A good stock picker in a good setup is a powerful combination – Learn about both in the interview with Henrik Stang Heffermehl

Henrik Stang Heffermehl is the portfolio manager at Oslo-based Park Lane Family Office. He talks about how he invests and discuss two of his holdings. Heffermehl’s investment writeups in the online investor community SumZero has earned him a spot among the top-performing members on multiple occasions. He mostly focuses on smaller companies with little or no analyst coverage. You can also learn about the family office’s interesting and differentiated setup – for example, the 10-year bonus period.

You have an unusual background and seem very passionate about investing. How did you get interested in investing, what motivates you, and how did you get where you are today without a typical finance education?

“I initially became interested in investing because several friends started working in finance, and their interest rubbed off on me somehow. After I started to read more and invest on my own, I was hooked. I quit medical school, which wasn’t an easy decision, and started to work as a stockbroker in 2007 (here you get a sense of my timing skills). I was already in my mid-twenties at this point, so I felt I was way behind my peers when I started to work in the industry. I suppose that made me work extra hard – I worked long hours and read everything I could get my hands on regarding investing, no filter, just plowing through whatever I could find.”

“I was also lucky to have generous colleagues who gave me a chance to prove myself without the proper background. They were willing to take me under their wings and share their own knowledge and experiences. I’m very grateful for that. I doubt a med school dropout with zero relevant work experience would get a chance in the industry today, it feels like it’s much more difficult to get a foot in the door now.”

“Some of the early reading experiences from that time were important and left a lasting impression. For example James Montier’s Value Investing, Margin of Safety by Seth Klarman and Value Investing: From Graham to Buffett and Beyond by Greenwald. I was also really inspired by the Market Wizards books by Jack Schwager. Some other titles maybe not so much – my expertise in outdated statistical arbitrage models or Japanese candlestick charting techniques hasn’t really come in handy on many occasions. But it was fun and exciting and something to do at the time. I remember thinking how amazing it was that almost everything could be relevant somehow and that there were so many different approaches to investing.”

“I’m better at filtering information now and I work normal days. I find having a proper work-life balance is more important for good decision making than working late nights. I still like to solve the puzzle so to speak, so I suppose that’s what motivates me more than anything else. I just really love the job. Paraphrasing Peter Cundill, there’s always something interesting to do. I also like the idea of financial independence, so I would be lying if I said that money is only a way of keeping score or something like that. But it’s about building something for the future for my principals and myself, not about having more spending money today.”

Can you tell us a little about the setup at Park Lane Family Office and give some examples of how you have structured it to improve your chances of delivering attractive long-term returns?

“We have a few important structural advantages, I think. First of all, I work at a private company for a single family and we are located on the same floor of the same building, so I don’t have to spend much time on investor contact and marketing, formal reporting, etc. All my time can be spent on finding good investments. I have a board which must approve my investment recommendations. That acts as another hurdle for decision making which I think is good – this obviously depends on an alignment of investment philosophies; otherwise the only thing to come of it would be conflict.”

“Our mandate is very flexible, which provides a large opportunity set. Since we are not a fund and subject to certain sizing rules such as, for example, a UCITS fund, we can concentrate our investment efforts in a few good companies, which I feel lets my best ideas count. I mostly focus on smaller companies with little or no analyst coverage since I believe the opportunity for meaningful outperformance is greatest in this space. But all else being equal, I prefer larger and more liquid stocks whenever possible.”

“In terms of incentive structure, we have chosen a model which rewards my efforts as a portfolio manager over a very long time frame. I don’t know anyone else who has a 10-year bonus period. I only get a bonus if I outperform a high single-digit compounded annual hurdle rate over a 10-year timeframe. If I achieve this, I receive a generous share of the accumulated portfolio gains. It helps the family focus on the long term rather than the short term and allows Park Lane to consider ideas that may be uninvestable for other market participants due to poor liquidity, asset-liability mismatch risk, high volatility, and so on. So, it’s a win-win for all parties in my opinion.”

“Do we have an edge? Maybe. Time will tell. So far, we’ve done pretty well, but we’re only 5 years in. Ask me again in another 10 or 15 years! The way I think about it, there are three main sources of edge: Analytical/informational, structural, and behavioral. Starting with the analytical/informational: There’s nothing special about the stuff I read or the way I think about investing, really. We all read the same material, and lots of people follow the Buffett/Munger intellectual framework. Though that style probably gives you a small edge versus many other market participants, I think it’s when you combine that approach with the right structure – that is, the right investment vehicle, one with very patient capital and a flexible mandate – that you can hope to achieve something really great. My investment philosophy and that of the family I work for is well aligned in this sense, I think that is key. Thinking long term underpins everything they do.”

