Is beating the pros possible? Yes! In this six-part series, Jason Del Vicario, CFA, portfolio manager, and Steven Chen, MBA, analyst, at HillsideWealth | iA Private Wealth Inc. explain why - and how - a concentrated portfolio of global high-quality stocks gives the long-term investor the best chance to outperform both broadly diversified indexes as well as professional money managers.
“Over the long term, it is hard for a stock to earn much better return than the business which underlies it earns.”
-Charlie Munger
“The person that turns over the most rocks, wins the game.”
-Peter Lynch
In the first three articles of the series, we presented our case as to why we feel investors who seek to outperform professional money managers and broad indexes be singularly focused on owning a concentrated portfolio of high-quality and predictable businesses and holding them for the long-term.
How to beat the pros, Part 1: Choose the right number of stocks to hold
How to beat the pros, Part 2: Simplify by focusing on stocks of high quality
How to beat the pros, Part 3: Identifying high-quality stocks
We then outlined the framework we employ to find and analyze high-quality/predictable business models. To reiterate, we define ‘quality’ as the predictable ability for a business to generate superior returns on capital over time.
How to beat the pros, Part 4: A Canadian stock we think will continue to outperform
How to beat the pros, Part 5: Two stocks you never heard of that fit our investing strategy
In this sixth and final installment, we highlight Kakaku.com (Ticker: KKKUF). We have held Kakaku.com since March 2020. It represents the seventh largest equity holding at Hillside with about a 5% weight.
What does the company do?
Kakaku.com provides purchase support, restaurant review and other services in Japan. The company operates kakaku.com, which is Japan’s largest price comparison site. They also operate tablelog.com, which is Japan’s largest restaurant search, review, and reservation site. In addition, the company operates smaller sites with varied focuses from movies, to travel, real estate and financial services.
Location, history & size: Kakaku.com is headquartered in Tokyo, Japan. The company was founded in 1997 and publicly listed since 2003. The company has 1,300 employees and a market capitalization of C$4-billion.
Business discussion: Kakaku.com is essentially a platform development and management business. In discussions with management, they told us they are patient with new ventures and gauge success by the number of unique users and user stickiness. They would be pleased if 10% of new platforms reach similar success as kakaku.com and tablelog.com. They prefer organic growth over acquisitions. We believe that kakaku.com and tablelog.com benefit from the ‘double sided network effect’ competitive advantage. Looking at tablelog.com, users are attracted to the site because they have 65,000 restaurants in their database and restaurants are attracted to the service because tablelog.com has the most amount of traffic. This creates a virtuous cycle where the value of the network grows as user/restaurant engagement rises and creates a formidable barrier to entry. However, as noted above, the ‘moatiness’ of large platforms cuts both ways in that it also makes it difficult for Kakaku.com to successfully spawn new platforms.
Capital allocation discussion: Platform businesses are asset light; but for employee salaries they do not require much capital to develop, maintain and grow. If successful, as Kakaku.com has been, these businesses can spin off healthy and growing levels of free cash flow. On its own this isn’t enough for us to get involved unless management has shown and continues to show effective allocation of excess capital. We have turned over a lot of rocks in Japan and we have concluded that, despite there being a number of excellent businesses in the country, most are ‘passes’ for us because they lack efficient capital allocation frameworks. We typically see Japanese companies either let cash pile up on the balance sheet (all things being equal this reduces the return on capital), conduct ineffective M&A (not unique to Japan) or set up venture arms. Kakaku.com is one of the rare companies in Japan that has clearly demonstrated the desire and history to return excess capital to shareholders, through a mix of buybacks and dividends. Not only this, but they are one of the rare companies on the planet with a stated return-on-equity goal… 40% no less. Kakaku.com is no longer founder run/owned (although the chairman owns a sizeable stake vicariously through the Digital Garage holding) and so we asked how or why they have a return on capital target. They responded ‘it was set as a target early, worked well in the past and we don’t see the need to change it’… music to our ears! While most of the free cash flow is returned to shareholders, they do re-invest a portion (20% average) and earn strong incremental returns.
Culture: Naturally, Japanese and Canadian cultures differ. However, in our discussions with the company they strike us as customer centric, conservative, frugal and return on capital focused. Culture is important in any company but particularly for the few we own that are not founder run/owned, as the risk of poor governance rises in the professionally managed company setting. While Kakaku.com is on their third CEO since founding, we have been satisfied that current management and board will continue to steward the company well going forward.
Financials, valuation & stock performance: The long-term performance of a company’s share price will generally mimic the payout adjusted long-term returns on invested capital of the enterprise. For example, a company with a steady return on equity of 25% that pays out 50% of its returns as dividends will see its share price rise about 12.5% over time. If it never paid a dividend the stock price appreciation would be 25%. We recommend reading these last two sentences a few times.
We’ll call out a few highlights from the table below:
1) Revenues have increased 7x since 2008 while FCF has advanced 10x and the stock price 7x.
2) The stock price has advanced 7x with the difference between FCF and stock price ratios explained by dividends received and company share increased (via buybacks).
3) CAPEX as a % of revenues has been consistently low and increased only 5x.
4) Price/free cash flow has generally fluctuated between 20-40 and is currently 22x.
5) Financials were affected during the pandemic which makes sense given tablelog.com’s end customers (restaurants) being severely impacted.
The return on equity has averaged 40% which speaks to their capital efficiency and return on capital target. Current multiple of 22 is reasonable both in historical and relative contexts.
Noteworthy: Whenever we discuss foreign companies, we are always asked about the investing mechanics. We own shares directly on the Tokyo exchange and Asian stocks have numerical symbols; Kakaku.com’s is 2371. A thinly traded OTC ADR in the US (KKKUF) exists but the lack of liquidity render this security un-investable, in our view. There is also the language barrier; fortunately, Kakaku.com does have English investor relations but when we conduct calls with Japanese companies to deepen our understanding, we hire a translator. Japan is a developed economy with a securities exchange to match.
Risks: No business is perfect and without risk. We have concerns about the lack of insider ownership. We feel there is a low degree of ‘hit-or-miss’ risk as they would need to keep launching platforms/verticals to maintain above average growth rates. Lastly, the business was affected by Covid and there is a risk they can’t re-capture their pre-Covid financial performance levels.
Further Learning: Kakaku.com does not attract much attention in North America but below are a few resources discussing the company in detail and the company’s English investor relations website.
Hillside Factory Focus – Kakaku.com
This wraps up our series - we hope you found it informative and that it leads to greater investing success. We will return with future columns highlighting other specific stocks we like and that adhere to our strategy.
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