The Compounders Hiding in Plain Sight | Joseph Shaposhnik on Finding Decade-Long Winners
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Joseph Shaposhnik, founder of Rainwater Equity and former portfolio manager at TCW, discusses the investment approach that generated his long-term outperformance. The conversation centers on why durability matters more than multiple expansion: free cash flow per share, not price-to-earnings multiple expansion, is what physically moves stock prices over time. Shaposhnik built his strategy around recurring-revenue businesses—those with predictable cash flows and minimal reinvestment needs—because they allow concentrated portfolios (20–30 positions with large weightings) without the volatility typical of cyclical bets. The core thesis is straightforward: buy high-quality companies run by owner-operators fanatical about their mission, hold them through compounding cycles, and resist the impulse to have an informed opinion on every sector.
The episode ranges across the mechanics of selection and holding discipline. Shaposhnik revisits lessons from Warren Buffett, Bill Miller, and Peter Lynch, arguing the common reading of Buffett is wrong—his biggest winners (Coca-Cola, Washington Post, Apple) were high-quality recurring-revenue businesses bought at above-average multiples, not cheap stocks. He defines what makes a business worth owning: dominant market position in a non-discretionary product, embedded growth, and low capital intensity. Red flags include management teams that "proforma out" investments from their bonus metrics, CEOs with short tenures or weak track records, and businesses trapped as price-takers in commodity or macro-driven industries. A recurring theme is that even brilliant management cannot time their own stocks—he cites Nvidia executives selling $3 billion worth as shares fell 50%, then missing a tenfold recovery. The conversation also touches on why active management has become harder (real-time information pricing), why a stock that has already doubled may not be missed, and how to think about valuation as a trade between multiple paid and free-cash-flow durability gained.
Shapiro argues that sustained outperformance requires focusing on predictable, recurring revenue businesses with exceptional management teams, allowing winners to run without trimming, and avoiding the false discipline of benchmark-relative investing that forces low-conviction bets.
- Recurring revenue businesses with strong market positions provide predictability that enables better capital allocation and management decision-making
- Management quality and fanaticism matter more than valuation; exceptional people run exceptional businesses, and great businesses are built by people on a mission, not mercenaries
- Portfolio concentration (20-30 stocks) with high conviction bets outperforms better than large diversified portfolios diluted by low-conviction sector-mandated holdings
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You do not need to have an opinion on every sector or security—Joel Greenblatt-style humility ('I don't understand banks and I don't own them') is a strength, and the whole task reduces to getting in the way of a large, long wave of free cash flow growth alongside a great management team.
“From my perspective, all we're trying to do is get in the way of a large and long wave of free cash flow growth.”
Even the smartest management teams cannot predict where their own businesses will be—Nvidia management sold $3 billion of stock in 2022 as it fell 50%, then the stock rose tenfold a year later, leaving ~$30 billion on the table; and Broadcom's Hock Tan sold ~150,000 shares at $1.50 at IPO, with the stock now at $350.
“Nvidia went down 50%. And management sold $3 billion worth of stock in 2022 as a stock was going down. One year later, Nvidia was up tfold. and the management team, one of the smartest management teams in the world, left $30 billion of value on the table”
Joe Markel was comfortable stating he did not understand banks and therefore would not own them, demonstrating intellectual humility and circle-of-competence discipline; this is a valuable lesson that investors do not need to have an opinion on every sector and should not feel pressure to participate in sectors they don't understand.
“I remember vividly a year or two before the financial crisis. I got to meet Joe Maria Vear that I met many times since a legend in value investing world...at that lunch, very small lunch, he told us, "I don't understand banks and I don't own them." And I thought, "Somebody that has studied every business out there...was so confident and comfortable sharing with us. I just don't get the whole industry."”
The common lesson taken from Buffett—buy cheap and sell when dearer, don't overemphasize quality—is the wrong one; his biggest winners (Washington Post, Coca-Cola, Gillette, Apple, Cap Cities) were high-quality recurring-revenue businesses where he paid above-average multiples, while his mistakes (e.g., Precision Castparts) clustered in cyclical, hard-to-predict businesses.
