LGF’s investment process

Long Game Financial ("LGF") manages portfolios for clients using a concentrated approach that seeks superior risk-adjusted returns across market cycles by focusing on a few positions at a minimum rather than a diversified portfolio. 

Our strategy is to identify investments for which we believe we can reasonably estimate prospective returns across holding periods exceeding those of many market participants. We allocate capital when we consider those investments mispriced relative to our forecasts.

We consider our willingness and ability to express our industry- and company-specific views through concentrated positions to be one of our key competitive advantages. While our ability to manage market price fluctuations is limited, we seek to position ourselves to play offense rather than defense during and after market declines, which are inevitable.

Lastly, LGF invests primarily—but not exclusively—in businesses that align with LGF’s two main investing frameworks: (1) C.A.M. (Competitively-advantaged, Attractively-valued, and Managerially-aligned) and (2) LGF’s Four-Step Pattern. We outline both below.

Investing Framework #1: C.A.M.

LGF’s C.A.M. framework is the beating heart of the our investment approach: we seek to invest in companies that are Competitively-advantaged, Attractively-valued, and Managerially-aligned.

(a) Competitively-advantaged

 

Unique customer value proposition: 

·         We seek businesses that can deliver sustainably (a) more value to customers than competitors and/or (b) lower prices to customers than competitors. Market share leadership often helps.

Stable or growing end markets:

·         We focus on companies that compete in growing industries or growing niches of stable industries. We tend to avoid economically sensitive industries near cyclical peaks. Over time, we believe this enhances return and reduces risk.

Reinvestment opportunities: 

·         We prefer businesses with opportunities to reinvest earnings attractively and grow sustainably in value.

Resilience:      

·         We favor businesses that can thrive despite adversity. Key types of resilience include macroeconomic, competitive, managerial, operational, and financial.

Recession dynamics:   

·         Recessions happen. All else equal, we seek businesses with acyclical and/or counter-cyclical characteristics that can outperform their competitors during recessions.

The WHY behind "competitively-advantaged":

·         Price declines are inevitable and buying during a decline requires confidence in the underlying asset.

·         Nothing is more fundamental to confidence than evidence that (a) the industries in which our businesses compete can thrive far into the future and (b) our businesses will likely be able to compete effectively versus their competitors within their industries far into the future.

·         Avoiding losses is more important than catching winners due to the disproportionately negative effect losses can have on long-term returns.

 

(b) Attractively-valued 

Attractive price:

·         We prefer stocks with growing intrinsic value that also trade below our assessment of current intrinsic value. As one example of how we might assess intrinsic value, we may consider a business “cheap” on a metric such as enterprise value versus estimated free cash flow three years hence.

Free cash flow outlook:

·         We aim for free cash flow to constitute a meaningful portion of each position’s prospective return except in certain cases, such as a company spending against high-return growth opportunities.

Long-term catalysts:  

·         We look for potential positive catalysts that lie beyond most market participants’ investment horizons.

·         Examples of these include accretive external growth, an acquisition of the company, incremental organic growth (such as new markets, new products, and/or pricing opportunities), margin expansion, and balance sheet optimization.

Private market value:

·         We seek to buy at a discount to our estimate of what a well-capitalized strategic or financial investor might pay for the entire company.

 

(c) Managerially-aligned

 

Managerial alignment:

·         We seek managers and employees who think and act like owners (that is, who operate leanly and reinvest wisely).

·         We often like to see shrinking share counts from stock repurchase programs.

Investing Framework #2: LGF’s Four-Step Pattern


As per our 2018 annual letter, LGF seeks to invest in businesses that fit our Four-Step Pattern framework, which describes the conditions required for a company to grow significantly larger and generate meaningful profits for its owners over years and even decades.


Step #1) Start with a company whose sales opportunity is large relative to its current sales and also large in absolute terms.

  • Investing is always about the future rather than the past—and future corporate giants tend to begin life in one of the following situations:

    • Small market share in an existing large market (e.g., McDonald’s and food or Priceline and travel)

    • Large market share in a new, small market that becomes large (e.g., Apple and smartphones or Monster and energy drinks)


Step #2) In order to scale into its opportunity, our plucky company must offer a sustainably competitively-advantaged product that customers love—or, at least, a product that customers feel economically compelled to pay for because of a characteristic like limited alternatives (e.g., Comcast) or high switching costs (e.g., Oracle…or also Comcast).

  • LGF defines a competitively-advantaged product as one that offers customers value that is either:

    • Sustainably greater than the value offered by competitive products (e.g., Google search), or…

    • Similar to the value offered by competitive products but at a sustainably lower cost (e.g., Walmart)


Step #3) In addition to a large sales opportunity and competitive advantages, our company’s process of scaling into its opportunity must be economical. That is, in financial terms its process of fulfilling its potential must occur at an attractive return on incremental invested capital.

  • “Attractive return on incremental invested capital” sounds complicated—but all it refers to is incremental earnings per incremental dollar of investment.

    • If a company can sustainably increase what it earns on its incremental investments, it can sustainably grow its earnings at a higher rate.

    • The most valuable companies are those than can grow earnings swiftly while also generating more cash flow than they can profitably reinvest. As such companies grow, their excess cash flow can be put to other potentially value-enhancing uses like acquisitions, share repurchases, debt reduction, and dividends.

    • Lofty returns do not mean infinitely fast growth. The earnings growth of companies with superior returns on incremental invested capital (e.g., VISA), if not limited by investment dollars, will be limited by some other factor, such as customer adoption or market size.


Step #4) Last, once our company in question reaches its maximum potential, we would prefer for its sales and profits to then be sustainable into the foreseeable future--rather than see it all retreat back to the primordial goo from whence it came.

  • In other words, we want investments that lead to significant capital gains over time and then we want to keep those capital gains.

  • For this reason we prefer companies with sustainable competitive positions in sustainable industries (e.g., Boeing) to companies whose competitive positions or markets have the potential to shrink due to forces like technological innovation (e.g., Exxon Mobil) or a change in consumer preferences (e.g., Coca Cola).