“Finally, there’s the behavioral aspect. So, we assume you’re using intellectually sound analytical tools and that your investment vehicle is well structured. How do you increase the odds of doing the right thing, of making the right decisions on a day to day basis? I think it’s important to structure investment activities so that they suit your personality. If you’re somewhat introverted and you don’t like stress (like me) – make sure you’re not working in a hectic, stressful environment. Conversely, if you thrive on action and you’re a gregarious person by nature, don’t sit in an office by yourself all day. I think that will lead to bad decision making.”

“It’s important to know what suits you, to try and be aware of one’s own strengths and weaknesses and to create an environment that is conducive to emotional discipline. As Adam Smith wrote in The Money Game: If you don’t know who you are, the stock market is an expensive place to find out.”

Do you consider opening for outside investors in the Park Lane Family Office?

“We may open to outside investors if we found a suitable structure and their investment philosophies and investment horizons are well aligned with ours.”

Can you describe your overall investment philosophy and talk about what kind of companies you typically invest in?

“Over time I’ve become most influenced by the later-stage Buffett/Munger style and Greenblatt. I guess I’ve evolved from a Graham-like focus on discount to liquidation value/hard assets to a focus on economic moats, high returns on capital and growth prospects. Graham is still a major influence though. The exact style mix in the portfolio varies with the opportunity set available.”

“Ideally, I’d only invest very long term in companies with strong economic moats and a proven track record of profitability, companies that can reinvest their profits in their primary businesses for further growth and long-term value creation. LVMH (MC:FP) would be a good example of a company in this category.”

What is the investment case for LVMH?

“LVMH is the world’s leading luxury/aspirational brand company. Its brands have timeless appeal and will continue to symbolize success and wellbeing for future generations. Over time, the global upper middle class will grow in size, that’s as close to a certainty as you can get in this business in my opinion. As such, the company should have a long if not indefinite growth runway ahead, albeit at a moderate pace and with growth pauses sometimes depending on economic cycles. I don’t see any compelling reasons why LVMH can’t continue to grow earnings at a mid to high single-digit pace for a very, very long time. LVMH is a giant, yet it has only about 8% market share of a global luxury market worth more than 520 billion dollars annually. And it grew at twice the pace of the market in 2018 – that’s unbelievably impressive. In the future I think the development of the Christian Dior brand will be an important driver for LVMH, and in a downturn, M&A may contribute a little too – there are several smaller houses that could benefit from being part of LVMH, say Ferragamo or Tod’s, or Audemars, Breitling and Chopard in the watch world (LVMH’s watch portfolio is a weak point in my opinion).”

“The company is well managed and has a long history of successful operations. Key assets/brands include Louis Vuitton, Christian Dior, Givenchy, Guerlain, Sephora, Dom Perignon, and Moet & Chandon. LVMH has a long and strong history of increasing revenue and free cash flow (a free cash flow CAGR of 12% over the last 11 years) and high shareholder returns. It’s the largest and arguably strongest company in its category, with wide moats in cost advantages from efficient scale and strong intangible assets (brands). These moats should be durable.”

“The long term thinking culture at LVMH is something I particularly like. It’s effectively run by the Arnault family. Controlling shareholder Bernard Arnault has 3 kids in central positions in the company, which will ensure power stays with the Arnaults after Bernard retires. I view this as a very good thing; long-term planning and avoiding short-term profit optimization is crucial for conserving brand value.”

“Why is it interesting now? 2019 could provide a great opportunity to buy LVMH at a discount to its long-term fair value. I view the risk of a global economic slowdown and deterioration in global trade conditions as significant, and this could provide headwinds – I’m especially worried about a significant slowdown in China. So I think it’s important to do the required work on LVMH now as this may mean a special buying opportunity could be close at hand. Should the stock not fall as I expect, it still looks like an OK investment from current levels over the long term. But the results are unlikely to be spectacular in that case given the current valuation (about 12x EV/EBITDA). We have started a smaller position now and will be adding more later should my expectation of a global economic slowdown be correct, and the pricing comes down.”

How do you see the risks in LVMH?

“I feel that bad acquisitions are always a possibility in a company such as this. There is also succession risk – after Bernard Arnault’s time is up, a potential conflict between the Arnault heirs could be detrimental. Then there’s the risk of a global economic slowdown and deterioration in global trade conditions as mentioned earlier. You have FX risks, EUR vs RMB for example, and in our case the EUR vs the NOK is also a risk. And there is a risk of changing global travel patterns due to war or some other conflict, or terrorism, or natural disasters, or you name it. Many things could go wrong. There’s also the fact that I agree with the consensus – not promising, I guess. But then again, the consensus may very well be correct. Most of those risks do seem temporary in nature to me, somewhat transient rather than existential in the sense that they are unlikely to destroy the basic business model of LVMH. I like its robustness over time in that sense. This is a high-quality business model.”

Can you give an example of other types of investments you look for?

“In reality, it isn’t always possible to find enough companies with the above qualities trading at attractive prices. These are fairly rare opportunities. So, I can also be happy with investments in companies that generate large free cash flows that can be distributed to shareholders through dividends or stock buybacks (at attractive prices) and that I believe can increase these cash flows somewhat over time, but which have limited reinvestment opportunities and often weaker economic moats. The small IT consultant Webstep (WSTEP:NO) would be an example from this category.”