“what people took from Buffett is buying inexpensive stocks and then selling them when they become more expensive... when I look at Buffett and I look at the big winning investments that he's made, it has consistently been in the recurring revenue highquality naturatured businesses. and where he's made mistakes, it has consistently been in the more cyclical uh more difficult to predict ends”
If a stock has doubled or tripled, you haven't missed it; a large prior move is often just the first act of a long play, especially when cash flow has followed the stock's rise—which provides a backstop against the price reversing.
“If a stock has doubled or even tripled, you haven't missed it. So many times people think that because they've seen a stock go up significantly, the story is over.”
The active mutual fund industry is broken largely because of an obsession with managing to the benchmark, which forces managers to hold low-conviction bets on companies they can't actually predict; these low-conviction positions add up and erode the gains from high-conviction picks.
“the uh mutual fund active equity management industry is broken and struggling. And the number one reason is this obsession with managing to the benchmark. And when you manage to the benchmark, you have to have an opinion on everything in the benchmark.”
Recurring-revenue businesses with little net debt and abundant free cash flow generate lower beta and smaller drawdowns, so they allow concentration (20-30 stocks, large positions) without the intolerable volatility seen in concentrated portfolios built on cyclical or leveraged bets; the old fund had ~0.95 beta despite large positions.
“If you invest in a business that has 75% recurring revenue, no meaningful amounts of net debt associated with it, abundant free cash flow generation, in a very strong position, you're not put into the same bucket as the managers that Hagstrom just described.”
It has become harder—but not impossible—to outperform, not because passive reduces active competition, but because information is now reflected in asset prices in real time, competing away short-term advantages and forcing genuinely active managers to be more long-term and conviction-driven.
“more information is being reflected more quickly in asset prices in real time than has ever been the case... which has forced us to be even more long-term with our orientation”
There is value in waiting to see a company perform—seeing the stock go up and the story play out—before buying, especially in the new-issue market; this poker-like accumulation of information (echoing Will Danoff) builds confidence that the story has long legs.
“I want to see the management team perform. I want to see the stock go up before I buy it. I want to see the story play out.”
The best lesson for the average investor is to buy good businesses rather than cheap ones; cheap stocks are often cheap for a reason (e.g., an over-levered chemical company with a difficult position is a value trap), and one should always err on the side of quality.
“the best lesson I could share with the average investor is to is to buy good businesses as opposed to buy cheap businesses.”
The ideal free-cash-flow-compounding business grows topline and FCF without heavy reinvestment—royalty/franchise models or software with pricing power tied to add-ons or inflation escalators—because the product is written once and monetized across many customers recurringly, especially as AI lowers software production cost.
“the ideal business is one that grows its topline and grows its free cash flow without requiring a lot of reinvestment. So, the ideal situation if we're going to get nerdy is the royalty business, the franchise business, uh, or the business that has pricing power on the existing product”
Value investing went wrong by overemphasizing current value and underemphasizing future value; the pendulum has now swung too far toward future value, but valuation properly weighs both. The discipline is to maximize free-cash-flow compounding obtained per multiple paid—willing to pay up to (but not above) the market multiple to get 2-3x the S&P's FCF compounding rate plus greater durability.
“value investing where it went wrong was an overemphasis on current value and an undermphasis on future value. And I feel like the pendulum has now swung to let's focus on future value maybe a little maybe to the detriment of investors”
Free cash flow is the fundamental driver of long-term stock price appreciation, and the best businesses are those that can grow their top line and free cash flow without requiring heavy reinvestment capital.
“our view is free cash flow is what physically moves stock prices. So if we can find businesses that are continuously improving free cash flow on a regular basis, we're going to stick with those businesses.”
Cheap businesses often appear cheap for a reason—fundamental structural problems like high leverage, difficult industry position, or failed acquisitions—and investors should investigate why a business is trading at a low multiple before assuming it's an opportunity.
“when I see what they present us in a press release or even more telling a management presentation or in an analyst meeting, whether it's 150 slide presentation, that immediately tells me what is important to them...I was a chemicals analyst for...more than for five years...I'd spent spent some time uh in that industry and it reminded me, you know, I I I was fortunate to be aware of how uh bad I should say that industry can be...I wasn't moved by the argument...that gez XYZ company is really inexpensive and has prospects for a turnaround. I wasn't moved by that because that company really is in a very very difficult position with a with a an overlevered balance sheet”
Will Danoff, a legendary Fidelity manager, approaches investing like a poker game where he seeks to reveal more information through managed experience before making decisions, modeling a patient, evidence-based approach rather than rushing to initial positions.
