Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
By dint of a devilish deal, the hero Westley is dragged down into the pit of despair in the 1987 movie The Princess Bride. When the villain's henchman explains his fate, Westley responds by saying that he can cope with torture. The henchman shakes his head and says, "nobody withstands the machine."
The capacity to suffer for a good cause is admired in heroes. But it also happens to be a quality that money manager Thomas Russo, of Gardner Russo & Gardner, looks for when selecting stocks. He's a devotee of Warren Buffett and seeks out high-quality businesses – that can withstand a few sword fights – with the view to holding them for the long term.
I first met Mr. Russo in 2013 when he visited Toronto to talk at Dr. George Athanassakos' annual Value Investing Conference the day before that year's Fairfax Financial annual general meeting.
After his talk, he graciously agreed to stay on for a long time to answer a barrage of questions from the crowd.
More recently, he gave a talk at Google and his speech was posted on YouTube. It's part of a series of lectures on investing organized by Saurabh Madaan that you can find on the Talks at Google page. Mr. Russo took the opportunity to expound on the notion that firms should have the capacity to suffer – when it makes sense to do so – and that relatively few North American firms can stand even the slightest bit of pain these days.
Problem is, CEOs of publicly traded companies are typically rewarded with stock options and therefore have an interest in seeing their company's shares march relentlessly higher. That becomes an issue when a firm can spend money today that will likely pay off handsomely over the long term. Even if a CEO were inclined to take a short-term hit, an activist investor might quickly knock at his door and demand an end to the expenses – or else.
Take the recent experience of Target in Canada as an example. The firm made a huge and costly push north of the border, ran into trouble, and then didn't have the fortitude to stick around and make it work.
Indeed, it didn't take long for a new CEO to be ushered in and he got with the program. The firm fled the country and in doing so burned up more than a little goodwill from former Canadian suppliers, employees and customers on its way out.
Nonetheless, the lesson is clear from a CEO's perspective. If you do something that isn't instantly profitable, your job is on the line. A heap of stock options makes management even more focused on the short term at the expense of the long term.
To protect against this sort of behaviour, Mr. Russo looks for companies where a shareholder, typically a founder or a founder's family, has a controlling interest. The management of such firms can take on short-term pain – for a good cause – without the fear of being replaced.
Mind you, such an approach isn't without its pitfalls. After all, some controlling shareholders are greedy and should be avoided by investors.
It's a danger that, frankly, Canadian investors know only too well.
In the end, Mr. Russo favours firms with strong consumer brands and likes many European names. His portfolio also tends to be concentrated and almost 70 per cent of it is in 10 stocks. They include Berkshire Hathaway, Nestlé, MasterCard, Philip Morris International, Wells Fargo, Heineken, Cie Financière Richemont, Pernod Ricard, SABMiller and Anheuser-Busch. (For what it's worth, I own some Berkshire Hathaway and Philip Morris myself.)
Take the time to watch Mr. Russo's talk. It will help you become a better investor. Afterward, if you don't already know, you can find out how Westley meets his end.
Norman Rothery