The playing field
The vast majority of stocks in the investable universe are “close the discount” stocks. Hold them for 10 years, and they will tend to “bob around” from
time to time. While there are potential trading opportunities along the
way, at the end of the day, investors as a group are not much further ahead
than when they first started. Simply put, if the underlying business does
not increase intrinsic value materially over time, neither will the stock.
Investors need catalysts to drive an attractive rate of return for a
business that fails to grow value at a satisfactory pace. Takeouts remain
one of the best catalysts to make money on “close the discount” stocks. The
quicker the discount is closed, the higher the IRR of the investment.
Pender has demonstrated an exceptional track record
in identifying companies with take-out potential, especially in small cap stocks.
On the other hand, ongoing business momentum, when also underappreciated by
investors, is the catalyst for “compounder” stocks. Interestingly, if you excluded all “compounders” out of the stock
market indices over time, the benchmark returns would be close to zero.
Logically, the stock market can’t go up much if it consists primarily of
mediocre companies that are unable to grow their business value over time.
The stock market goes up over time because the returns of compounders more
than offset the anchor created by the much larger group of run-of-the-mill
firms in the market. Following through on this line of reasoning, Charlie
Munger was clearly referring to compounders when he opined, “The big money
is not in the buying and selling…but in the waiting.” Historically, Panera
has been a compounder. The stock vastly surpassed the market because its
business value compounded at a very high pace, but this was not fully
appreciated by investors who undervalued the stock. We expected this track
record to continue.
Finding a winner
As we know, Panera made heavy forward-thinking investments over the past
several years (Panera 2.0, delivery, Panera-at-Home, Rapid Pick up etc.)
prior Pender blog post). The inflection point for the big payback was finally in sight. Panera
just pre-released their Q1/17 results, and its underlying store performance
was once again far ahead of its peers. The business is just starting to
fire on all cylinders. The tailwind from these investments and ongoing
business momentum would likely have carried the business (and the stock) to
much higher levels over the next five years or so. It could have been a fun
When investing in compounders, the most important part is to not stop the
compounding process, either by selling too early (by the investor himself)
or being taken out (by a third party like JAB). It’s as if Starbucks was
taken out in 2010 for an attractive takeout “premium” at the time, just as
its heavy investments was paying off and the business was taking off again.
Investors were probably better off letting Starbucks continue to compound
in value instead of taking a theoretical high bid at the time (e.g., a
three to four “bagger” over six to seven years vs. a one-time 30% takeout
premium in 2010). Unfortunately for public investors of Panera, the
compounding process for this wonderful business has now stopped. That is
why we find the news “bittersweet.”
Still, PNRA has provided a very satisfactory return since we first started
accumulating shares in late 2013. If we sold our stake today, we estimate
the IRR of our PNRA investments would be about 20% annualized vs 11% for
the S&P500 (note that the return would be even higher if measured in
CAD). The good news is that Panera was a high-conviction “best idea” for Pender – it is the largest holding in both the
Pender Value Fund
Pender US All Cap Equity Fund,
so it has definitely moved the performance needle in a positive way. Panera
was a gem. We thank Panera founder/CEO Ron Shaich and his team for their
superlative performance and wish them much luck with JAB. We are now tasked
to find a replacement for PNRA…
As a final word on investing in compounders, we are reminded of a quote by
investor George F. Baker. To make money in stocks you need “the vision to
see them, the courage to buy them, and the patience to hold them.” We would
only add that patience is the rarest of the three.
Felix Narhi, CFA, is Co-Chief Investment Officer and Portfolio Manager at PenderFund Capital Management.
He works alongside David Barr, Pender’s President, in setting the
direction of Pender’s overall investment strategy. Prior to joining
Pender in July 2013, Mr. Narhi spent over nine years at an independent
and value-oriented investment firm in Vancouver. As a Director and
Senior Equity Analyst, Mr. Narhi contributed thought leadership and
primarily US investment equity ideas to the company’s Model Portfolio,
a concentrated equity portfolio that has outpaced the North American
benchmarks since its inception in 1994. Mr. Narhi holds a Bachelor of
Commerce degree from the University of British Columbia. He earned his
Chartered Financial Analyst (CFA) designation in 2003 and is a member
of CFA Vancouver.
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