“I'm also reminded of uh what will Danoff talks about which is investing as much like a poker game and he's looking to gain more information as more cards are revealed uh on the table before he makes a decision.”
Quality businesses worth owning have three traits: a dominant (monopoly/oligopoly) position in a non-discretionary product or service, an element of growth that drives free-cash-flow-per-share, and low capital intensity—exemplified by stock exchanges, software, and aftermarket aerospace parts; a great position without growth only yields stable but non-appreciating equity value.
“We want to invest uh with a dominant position u in an industry or product that is not discretionary... You'll see us invest in stock exchanges, uh software companies, uh uh aftermarket aerospace parts where they have monopoly positions”
Free cash flow is what physically moves stock prices over time, so a business that continuously improves free cash flow per share will see its equity value follow—even if not immediately.
“our view is free cash flow is what physically moves stock prices. So if we can find businesses that are continuously improving free cash flow on a regular basis, we're going to stick with uh stick with those businesses.”
Investing only in recurring-revenue, predictable, cash-flowing businesses—to the exclusion of everything else—was a primary driver of outperformance because it lets you evaluate where a business will be in a few years and bets with management teams who have an 'easier hand to play.'
“we focused on what we thought we could predict which is recurring revenue, predictable growth, cash flowing businesses and we to the exclusion of everything else.”
Letting winners run rather than trimming to a fixed target weight (3-5%) is critical; allowing a position to grow from 8% to over 20% as cash flows grow captures nonlinear upside that most investors forfeit by mechanical trimming.
“At one point we had a 20% position for a number of years in the portfolio... those positions started at 8% positions and then grew to 20some percent positions. But we were willing to let those businesses become a large part of the portfolio because ca the cash flows of the company followed the growth of the equity value.”
The combination of fast machine-driven information processing, high passive participation, and few active thinkers creates opportunities: stocks drop 10-20% on slightly lowered guidance even when the underlying business remains healthy with growing recurring cash flows, benefiting investors who actually analyze fundamentals.
“I see the stocks dropping 10 20%. Because the guidance was lowered a little bit and if you actually look through the numbers, the business is still doing fine.”
The bar for adding a new position must be very high because you know your existing holdings well; a portfolio manager who buys an idea on the spot reveals how low their conviction in the rest of the portfolio is. New ideas should replace the weakest existing holding rather than expand the count.
“I always thought it was curious where you could bring an idea to a portfolio manager and they would buy it on the spot... your conviction is that low that you you're willing to bring something in that quickly.”
More active managers leaving the industry due to passive competition could theoretically make active management easier (less competition), but in practice this has not been observed; instead, the remaining active competition has intensified because information dissemination has accelerated faster than the rate at which managers have left the industry.
“I think that there are a lot of people who say passive is making active uh easier to perform because there are there is less active competition. Every day more active managers leave the market and more of this is being competed away by passive. That in theory sounds good but in practice that is not what I see.”
Incentive system design matters enormously for management alignment, but incentive systems cannot overcome a lack of intrinsic mission/fanaticism; well-aligned compensation paired with a mission-driven CEO generates exceptional outcomes, but even generous equity-aligned compensation cannot motivate a mercenary executive.
“There are the basic incentives that convince a guy to show up at 4:00 a.m. and open his bakery. And we're trying to apply that incentive to somebody that's on a mission running a big business. These folks that you described and many more that come to mind show up every day and do their best, no longer for a paycheck. They probably have never done a single thing really really for a paycheck unless they had to pay rent as a student. But since then they're on a mission doing things. And no matter what incentive system you set up, as long as it's not insulting to them, I think that's key.”
Value investing went wrong by overemphasizing current value and underemphasizing future value, causing an overweight to cheap, deteriorating businesses; the pendulum has now swung to emphasize future value to the detriment of investors who overpay; the correct balance is optimizing for free cash flow compounding for every multiple of free cash flow paid.
“I feel like value investing where it went wrong was an overemphasis on current value and an undermphasis on future value. And I feel like the pendulum has now swung to let's focus on future value maybe a little maybe to the detriment of investors because valuation is about I think mostly future value but also to some extent current value as well.”
He avoids businesses that cannot control their own destiny—price-takers tied to macro end-markets or commodity prices such as energy, financials, and utilities—because their fortunes hinge on factors that are difficult to predict.
