Kurt Kara is a value investor. He likes to buy companies for less than what they are worth, and he has been very good at it. Kara and the team run a relatively concentrated portfolio of 25–35 holdings.
According to Kara, a key reason why some value investors make it work – and many do not – is the implementation and the setup. I met with him to discuss some of the reasons behind the success and how they work. Below are the highlights from our conversation.
(The text has been translated and edited for clarity.)
Staying independent – one of the most important things
One of the key reasons behind the fund’s success is its focus on independence. Kurt Kara and the team have made a number of choices to secure it. Both the company, the personal setup and the information sources are structured to help them stay rational and not be influenced or tempted to deviate from their process:
“There are a number of reasons for our success. One of the most important is that we are independent. As a starting point you always think independently, but then something influences you and then suddenly you are not thinking independently anymore. We are independent because we have done a number of things to stay independent.”
“Maj Invest as a group is independent. We are financially independent as fund managers. That means, in principle, we can afford to be fired tomorrow. If you are not financially independent, then you might be a little more careful and a little less brave. Your actions might not be in the best interest of the portfolio. You also have to think about your mortgage and the down payments on your debt. It can impact your decisions.”
“Another way we stay independent is by not talking much to brokers. There is nothing wrong with brokers, they just have a different agenda than we have. They have an interest in higher turnover for the customers, so they get more commission. If you get your ideas at the same time as all other fund managers – who are using the same broker, who is pushing those ideas – you are not thinking independently.”
“Ulrik and I have worked together for many years and I guess we have met around seven companies. Roughly one every other year.”
“We also don’t talk to management. The reason is you don’t find a large company that does not have a charismatic CEO. The management cannot tell you something material that is not public, then it is insider information. So, what’s your edge? You can see him and most of the market can’t. Are you good at judging people? What is most likely if you meet the CEO of a 50-billion-dollar company? That you will go home fascinated, thinking “he’s one hell of a guy,” or that you pick up some negative vibes? Obviously, he is one hell of a guy, otherwise he would not be the CEO of a large company.”
“You will be influenced and thinking less independently. Your hit rate will be close to 50–50 at best. Even very experienced judges have a hard time telling if a witness is lying. So why should you, as a fund manager, be able to do it any better? Ulrik and I have worked together for many years and I guess we have met around seven companies. Roughly one every other year.”
“I am not any more intelligent than you are. So, if my results are better than yours, or worse, then it is because I have a different setup. The setup we have created is not too bad. We are independent. We have made ourselves independent. That is very, very important.”
Idea generation – generating a flow of ideas through a scoring model
To secure a steady flow of new investment ideas that fit the investment philosophy and is independent of outside sources, Kurt Kara has developed and programmed his own scoring model from scratch. The model rates all companies in the investment universe on a large number of variables. Once a week the team goes through the list of stocks with the highest score and decides what to look at:
“The scoring model was developed in 2004. It was built based on what we look for in an investment. The underlying thought is simple: ‘Price is what you pay. Value is what you get.’ What you pay is obviously multiples like PE, PS, and PB. What you get is the quality, profitability, balance sheet, growth and so on. It is the ROE, the profit margins, it is the whole package. It’s a tradeoff between value and quality. The model also looks for red flags. If you have changed accountant four times in a year, that’s a bad sign.”
“We have now had nine years of economic expansion in the US. Many cyclical companies do not appear to be cyclical due to the long cycle. But they are. And it hurts when the market changes and we get into a recession.”
“We use Bloomberg input. More than 150 different parameters. We use historic numbers over forecasts to avoid excessive optimism or pessimism. Most people tend to extrapolate. A linear projection based on what happened in the last 3 years is the most common way of forecasting. Obviously, we look forward when we analyze the companies, but we try to avoid external forecasts as an input.”
“The highest-scoring companies in the model generate an excess return. However, an issue is that the highest-ranked companies can sometimes include cyclical companies that look cheap at the top of the cycle, especially if the cycle is long. We have now had nine years of economic expansion in the US. Many cyclical companies do not appear to be cyclical due to the long cycle. But they are. And it hurts when the market changes and we get into a recession.”
“The top of the list does not change much from month to month because most of the score is based on the quality of the company. Prices can change fast; companies do not change that quickly. Currently, there are few companies from the US in the top. Five years ago, there were many. American companies have become more expensive.”
Sources of information – Balancing structure and creativity while building a large knowledge base
Kurt Kara and the team combine a structured investment approach, including its scoring model and checklists, with a creative freedom to seek new inspiration. Reading annual reports is the main way to learn about companies, while reading books helps to build a general knowledge base and give perspective:
“We live in a time of constant information overload. Today information is not an edge. On the other hand, disinformation can be a negative edge. You have to keep the bad and useless information out and boil it down to what’s important. “
“Most people like shortcuts and many value investors take a shortcut by buying low PE stocks. But, the only free cheese is in the mousetrap. You might buy companies where the market has already realized that the earnings will decline. Sometimes you might be right, but it can be a disaster. You must distinguish between optically cheap and fundamentally cheap. We do not need to know everything about the companies we buy, but we need to know what is important to know.”
