottery Corporation and other companies like that—I like to think that in 10 years, these guys are going to be—I'm very confident that these guys are going to be earning more money, potentially a fair bit more money. If that happens and you get a downturn in the interim, you can think, well, these guys' earnings are probably going to be 30% higher in three, four, five years or whatever it is. That's going to make the stock go pretty cheap in a downturn. So, that probably gives you some solace that you can sit through it a bit better.

Lamonica: One last, I guess, we'll call this a bonus question. You used to be a portfolio manager. So, you used to run a fund and you did this for a living. How different is the way that you approached investing professionally versus how you were doing it even at the time and now, how you do it individually for your own portfolio?

Gruber: It's very different. Investment management is very process driven. So, you screen for stocks, you analyze them in a certain way, you put models together in a certain way, you discuss them with your team in a certain way and you set up a portfolio in a certain way and that will depend on the investment philosophy of the firm. That process is—you don't have that as an individual investor as much. You can pick and choose what you do in terms of that. For instance, I did a lot of modeling as a portfolio manager, and I think largely, it's mostly useless. I think DCF, discounted cash flow analysis, is pretty useless. You can do a bit with it, but it's not something that I would solely rely on. So, you do a lot of detailed work on that, and I've learned that what I trust is something different and I go with shortcuts that I know that help me as an individual investor. I just think that as an investor, you can make your life a lot easier if you buy decent stocks and hold them for a long time. That to me is the simple way to do it.

Lamonica: Yeah, and I don't know if you'd agree. I've always thought about a discounted cash flow like it's important that people understand them. It doesn't mean you need to build one, but you understand what this process is. You're projecting out these cash flows, you need some sort of discount rate. But yeah, I don't personally know any individual investors that are sitting out there and building these DCF models like an analyst does. I always tell people when you're reading our analyst reports, the important thing is look at the assumptions that they're making in this, so whether that's revenue growth, whether that's margin, those are the things to think about. You don't have to build that model.

Gruber: No, I would urge that you're familiar with financials and that you've got a reasonable assumption as to what a company can grow revenue by, what its margins might be in the future and what its earnings and return on capital might be in the future. You can get a rough gauge of that, and you can do some ballpark analysis out of that. I think that it's good to think in—what I've learned, it's very good to think in scenarios and that is, what happens if it does really well, what happens if it does okay, what if it doesn't do as good and put some possibilities on that and try to think about it in that way. Because another thing that's a bit controversial is I actually don't think that there's a fair value for a company. I just don't. My portfolio management experience as well as individual investor experience just suggests that saying that something is worth $11.20 like sell-side analysts do and I used to be a sell-side analyst as well, I think is junk. I just think that you have scenarios around prices, and you've got to think about what's reasonable and what's not. But I think having an exact science of price targets and what something may be worth, I just don't believe in that.

Lamonica: Yeah. And I think that's what people don't see that a lot of those scenario analysis, even when an analyst is putting a fair value on something, a lot of that happens to come up with the fair value.

Gruber: Yes.

Lamonica: And like I understand why you can't present stuff in ranges because that just confuses people and they want to know, yeah, this share is worth $13. But no analyst would also sit there and say, okay, well, if it's worth $13, you should buy it for $12.50. Like everyone says, obviously that margin of safety concept and that sort of accounts for those various scenarios.

Gruber: Yeah. People love precision, but I don't think it's that precise.

Lamonica: Yeah. Exactly. So, I think we'll leave it there. But that was a good discussion. If you keep doing this, we're going to have to keep having you back on. So, watch out. Everyone, check out James's article. There is a link in the show notes. And thank you very much for joining us.

Gruber: Thanks, Mark.

 

The following is an excert from a podcast episode of Investing Compass. Listen to the full episode below.

James' article can be read here.

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