“if the business is a price taker, energy, financials in a lot of ways, we're utilities in a lot of ways. We will shy away from businesses that can't control their own destiny and are tied to a macro uh end market or or or tied to a to an underlying commodity price that is difficult to predict.”
Bill Miller's exceptional record (beating the S&P ~13 years in a row) came from being dynamic—operating both a deep-value approach and rotating across sectors to find value, while also holding great winners like Amazon (since IPO) and Bitcoin for long periods.
“he could not just identify what was cheap and going to get better, but he could also stick with the great winners. So, he held Amazon for such a such a long period of time.”
Nvidia's management team sold $3 billion of stock in 2022 when the company's stock was declining 50%, and one year later the stock was up 10-fold, meaning management left $30 billion of value on the table—demonstrating that even the smartest management teams at the world's best companies cannot accurately time or predict their company's long-term trajectory.
“in 2022, Nvidia went down 50%. And that was just a couple years ago. Nvidia went down 50%. And management sold $3 billion worth of stock in 2022 as a stock was going down. One year later, Nvidia was up tfold. and the management team, one of the smartest management teams in the world, left $30 billion of value on the table in a very short period of time.”
Mean-reversion bears on S&P margins and returns have been wrong for 15 years; the changing economy may justify a structurally higher average multiple because US corporate returns and margins are at record highs and meaningfully above the rest of the world, though the US market is now more expensive and more concentrated than ever, warranting caution.
“There are folks that are in in the camp of mean reversion and they've been talking about mean reversion for the last 15 years. And if we had listened to the mean reversion crowd... we would not have performed very well over the last 15 years.”
The ability to eliminate losing positions quickly and decisively improves portfolio returns substantially, because holding onto mistakes compounds their damage, whereas fast recognition and exit reduces the drag on the overall portfolio.
“we were uh quick to eliminate losers. So if we thought we made a mistake, we were we we weren't ashamed to to make a change.”
Peter Lynch's approach to management meetings demonstrates the value of careful preparation and identifying the key swing factors (critical variables that will determine investment outcome) before entering meetings, allowing investors to ask precise, high-value questions and extract the most relevant information efficiently.
“His ability to get to the point with the with management to come in very prepared to the meeting and to get what he needed to get out of that meeting was as good as I'd ever seen. He was that good even at at his age. Preparation was incredible.”
Giving the management team time to execute strategy through inevitable bumps in the road is underappreciated; if investors are too quick to change their minds on positions, they never allow great leaders the opportunity to play out their strategy, which means portfolio managers must have conviction and patience to capture the full compounding benefit.
“if you have these other elements in place, you want to give the management team the time to execute the strategy and to go through the inevitable bumps in the road that are going to happen. And if we're too quick to change our minds on positions, we never give these great leaders the opportunity to to play the hand out.”
Businesses run by people, not by products or secular tailwinds; therefore, management quality should never be compromised even if a business has great products, strong tailwinds, or attractive valuation, because great execution requires great leadership.
“businesses are run by people. They're not run by businesses. They're not run by products. You could have great products, but without great people, it doesn't work. So for us, we tried not to compromise on management quality.”
The bar for adding a new idea to a portfolio should be extremely high—higher than the conviction level of most existing positions, because new additions displace existing positions and dilute the portfolio, so only ideas genuinely more compelling than what you own merit inclusion.
“what you own you know really well. So the bar for bringing something new to the portfolio needs to be really high. What you know you have high conviction in and you've diligenced a great deal.”
Observers have claimed for 15 years that mean reversion in S&P 500 margins, returns, and earnings growth is imminent, but this has not occurred, suggesting either that mean reversion is false or that the structural conditions have genuinely changed and do not require reversion.
“There are folks that are in in the camp of mean reversion and they've been talking about mean reversion for the last 15 years. And if we had listened to the mean reversion crowd on the index and on gross margins, returns, earnings growth, uh we would not have performed very well over the last 15 years.”
Constellation Software is a prime example of a stock that appears to have already compounded significantly (from IPO at ~$16 to $650) yet still demonstrates early-stage characteristics and continued strong free cash flow growth, validating the principle that past appreciation does not mean the opportunity is exhausted.
