François Rochon is one of the best value investors in the world. He invests in long-term compounders that aim to grow their earnings significantly over time. These include Berkshire Hathaway, CarMax, Alphabet, Ametek, Charles Schwab Corporation and Markel.
His investment record is incredible, averaging over 15% over the last 27 years.
Below, I’ll outline some key takeaways from his interviews and annual reports that he has shared over time.
1. Great businesses have financial strength, a great business model, skilled managements and to be investable, they need to be selling cheaply in the market!
Rochon looks for businesses which meet the criteria above. The rationale is that a wonderful business in and of itself is great, but pairing it with financial strength and a gifted management team can boost its performance over time.
2. Concentrating on owner’s earnings, not stock price movements
Warren Buffett has always spoken to the importance of concentrating on business performance and not stock prices. Through studying Rochon, one of the biggest takeaways gained is the mechanism he uses to apply this Buffett principle. He simplifies the investing process by distilling stock returns down to two main sources, shown below.
From 2010 onwards, Rochon has stated this same explanation of what he concentrates on:
He does not include change in valuation as a further return driver, because over the very long-run, valuation plays a smaller role in stock returns. In order to address this, Rochon simply tries to buy stocks at cheap prices, so that any change in valuation (i.e. change in the P/E ratio) of a stock he owns contributes more upside than downside.
Rochon simplifies the process of ignoring the noise around stock prices and volatility in markets by consistently analysing his portfolio from a business owner perspective. He believes timing the market is futile.
Here is the result from his owner earnings assessment of his portfolio over time:
As we can see, the underlying business return (12.6%) that Rochon measures is extremely close to the true return he achieved in the market (13.3%). So essentially, by concentrating on the businesses we own and how well they are growing earning power, the return we achieve in the stock market will follow.
3. Important psychological traits for successful investors to possess are patience, humility and rationality
Patience
Rochon explains that in investing, patience in waiting for opportunities as well as waiting for the market to fully value investments is an important quality to have. A great example is Rochon’s fantastic investment in Disney, presented below.
As we can see, François had to endure four years of no returns to eventually have his investment rewarded. The key here was to concentrate on business fundamentals. In this period, Disney acquired Marvel Entertainment (2009) and the Star Wars franchise (2012). EPS also grew at roughly 10% from 2005 to 2010. Rochon accurately balanced patience with stubbornness here, because from a business owner mentality, the business was doing great and the fundamentals were still in tact. Therefore, the lack of stock return was not a result of a mistake in choosing this business, but instead simply the market not valuing Disney’s quality accurately.
Humility
Rationality
Also, applying this rule of three can allow us to stay rational and not get convinced to make any rash decisions. Rochon accepts these three facts above, so if he underperforms the index in a year or makes a mistake on a stock, he is willing to accept these and not get caught up in being perfect.
4. Valuation doesn’t have to be complicated
Let’s dive deeper into Rochon’s valuation methodology. He simply thinks about what earnings per share (EPS) could be in 5 years, multiplies this figure by a suitable P/E ratio and divides that value by 2 to arrive at the value today. Just as a side note, dividing by 2 is roughly equivalent to dividing by 1.15^5 (=2.011). This means if he buys it at this calculated price and is right about his assumptions, he will achieve a 15% return over the next 5 years.
Technically, the intrinsic value of a stock is equal to the sum of the discounted cash flows it can distribute to shareholders over time. This intrinsic value depends on the growth rate of the business, meaning a rational investor should be willing to pay more for $1 of earnings today if those earnings will grow substantially in the future. Rochon accounts for this fact in the P/E he assigns in 5 years. If he believes the growth prospects will be largely exhausted in 5 years, he might use a P/E around 10x and if the prospects are still high, he would stick to a higher ratio such as 15-20x.
One thing to be careful of is that Rochon uses owner’s earnings. A lot of times EPS makes sense, as we’ll see in the examples he gave below. However, in some cases, such is with Markel (a specialty insurer), he doesn’t use EPS. Instead, he uses the increase in book value as a proxy for intrinsic value growth.
Some businesses make long-term investments which flow through the income statement. For example, there are software companies that show accounting losses, but in reality are paying an upfront cost to acquire a valuable customer. In these cases, EPS wouldn’t be the ideal measure for true earning power.
Two examples
Let’s take a look at a successful example and a mistake of omission Rochon has generously shared with us over the years.
CarMax
CarMax was a business that Rochon understood, which benefits from economies of scale in the used car market. Here is a quote from Rochon on CarMax:
The below graph shows the various times that Rochon purchased CarMax.
Here is a rundown of Rochon’s 2011 purchase.
Copart
Rochon’s Copart example is a mistake of ommission, which he explained below.
