Authored by Louis Stevens
L.A. Stevens employs four foundational investment frameworks to select the businesses it covers and ultimately rates as "buys."
In today's Brief, we will walk through those foundational investment frameworks. Below, I will share each of the four frameworks and provide definitions and examples.
Let's begin.
Vertical integration within a fragmented, low NPS, and mature industry
- In this framework, businesses vertically integrate portions of the industry within which they operate. By vertically integrating, they create differentiated consumer experiences with differentiated unit economics for those experiences. Let's consider a few examples: Beginning in the early 1960s, Walmart vertically integrated the grocery and department store businesses that were largely dominated by "mom and pop" grocers and department stores like Sears. Walmart developed a business model in which it vertically integrated all of the products of those market segments and employed supply chain technologies to create a lower cost, more centralized and convenient experience for consumers, which created greater consumer surplus. This differentiated experience resulted in Walmart capturing substanital market share of the retail industry, which it continued to grow in the subsequen four decades. Uber vertically integrated the ride hailing ecosystem, resulting in it capturing a majority of the industry's market share over time. More specifically, it vertically integrated payments, maps, telecommunications with driver, rider, and dispatch, trust-creating reviews, driver onboarding, and pricing. This created materially differentiated experience for consumers that actually cost less! Consumers received a more premium, convenient experience in exchange for less money: Consumer Surplus extraordinaire. We can see in these two examples that vertical integration within fragmented, low NPS, and mature industries can result in differentiated consumer experiences with differentiated unit economics, which results in sustained market share capture over time, which is synonymous with revenue growth, profits growth, and share price appreciation.
Businesses buying back shares or on the verge of executing a leverage recapitalization
- In this framework, businesses usually operate a fairly simple business model, such as AutoZone's auto-parts stores. They develop a series of moats, e.g., brand, economies of scale, or just plain quality company culture that yields sustained excellent results (which usually feeds into a brand moat over time). Chipotle is another good example. As these companies gradually replicate their product throughout the U.S., and potentially around the world, they simultaneously return capital to shareholders via share buy backs. The combination of steady revenue growth and share repurchases result in free cash flow per share growing at 15-25% and correspondingly the companies' stock prices grow at 15-25% (because, as we know, free cash flow per share is the basis of all equity value).
- Another variation of this framework is identifying companies on the verge of executing leveraged recapitalizations, in which they "recapitalize" using "leverage," i.e., they start with a very clean, giant cash hoard balance sheet, then add debt to achieve a net cash neutral position, resulting in a lower WACC (weighted average cost of capital) and providing a tax shield, both of which theoretically serve to maximize the net present value of the firm. Apple, Alphabet, Meta, and Microsoft have all used some variation of a leverage recapitalization over the last decade to return capital to shareholders, lower their cost of capital, create a tax shield, and create corporate fiscal discipline (via returning huge sums of capital to shareholders, which ensures fiscal discipline, which creates constraints, which creates great business outcomes).
Cultures that consistently field new, commercially viable products
- In this framework, businesses produce new lines of business over time. They start with one commercially viable, profitable product, then expand into new product lines. This act of layering on new products has a number of incredible benefits for a company, which I would strongly encourage you to read about here, especially if the products can be woven together into one seamless platform or Walled Garden Ecosystem. The central benefit is that it extends a business' runway for growth, allowing it to grow its revenues and profits at elevated rates for years and decades at a time, which allows shareholders to comfortably hold onto their shares knowing that growth is likely set to continue, and, as a result, share price appreciation is likely set to continue. The most important and, very notably, most durable businesses of the last 100 years have fit within this framework. From Tesla to Apple to Microsoft, these companies' cultures have been structured in such a way that they can competently develop new products, and these products achieve profitable product-market-fit.
Competent Capital Allocators
- In this framework, businesses demonstrate an especial ability to deploy capital into acquisitions that either increase in value or increase in value while also acting synergistically with the rest of the business' products. Meta is arguably the best and most prominent example of a business exemplifying this framework. Today, Instagram could be worth $300B to $500B, and Meta paid only $1B for the asset. Similarly, WhatsApp could be worth hundreds of billions over time, if not more, and Meta only paid $19B for the asset. These acquisitions made Meta the most dominant social media business on earth and demonstrated the company's ability to competently allocate capital. Other notable examples of exceptional capital allocators have been Constellation Software, Salesforce, and Alphabet. Importantly, capital allocation into acquisitions is a very challenging activity. Companies can and do blow themselves up by poorly acquiring, so it should not be ignored when a company demonstrates capital allocation acumen such as Meta's 2010s social media acquisitions.
To close, all of the businesses LAS shares with you fit within one of more of these frameworks.
The best businesses on earth, e.g., Apple, Microsoft, Nvidia, Amazon, and Alphabet, fit within all four, and, as a result, have created shareholder value at an exceptional rate for incredibly long periods of time.
A fun exercise to perform involves placing the companies you own into these frameworks. It's possible that, granted they fit in one or more of these frameworks, generate free cash flow, grow at healthy rates, and have solid corporate cultures, they could be poised to be one of earth's next great enduring franchises!