“I go back to my investment in Constellation Software in 2016. The stock had gone from I think it IPOed at around $16 a share to $650 when the geniuses from Los Angeles showed up to the annual meeting 10 years too late in Toronto to meet Mark Leonard and see the story for the first time.”
Hock Tan, CEO of Broadcom, is considered one of the smartest CEOs alive and has spent 20+ years building a small, dismissed aftermarket aerospace parts business (formerly called Vago) into a dominant semiconductor company through disciplined acquisition and integration.
“Hawk 10 I think is one of the great CEOs of our time, one of the smartest CEOs of our time...took a company out of private equity the way Hawkan did uh with what was called a Vago. It's this little teeny weeny uh uh semiconductor company that was kind of an afterthought passed around by private equity, but he got it and they had these nice positions and he spent the next 20 years building it.”
Mark Leonard, CEO of Constellation Software, exemplifies the fanatical operator who identified an opportunity in boring, unloved software businesses and spent his career building a world-class consolidator and operator in that space.
“Or Mark Leonard who saw this opportunity in uh boring and unloved software businesses and then spent his life building it. Those are our fanatical leaders.”
Exceptional investment returns come only from exceptional people—CEOs like Nick Howley (TransDigm) and Mark Leonard (Constellation) who are 'fanatics on a mission' with unusual backgrounds; ordinary people doing ordinary things do not generate extraordinary performance, so management quality should never be compromised.
“we haven't found that ordinary people can generate extraordinary performance by being ordinary. They have to do something unusual.”
A change of CEO can itself justify an immediate sale even when the business is thriving: he sold a position the same day a successful 50-year-old CEO unexpectedly retired and was replaced by a successor he judged weak—because durable businesses give you time to reevaluate and the move signaled a board not holding management accountable; the stock subsequently underperformed.
“they announce that this 50-year-old CEO is going to retire and that and they're going to promote the head of the the US business... That for us was a huge red flag. We sold the stock that day.”
A major red flag is management that 'proformas out' investments (e.g., a tech transformation) from their compensation metrics like EBITDA/operating income—they should have to live with investments just as shareholders do; similarly, acquisitions should be tied to return-on-invested-capital in compensation without being excluded.
“If the management team is going to make an investment they should have to live with that investment just like all of us do.”
What a management team voluntarily puts in its presentations and analyst materials—versus the mandatory SEC filings—reveals what is truly important to them and, cascading down, to their employees; a red flag is presentations where you can't find the right numbers (segment reporting, free cash flow, organic growth).
“what they have to report to to the SEC is required. They have no discretion over that. But what they put into their presentations invariably is what's important to them and then is what's import is what is presented to uh their employees”
Mission-driven CEOs work for the mission, not a paycheck, so the role of incentives is mainly to avoid insulting them rather than to motivate them; as long as compensation isn't insulting, such leaders will make long-term, hard-to-measure decisions that benefit shareholders over the next decade.
“no matter what incentive system you set up, as long as it's not insulting to them, I think that's key. As long as it's not insulting to them, they will show up and do their best”
Portfolio managers at large firms feel obligated to hold an opinion on every stock in their benchmark index, which causes them to make low-conviction bets that dilute portfolio performance, particularly when they are wrong about non-core holdings.
“What we found as portfolio managers as an analyst is our portfolio managers wanted to have an opinion on all of the companies in their index. All of them. And what I found is you can't have an opinion on every company in the index.”
Management teams often disguise poor capital allocation decisions (especially failed acquisitions and technology transformations) by selectively excluding those costs from their proforma compensation metrics, which is a major red flag for investor misalignment because it shows management is not holding itself accountable to shareholders in the same way.
“The flip side is when you've got a management team that is making decisions that they can proform out of their compensation measurements...they decide that while a lot of this is going to hit operating income and ibida you look at the proxy they're able to exclude it. That's a terrible sign. If the management team is going to make an investment they should have to live with that investment just like all of us do.”
Management presentations, press releases, and slides reveal what management believes is important about their business (as opposed to SEC-mandated filings), and careful analysis of which metrics management chooses to highlight indicates their true priorities and whether those align with long-term shareholder value creation.
“when I see what they present us in a press release or even more telling a management presentation or in an analyst meeting, whether it's 150 slide presentation, that immediately tells me what is important to them because what they have to report to to the SEC is required...But what they put into their presentations invariably is what's important to them and then is what's important is what is presented to uh their employees which is what now becomes important to their employees.”
