100 Baggers: Stocks that Return 100-1 w/ Chris Mayer (TIP543)

Owner-operator CEOs and executives with substantial stock ownership exhibit different behavior patterns than hired-hand CEOs, particularly during crises when they continue investing in the business while hired hands may pull back to preserve their jobs.

“You know, the behavior of people who own a lot of stock is just different and especially comes out in times of crisis. And there's different studies for this that show that they all invest and continue to invest even during downtimes where a more hired hand CEO might, you know, kind of pull back and wants to preserve his job, doesn't want to be called in a question.”

Constellation's decentralized M&A model, where acquisition authority is distributed across six operating units and even within those units to specific managers, is remarkable and represents a level of decentralization that few companies have successfully replicated.

“So it's really, you know, farmed out to these six groups and even within those groups and there's certain MNA, the ability to MNA. So it's a very decentralized. Which is remarkable. I don't know that anyone has succeeded to quite the extent Constellation has with that model.”

Old Dominion Freight Lines, an owner-operated company, continued opening new distribution centers even during weak trucking market periods when competitors did not, demonstrating superior capital allocation discipline.

“like Old Dominion Freight Lines is a business I own and I've continued to invest in opening new distribution centers, even when the trucking markets are weak and where their competitors don't.”

Thomas Phelps' 1957 book '100 to 1 in the Stock Market' inspired Mayer's research and motivated him to update Phelps' study with contemporary data and analysis.

“he mentions a book by Thomas Phelps called 100 to 1 in the Stock Market. And I was an investing junkie... and I'd never heard of that one. So I got it, and you know, I really loved it.”

To achieve a 100-bagger, you must compound capital at 20-25% annually for 20-25 years, and almost all 100-baggers took a long time to get there, with most taking 20-25 years.

“like most of them were 20, 25 years it took to get there and to do that, you have to compound capital at 20 to 25% a year for 20, 25 years and that gets you your 100 baggers.”

Individual investors do not need to beat the market directly as a goal; rather, beating the market is the end result of a good investment process, and hybrid approaches combining index funds with active stock selection for higher returns are viable.

“I don't know that you necessarily want to make, like be in the market your goal right off the bat, because it's kind of like saying you want to be happy. It's just not a goal you go at directly. It's the end result of a good process and also you don't have to do it whole hog. If you were an individual investor, you could take some of your money, put it in index fund and leave it there, and then put some other part where you're trying to do better than that by studying businesses and doing, as you suggest, trying to buy the winners.”

Mayer has done extensive work on Constellation, including talking to people who have worked there, and believes it is 'supremely rational' with focus on return on invested capital and growth rates at its heart, and with strong incentive systems requiring executives to buy shares with portion of bonus.

“I've done a lot of work and I've talked to a lot of people who've worked there, and I think it's a supremely rational place, really driven by all the things we're talking about. I mean, return on invested capital and growth rates at the heart of the incentives there. So, yeah that's the gist of it. I mean, there are a number of interesting markers. Like they have the same number of shares outstanding now as they did when they went public.”

Constellation has a database of over 100,000 potential M&A targets and made approximately 134 acquisitions last year, creating a discovery problem where identifying good targets is the challenge, not finding acquisition opportunities.

“I mean, I think their database, from what I've heard, is over a 100 thousand names. So suddenly, you know, context, I think they bought 134, something like that last year. So suddenly in the context of over a 100 thousand names, maybe 134 doesn't sound.”

Great companies often trade at higher valuations and premium multiples, but even at these elevated valuations, if an investor is correct about the business fundamentals, the investment can still produce 10%+ compound annual returns over decades, as demonstrated by Terry Smith's analysis.

“I always think of those little exercises like Terry Smith is famous for doing, where he looks at a company and then he rolls back 20 years and shows you what you could have paid and still made and still earn whatever 10% compound return. And the PE multiples are always really high.”

Incentives drive human behavior and outcomes, as famously stated by Charlie Munger: 'Show me the incentive and I'll show you the outcome,' making understanding incentive structures critical to predicting business behavior.

“I mean, but my Munger's famous quote on that is show me the incentive and I'll show you the outcome.”

Winners in business tend to keep winning because they possess competitive advantages and moats that persist, making it easier to invest in companies that are already winning rather than trying to pick turnarounds or identify emerging winners from scratch.

“that the winners tend to keep winning. There's always, again, there's always exceptions, but it's easier. You know, I was saying kind of joke with the end, you're just buying, you're buying a chart that goes up into the right. You want to keep going up into the right. But that's what tends to happen. The winners do tend to keep on winning again, because they have some competitive advantage and something special, and then they keep doing it.”

Copart's moat is rooted in the real estate it owns and accumulates over a long period, plus network effects from having many buyers and sellers of salvage vehicles on its marketplace, making it difficult for competitors to replicate.

“Copart is a name I own. I always mention it because it seems to be a good example of a company that has a moat, has basically one other competitor, Insurance Auto Auctions but it's competitive advantages really rooted in the real estate that it owns and accumulates over a long period of time. And then the network effects of having all these different buyers and sellers of salvage cars, salvage vehicles on their marketplace and so that becomes very difficult for competitors to crack over time.”

When Mayer opened his fund in 2019, he initially held some positions in value and special situations, but has gradually shifted to a 100% focused strategy of owning only high-quality companies held for the long term, with no interest in deep discount value or short-term trading opportunities.