“To learn about companies, we read annual reports. It may sound boring. But it is the right way to do it. The difference between reading a sell-side report and the annual report is like reading the book in its original language and reading a summary translated into another language.”
“Another benefit of reading annual reports is that you can see whether they are trying to hide something. Making an annual report is a relatively simple task. The company is telling us what has happened during the year. If you read one and you don’t understand it, it’s not because you are stupid. It’s because they don’t want you to understand it. It’s a warning signal. When you read an annual report, you are figuring out what kind of people you are dealing with.”
“You don’t get that from reading a broker report. Broker reports can be a good way to get information on industries or sectors. It can create a lot of value when we need industry insights, but when it comes to the company, we read annual reports.”
“We have a lot of freedom in how we prioritize the time in our team. Otherwise, you can kill the creativity and the spirit. Sometimes you let your intuition guide you. You google some things, you watch a bit of video with someone explaining about an industry and this leads to something else. It might end up not generating value, but you never know. And our work does not have to create value right now. Eventually, it creates value because it brings us new knowledge and leads to new thoughts and inspiration.
“We also read a lot of books. They don’t have to be about investing. It is important to have a broad base of knowledge in a lot of different areas. You cannot just be good at making DCF models. That’s also one of the reasons why we do not assign sector responsibility in the team. We are all generalists.”
Preferred industries
When you go through old holding lists from the fund you will find a number of industry groups that keep popping up with multiple holdings in them. These industries have characteristics like few competitors, high barriers to entry, and clear visibility into long-term future cash flow generation. We discussed the dynamics and attractiveness of two of the industries Kara and the team like: jet engines and railways.
Investing in the jet engine industry
“You only have three large producers of jet engines for commercial airplanes, and then some suppliers of components and systems. The barriers to entry are very high.”
“The government actually helps to create barriers in the industry. The Federal Aviation Administration, FAA, examines each component that goes into a jet engine. It is a long process and it protects the players already in the market. Safety is the priority for the buyers and the government – they cannot risk the planes will crash.”
“With some companies, the visibility into the future is better than others. In the engine market, the product life-cycle is very long. You sell your engine, perhaps even with a small loss, and the customer signs very long maintenance and repair contracts that can last 25–30 years. This makes it difficult for new players without scale or track record to enter. It makes it more like an annuity. More like a bond, but with a growing coupon, because they get more customers.”
“Air traffic grows 4–5% per year. Last year there were four billion commercial passengers. Not four billion different people, but four billion passengers in total. Even if every passenger only flew once a year it would only be a little more than half of the world’s population that flew last year. The industry is growing, and it will keep growing.”
“It is more the exception than the rule that you find these kinds of industries and business models. “
Investing in railway companies
“People say that railway companies are expensive on PE or PB. But they are actually pretty cheap if you look at the replacement value. If you had to build new tracks today it would be extremely expensive, and it would be very difficult to get approvals and buy land. Each mile of new track costs about 2 million dollars, and then comes all the time spent and the issues with making it happen.”
“Railways are a monopoly. The management of Union Pacific does not wake up tomorrow and see a whole new set of brand new rails right next to its own track. That’s not going to happen. So, they have a protected business model, a local monopoly, and a geographic monopoly. It is easier to find local champions than global champions. Just like it is easier for you to become chess champion in Tåstrup than chess champion of the World. Niches are good, protected areas with little competition. They have pricing power.”
“After the crash in 1929, the railways increased prices significantly. The government started to regulate the industry and it became overregulated. The railway companies almost died. Then, in 1981, they started to deregulate. That transformed the whole industry from an overregulated, publicly-controlled sector to a private sector, where the main regulation is on speed and the volume you can load onto each railway wagon. That has made the industry profitable, very profitable actually.”
“Railways are also very competitive compared to the alternatives. It costs 0.03 cents to move one ton of goods one mile on a railway. Nothing comes close to this, either on cost or on energy efficiency. It’s very difficult to compete with.”
“Another attractive feature is the long lifetime of the tracks. You have an asset with a lifetime of more than 50 years. If you make smartphones your asset has a lifetime of, what, four years? Nokia missed the cycle and then they were dead. That’s the issue with consumer electronics. Railways have a long life, so you don’t have to worry about them going out of fashion for many, many years. That’s why we own railways.”
If you want to learn more about Maj Invest Global Value Equities or want to learn how you can invest together with Kurt Kara, Ulrik Jensen, and Rasmus Quist Pedersen visit the Maj Invest homepage.
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