The most durable assets—not the highest-projected-return businesses—should carry the highest portfolio weights; the highest-upside names may sit in positions five through nine, because the goal is the most durable outcome rather than the absolute best possible outcome.
“we don't have our uh highest projected return business as our largest position. We have what we think are our most most durable assets... with the highest waiting in the portfolio.”
A position taking 1% of the portfolio but half of your attention should be sold; the amount of attention a small position consumes is a signal that it doesn't belong.
“If you have a position that takes up 1% of your portfolio, but half of your attention, sell it.”
A company that has 75% recurring revenue with no meaningful net debt and abundant free cash flow generation will experience significantly smaller portfolio drawdowns compared to cyclical, leveraged, or competitively fragmented businesses, because the durability of cash flows provides a cushion that prevents catastrophic losses.
“If you invest in a business that has 75% recurring revenue, no meaningful amounts of net debt associated with it, abundant free cash flow generation, in a very strong position, you're not put into the same bucket as the managers that Hagstrom just described...taking large bets in situations they think will have asymmetric payoffs...could be in cyclicals, could be in businesses with a lot of leverage...Any one of them will hurt you and create the draw down. But put together two or three and they will destroy the equity value.”
Investors should not allow low-conviction, small portfolio positions (1% or less) to consume excessive attention and mental energy; if a position takes half your attention but only 1% of your portfolio, the asymmetry indicates misalignment and the position should be sold regardless of merit.
“a position that is 1% could take up 50% of your attention...And I learned the hard way, and hopefully people listening to this can take this lesson for free here. If you have a position that takes up 1% of your portfolio, but half of your attention, sell it.”
Preference for sector exposure should be based on where management finds recurring revenue, monopoly-like businesses with growth, not on a predetermined target allocation to each sector; this naturally results in high technology concentration because technology companies are more likely to meet the criteria of recurring revenue, non-discretionary products, and scalable cash flow.
“we have some sector exposures because we just naturally like certain sectors. they have these recurring revenue monopoly like positions that we gravitate to.”
Passive investing and index funds have made real-time pricing more efficient, causing information to be reflected in asset prices more quickly than in the past, which means active managers must become more long-term in orientation and rely more on conviction in management and business quality rather than short-term information arbitrage.
“I think it's become harder to outperform because I think more information is being reflected more quickly in asset prices in real time than has ever been the case...the pricing of businesses whether accurate in that moment in time may not be the case but the information is being reflected in real time which is changing the way information flows into prices which I think has forced us to be even more long-term with our orientation and our thinking because any short-term advantages I think are being rapidly competed away because information is so readily available and being so uh rapidly reflected in the share prices of businesses.”
Preferring to see performance and stock price appreciation before investing in a new situation—particularly in the new issue market—increases confidence in the thesis, allows managers to observe that management is executing on its strategy, and reduces the risk of investing in unproven concepts; this contrasts with buying early-stage concepts before proof points exist.
“Sometimes in my mind, and this may be even more controversial to say, I want to see the management team perform. I want to see the stock go up before I buy. I want to see the story play out. And then I have more confidence that this story has long legs, that I can feel confident that they are on the right path.”
The largest mistakes and missed opportunities in Warren Buffett's portfolio have been in cyclical, difficult-to-predict businesses (e.g., Precision Cast Parts), while his most successful investments have consistently been in recurring revenue, high-quality businesses with exceptional management (e.g., Coca-Cola, Apple, Capital Cities), suggesting that the key lesson from Buffett is the importance of business quality and leadership, not simply buying cheap.
“when I look at Buffett and I look at the big winning investments that he's made, it has consistently been in the recurring revenue highquality naturatured businesses...where he's made mistakes, it has consistently been in the more cyclical uh more difficult to predict ends of the ends of the spectrum.”
Even when stocks have doubled or tripled in price, investors often believe they have missed the opportunity, when in fact they are only witnessing the first act of a much longer value creation story that can continue for years or decades.
“If a stock has doubled or even tripled, you haven't missed it. So many times people think that because they've seen a stock go up significantly, the story is over. They should look elsewhere. And so many times that's just the first act to a very, very long play.”
Constellation Software, which IPO'd around $16 and had reached $650 by 2016, was bought despite a vertical-looking, 'scary' chart because free cash flow had followed the price move—demonstrating that a frightening run-up backed by growing cash flow is not a reason to avoid a stock.