“But it took a while. I was kind of slow to go that way entirely. Cause even when I opened my fund in 2019, I was still, I still had some positions that were like some of the parts or deep value kind of, or special situations. And it's only, you know, it's gradually over time it's been pushing more and more to just doing the, finding some high-quality companies I can just own for a long time.”

There is strong academic research showing that diversification benefits roll off quickly, with research suggesting that 6-8 stocks to 10-12 stocks capture most diversification benefits, and that owning 25 stocks is not necessarily safer than owning half that number if the quality is right.

“There's a lot of different research. I forget, you know, I remember Joel Greenblatt he said something like six to eight. You know, there's other ones that say 10 to 12, whatever the number is. The advantages of diversification roll off pretty quickly. Certainly you capture almost all of it benefits up 20, probably at 80% or so, maybe more with even. So I'm more comfortable with that because, you know, I can get to know those businesses really well.”

Constellation's M&A teams are highly data-driven and strictly adhere to hurdle rates on acquisitions, for example rejecting deals at 24.8% expected return when their 25% hurdle rate has been set.

“the, they, how data driven they are, how they really stick to their hurdle rates on these acquisitions. So that definitely stood out. I mean, I remember l you know, if it's a 25% hurdle rate, if you have a deal it's 24.8 then no go.”

For Constellation, the critical long-term questions are whether its moat is durable and whether it has significant remaining growth runway, which are knowable through analysis of the target database size and confidence in Mark Leonard's capital allocation ability.

“I think the big if for me with Constellation is their moat and their growth runway. I know that the management team is going to do right by shareholders. They're going to try and take advantage of them. They're never going to budge on their hurdle rates and they're going to be transparent when they think the returns are going to be lower on their acquisitions going forward.”

Berkshire Hathaway has kept growing and growing for decades despite skeptics saying for years that it had run out of room to grow, suggesting that companies led by great capital allocators like Leonard can sustain growth longer than conventional forecasts predict.

“people said the same thing about Berkshire for a lot of years and just kept going and going. So, I suspect we have a lot of time left on Constellation.”

Cyclical businesses, such as oil and gas companies that appear to have high returns on capital, should be excluded from 100-bagger consideration because their strong returns are driven by temporary favorable market conditions rather than durable competitive advantages.

“So naturally excludes a lot of things that are very cyclical. You know, you might have some obvious examples, we say you have oil and gas coming, it's earning great returns, but that's only because it's we're at a good spot and the oil cycle, for example, that might not always be the case, right?”

A CEO's capital allocation decisions determine where approximately 60% of a company's capital is deployed over a 10-year period, making capital allocation skills a critical component of management quality.

“over 10 years, a CEO determines where 60% of capital of the business is employed. Something crazy like that. So capital allocation makes a big difference”

Mayer underwrites to at least a 15% compounded return target (doubling in 5 years, quadrupling in 10) using reasonable assumptions about return on capital and reinvestment rates to estimate future compounding.

“Yeah, I mean, I try to underwrite to at least 15% compounded, so double over five, quadruple over. And that's, you know, with what I think are reasonable assumptions for the business”

There are exceptions to the rule that insider-owned companies outperform, with examples of businesses where insiders owned significant stock but still treated minority shareholders poorly, but by and large, insider-owned companies represent the better 'fishing ground' for long-term investments.

“I'm sure we can all come up with it. Examples of businesses where the insider owned a lot and you know, still treated minority shareholders very. But by and large, when we look at the good place to fish, you know, by and large the populations of insider owned companies tend to outperform.”

Copart's competitor Insurance Auto Auctions paid dividends to investors while Copart reinvested its cash, and over the long term this capital allocation difference drove Copart's market share from roughly 50/50 parity to 60/40 dominance.

“Copart and its competitor, where the competitor was paying out dividends and Copart was keeping the money internally and reinvesting. And the difference in their returns, just like is astounding over time.”

Constellation has maintained the same number of shares outstanding since going public, representing a disciplined capital allocation approach that focuses on earnings per share growth through operating improvement rather than dilutive buybacks or acquisitions.

“Like they have the same number of shares outstanding now as they did when they went public. Just the track record of compounding free cash flow per share.”

Constellation has shown strategic flexibility by exploring alternative growth vectors beyond core M&A, including horizontal market software, vertical market expansions, and previous spinoffs like Topicus, suggesting multiple paths for future value creation if acquisition opportunities decline.

“I mean, they have other avenues. We saw the way they did the All scripts deal, we saw how they did the spinoff with topics they're doing another. So, yeah you know, I've heard they could go in the horizontal market software, they could go into another vertical.”

Topicus, a Constellation spinoff, is roughly at the size Constellation was in 2010-2011, and operates in Europe which is slightly less competitive than North America, with local language and regulatory knowledge advantages that position it well for growth.

“I think that's about right. I mean, they're focused more on Europe, and Europe is a little less competitive than North. And Topicus has some advantages there being in those individual markets, having local people there that speak the language, know the rules.”

Old Dominion Freight Lines, founded and operated by the Oden family starting in the 1930s with a single truck lane, represents a multi-generational family business with an interesting corporate story told in a book about their history.

“old Dominion also has a very good story cause they're the Conden family and they've started back in the thirties with like a single truck lane and there's also a book they have that tells their corporate story.”

When insiders own substantial stock in a company, they are naturally aligned with minority shareholders by virtue of owning the same asset, creating better incentive alignment than any governance mechanism can achieve.

“the incentives are just more aligned naturally when you have, when you're investing with people who have a lot of stock of their own, they're already on the same side as you, just naturally by the fact that they are paying so much stock.”