What is the investment case for Webstep?

“Webstep’s business is steadily growing due to long-term growth in IT spending in the broader economy, at a minimum, mid-single digits over the longer term looks realistic. It is low-cyclical and capital-light, with very high returns on tangible capital and highly cash generative. Its cost structure is variable based on invoiced hours, providing a flexible and efficient cost base acting as a buffer against margin contraction when times get tough.”

“The catalysts for the re-rating are likely to be: Increased analyst coverage and investor attention, earnings growth from both core digitalization operations and increased earnings potential from emerging business lines like the Internet of Things and machine learning, recovery to normal earnings power in Sweden, and high dividend payments. M&A is not impossible, though not that likely in the short term, I think – it’s reasonable to assume that Reiten shopped the name around before deciding to take it to market in 2017. That being said, Acando (ACANB:SS) in Sweden was recently bid for at a huge premium, and it’s a pretty good comparable. A similar premium for Webstep would mean a share price over 100% higher than the market price today. In absolute terms, Webstep is trading at 9x EV/EBIT for 2019, and it’s debt-free and will pay a hefty dividend of around 7% for 2018. I think it looks extraordinarily cheap. My DCF value here is 38 NOK vs a 24 NOK share price currently.”

“Risks include management changes underway with a new senior leadership – I think it was time anyway, the current CEO had been there for close to 15 years. He seemed competent, but times change and new blood might not be so bad. There is also a risk of increasing churn in the workforce, and there is always a risk of losing large clients. But overall, I think Webstep looks really attractive, and it’s our largest position right now.”

“I hope and expect that my investment framework will evolve from here as well. I’ll undoubtedly keep making mistakes and hopefully learn something from them and get better with time. 2018 was probably my worst year to date and there is no doubt in my mind that last year held more valuable lessons for me than the four years preceding it combined. In one case I strayed from my circle of competence and at the same time, I weighted the position too heavily in the portfolio. I have introduced certain rules and limitations on my mandate to avoid repetition.”

How do you find new investment ideas?

“I try to read a lot and broadly. Most of my day is spent reading at my desk. That could mean books or newsletters or sell-side research or anything really. I try to stay in touch with smart investors, brokers, and analysts that I’ve gotten to know over the years, and I participate on Value Investors Club and SumZero. I use Bloomberg screening as a tool, but much less than before. I don’t try to force a good idea so much anymore. I’ve gotten better at putting stuff in the too-hard pile and waiting for the fatter pitches.”

“If I should come across a special company with strong fundamental qualities such as high historical returns on capital, a high/consistent historical growth rate and/or durable competitive advantages, I try to begin work on it right away even if the valuation is currently unattractive. That way I build a database that I can use later. I try to get a sense of what that company is worth in different scenarios, and I keep a spreadsheet with updated expected returns open every day, so I won’t miss out if/when the valuation becomes attractive.”

What is the first thing you look at when you get an idea and how does the process look from there?

“The way I approach the analysis itself is pretty straightforward. I try to read primary source material like annual reports first, then supplement with buy or sell-side research. I work slowly to allow the info to sink in and new questions to form. My biggest mistakes in judgment have come when I rush through the analysis process to make some sort of arbitrary deadline. Feeling like you’re working hard doesn’t necessarily mean you’re doing good or meaningful work.”

“After a while, I’ll contact investors I know and/or brokers or sell-side analysts if someone’s covering the company in question. That’s always useful. Then I’ll contact management or IR reps when new questions arise. I’m not a great interviewer or judge of character, so I don’t expect lots of revelations during that part of the process. But sometimes red flags are raised during those conversations, and it’s worth the time and effort it takes anyway. In smaller companies and companies with weaker economic moats, I feel that speaking to management is more important than in larger companies. The weaker the moat is, the more important is the management team. Bad management tends to be left alone for longer in smaller systems – they can probably also do more damage there if left unchecked.”

“I’m mixed on scuttlebutt research; I prefer to rely on statistics when possible. I find it’s difficult to judge whether your sample (for example, a random selection of customers or competitors) is properly chosen and representative of the truth. That being said, I’ll happily go on site visits if I think there’s something to learn. As an example, we recently flew 22 hours across 11 time zones to Hawaii to look at properties owned by a portfolio company and felt we gained a much deeper, more nuanced understanding of what we own from doing so. So it can be useful (and pleasant, Hawaii is unbelievably pretty).”

“I use checklists to try and make sure I’m not missing something important. We all fool ourselves to some extent in this business, so the checklists are all about minimizing the self-deception that creeps into the process. Finally and importantly, I write the investment up and present it to my board (most investments I look at never make it that far, though, and get discarded somewhere along the way). The writing process structures my thesis properly and helps expose weaknesses and makes it easier to get good feedback.”