“I go back to my investment in Constellation Software in 2016. The stock had gone from I think it IPOed at around $16 a share to $650... It was a vertical line going straight up like this”
TCW's New America Premier Equities fund generated 16.7% annualized returns versus the S&P 500's 13.1% over nearly a decade, ranking number one out of 343 peers, demonstrating the sustained performance of quality-focused, concentrated portfolio approach.
“TCW, New America Premier Equities. I mean, wild numbers. Really, really impressive. 16.7% annually versus the S&Ps, 13.1% over nearly a decade. Number one at a 343 peers.”
Most investors erroneously believe that trimming winning positions back to target weights is prudent risk management; in reality, allowing winners to run and grow as a percentage of the portfolio is key to long-term wealth accumulation.
“one of the limiting beliefs for investors maybe is the fact that the position once it runs up you have to trim it back to some target. People have 3% 5% whatever it is. But letting the winners run what you talked about, that's a lot of money left on the table by a lot of people.”
The best management teams have return on invested capital (ROIC) metrics in their compensation and are held responsible for acquisitions they make, not exempted from the metrics impact; this accountability creates alignment and ensures capital allocation discipline.
“The ideal situation is you have an element of return on invested capital uh as an element for man or as an element associated with management compensation and you don't proform of the deals out from that calculation. That's ideal. It rarely happens but some responsibility for the improvement of the or generating returns from the acquisitions is really important.”
The primary selling discipline is continuous evaluation of whether the three key investment tenants (recurring revenue, strong leadership, long-term holding orientation) remain intact for each position; if any tenant breaks down, the position should be exited.
“the selling discipline, the first thing that we're looking for is are we wrong? And we're often wrong. That's part of part of this business. And the key, I think, to to working with being wrong is try to identify that you're wrong more quickly and be more decisive with it. So, the first element of the strategy is of the cell discipline is we're constantly evaluating these businesses to to ensure that the three key tenants of the investment philosophy are being upheld.”
A critical sell signal is when a company's CEO unexpectedly retires young while the business is performing well, and the chosen successor is questionable; this indicates board dysfunction and poor capital allocation discipline, and was a red flag to immediately exit a previously held winning position.
“we were invested in a great company and this is several years ago and the CEO everything fit. CEO was great. He took them from a from being an underperformer as a private company. Took them public with the help of uh private equity. Did an unbelievable job. And we had studied the team. The position was great. And uh you know, one of the things that's important to us is to know the next layer of management. One, we want to judge how skilled they are at what they do. And two, in the event that one of them is promoted to CEO, we'd like to have an early read on whether they're good or they're not.”
Portfolio concentration between 20 and 30 stocks provides sufficient concentration to generate meaningful alpha while maintaining investor comfort with volatility and diversification; concentrating further (10 stocks or fewer) increases tracking error and drawdown risk beyond what most investors will tolerate.
“we're keeping the portfolio concentrated, not too concentrated, between 20 and 30...I feel very comfortable with that and I feel like investors can get comfortable with that 20 to 30 range as opposed to going lower which is 1 to 10...you get more concentrated there.”
Investors should avoid businesses that cannot control their own destiny because they are price-takers subject to macro cycles or commodity prices that are difficult to predict; examples include energy, many financial services, and utilities where the business outcome depends on external factors rather than management execution.
“We don't really want to be in in a business that can't control its own destiny. And so if the business is a price taker, energy, financials in a lot of ways, we're utilities in a lot of ways. We will shy away from businesses that can't control their own destiny and are tied to a macro uh end market or or or tied to a to an underlying commodity price that is difficult to predict.”
Successful investment requires identifying management teams that are 'fanatics' on a mission to build their business, not 'mercenaries' seeking short-term gains; Buffett explicitly described looking for fanatics as managers, and the greatest CEOs are defined by their passion and mission rather than compensation.
“Buffett talked about in an address he gave in I think the 1980s looking for fanatics as his managers. So we look for fanatics and not mercenaries.”
Peter Lynch, still active in his older years, remains intensely prepared and curious—running management meetings by going straight to the swing factors—and continues to favor 'build once, replicate across the country' physical business models (restaurants, retail) and new issues, while being macro-aware but not macro-driven.
“he likes those build once and then replicate across the country physical business models like restaurants and and retail stores.”
The valuation approach should optimize for free cash flow compounding relative to the price paid; investors should target mid-teens rates of free cash flow compounding for individual portfolio holdings in order to achieve mid-teens equity value compounding at the fund level.
“we target a mid- teens rate of free cash flow compounding for the individual businesses in the portfolio because our goal is over the long run to deliver a mid- teens rate of equity value compounding for the fund that we manage.”
Portfolio positions should not start above 10% weight; instead, they should start smaller (e.g., 8%) and be allowed to grow naturally as the underlying business compounds, eliminating the need to set positions and hit size targets, which forces mechanical rebalancing divorced from business fundamentals.
“our view is we shouldn't have to have any positions started at above a 10% weight. And so we're starting positions below a 10% weight. We're going to be willing to allow the winners to to win and to run.”
A 20-30 stock concentrated portfolio with positions started below 10% weight provides enough concentration to generate meaningful alpha (the old fund delivered ~350 basis points of alpha after fees) while remaining diversified enough for investors to stay comfortable.
“we don't have to have any positions started at above a 10% weight. And so we're starting positions below a 10% weight. We're going to be willing to allow the winners to to win and to run.”
Current US market margins and returns on capital are at the highest levels in history, which could justify a higher valuation multiple for the S&P 500, but this does not mean all stocks deserve current valuations; individual stock selection remains critical because not all businesses can sustain current margin levels.
“today margins on the S&P 500 are are the highest they have ever been. Returns are are at at rates that they as high as they have ever been.”
Bill Miller is a value investing legend who achieved 13+ years of consecutive outperformance against the S&P 500 by combining deep value investing with the ability to hold long-term winners; he can identify both what is cheap and what will get better, and rotate across sectors while maintaining conviction in exceptional companies like Amazon.
“he's one of the value investing legends of the last 25 years...beating the S&P 13 years in a row or something along those lines. But he could also not just identify what was cheap and going to get better, but he could also stick with the great winners. So, he held Amazon for such a such a long period of time.”
In situations where management is invested significantly in equity value (has meaningful skin in the game), investors can offset concerns about acquisition track records, because personal financial incentives often align management with shareholder outcomes even without explicit return-on-invested-capital clauses.
“You can offset that by investing with teams that are invested in the equity value of the of the business itself. That can help as well.”
Peter Lynch is particularly interested in small-cap businesses and continues to identify the same business models that worked when he wrote 'One Up on Wall Street'—physical businesses that can be tested in one location and then replicated across the country, such as restaurants and retail stores.
“he sees opportunity sees the opportunity in focusing on small caps. So, he spent a lot of his time uh on small cap businesses. He likes some of the same themes that he liked when he when he wrote the book One Up on Wall Street...he likes those build once and then replicate across the the country physical business models like restaurants and and retail stores.”
Peter Lynch shows surprising value orientation and valuation sensitivity, which somewhat surprised Shapiro given his historical focus on growth investing, suggesting Lynch's approach has evolved toward greater valuation discipline.
“His uh value orientation also surprised me. He certainly was more more valuation sensitive than than I had uh remembered.”
Peter Lynch is warm and pleasant to spend time with despite his intensity and competitiveness; he spends significant time with family and on travel/life enjoyment, demonstrating that intensity in work does not require sacrifice of personal life.
“despite his intensity, his competitiveness, he you know spends a lot of time with his family and spends a lot of time going on trips and enjoying life and uh was just the the warmest human being and just such a pleasant person to be around for for for half a day out in Los Angeles.”
Rainwater Equity, Shapiro's newly launched fund, is structured as an ETF with Bill Miller as a cornerstone investor, leveraging Miller's validation of the strategy and providing a more accessible vehicle for investors to access this concentrated, quality-focused approach.
“We're we're just honored and and and pleased to to have his support. Uh you know, I think it's very difficult to put Bill Miller in a box. Uh you know, he's one of the largest shareholders of Amazon and has held Amazon since the IPO.”
Peter Lynch continues to be deeply engaged in investing even in his later years, demonstrating great passion and fire for stock-picking with a team of analysts working with him.
“he's very curious and very passionate about uh stockpicking even in his uh older years these days.”
The firm is named Rainwater because rainy days, being rare in Southern California, are the ones the team enjoys most.
“rainwater are the days that we enjoy the most because they come so rarely.”