Keith Smith, a guest with over 20 years of business valuation experience, discusses unique ideas and topics such as BDCs, auto dealers, recurring service revenue, and consolidation in car dealerships. The podcast also covers the challenges faced by banks, the importance of understanding recourse in commercial real estate investing, success in automotive dealerships in Japan and Korea, managing dilution and accounting challenges, and strategies for improving ROI through acquisitions.
Understanding the life cycles of companies and the returns on invested capital at each stage is crucial for successful investing.
Business development companies (BDCs) can offer solid returns, especially for income-focused investors willing to take on some risks.
Car dealerships and construction businesses present investment opportunities with recurring revenue and potentially higher returns.
Finding businesses that are growing or moving towards growth in unconventional industries is a key strategy for investors.
Deep dives
Podcast Episode Summary
This podcast episode covered various topics, including the life cycles of companies and the returns on invested capital. The speaker discussed different stages of a company's development, such as introductory, growth, maturity, shakeout, and decline. They highlighted the importance of understanding these stages and the returns on capital at each stage. The podcast also emphasized the significance of finding businesses with declining operations that can be transformed into growth or mature businesses, as it can result in higher rates of return. Additionally, the episode explored the world of business development companies (BDCs) and the potential opportunities they offer. It explained how BDCs can provide solid returns, especially for investors who prioritize income and are willing to take on some risks. The podcast also touched on other investment opportunities, such as car dealerships and construction businesses, which can provide recurring revenue and potentially higher returns on equity. Lastly, there was a discussion on banking, with a focus on East West Bank and its strong returns on equity, minimal losses, and low exposure to central business districts.
The Growth and Challenges of Auto Dealerships
Auto dealerships, particularly East West, have been able to maintain steady growth despite challenges in the market. East West has seen a decrease in inventory turnover from 3-4% to around 1%, but has managed to offset it through strategic acquisitions. The company has a well-balanced franchise with diverse loan portfolios, and their efficiency ratios are in the thirties, indicating strong operational efficiency. However, a potential risk lies in their loans in China, which account for about 1/40th of their overall book. Changes in the geopolitical landscape could impact these loans, but East West's balanced approach and strong underwriting provide stability and opportunities for growth.
The Robustness of the Car Dealership Industry
Car dealerships, such as Asbury, have demonstrated the robustness of the industry despite challenges. Asbury's focus on matching cars to customers quickly has led to higher ROEs and efficiency ratios. The company has a culture of productivity and improvement, constantly aiming to increase revenue and other related metrics. While the agency model could pose a potential threat, larger dealerships like Asbury are better equipped to handle the transition. Furthermore, the service aspect of the industry continues to play an essential role, especially with the increasing complexity of cars. Sensors and autonomous driving present opportunities for enhanced service revenue, ensuring a thriving business in the future.
Prospects in the Recreational Vehicle Industry
Recreational vehicle (RV) companies like Winnebago face cyclical challenges but have potential for growth due to demographic shifts. As the population goes into retirement, many individuals find RV travel enjoyable and more affordable than traditional means of accommodation. COVID-19 has further highlighted the value of outdoor experiences, and RVs provide an opportunity to travel comfortably. However, asset turns and profitability for the industry as a whole have declined due to supply chain disruptions and affordability issues. Rational competitors and strategic acquisitions could mitigate the cyclicality and present growth opportunities in the RV industry.
Opportunities and Challenges in the Manufactured Homes Market
The manufactured homes market, including companies like Legacy Housing, offers potential for growth but also faces zoning challenges. Affordability and changing housing preferences can drive demand for manufactured homes, but zoning constraints have hindered growth in the past. Companies that manufacture and sell homes directly, like Clayton Homes, have a more favorable outlook due to their control over the value chain. Recurring revenue from parts and service also plays a significant role in the industry. Understanding the cyclicality of this market and capturing opportunities in the fragmented private market are key considerations for investors.
Finding Growth Stocks in Unconventional Places
One key strategy in investing is to find businesses that are growing or moving towards growth, even in unconventional industries. This involves looking beyond traditional sectors and exploring areas like financials, natural resources, and capital-light businesses. The goal is to identify companies with sustainable and compoundable growth prospects. The focus should be on understanding the direction of the business and being aware of its long-term trajectory. It is also important to consider return on incremental capital and free cash flow conversion to gauge the potential for continued growth. While catching the market at the absolute bottom is challenging, the goal is to ride the momentum of growing businesses as long as they continue to move in the right direction.
Balancing Investment Priorities and Personal Responsibilities
Investing requires striking a balance between investment priorities and personal responsibilities. Priorities may vary depending on factors such as age, family obligations, and cash needs. It's crucial to allocate time and effort to both investments and personal commitments. For example, if time spent on a podcast or other pursuits impacts the portfolio, it is essential to reassess the balance and make adjustments accordingly. Additionally, as circumstances change over time, such as when children grow up or financial needs evolve, investment strategies may need to adapt. This could involve outsourcing research, focusing on growth-oriented businesses, or making strategic hires. Ultimately, finding the right balance is a continuous process that requires evaluating priorities and adjusting as necessary.
Keith Smith stops by The Business Brew to discuss BDCs, auto dealers, and other ideas he has been looking at. Keith has been looking in areas that are less well covered.
Keith has over 20 years of business valuation experience as well as being trained as an engineer. In addition to managing the Bonhoeffer Fund’s portfolio, Keith serves as an advisor to Willow Oak Asset Management. He is a CFA charterholder and received his MBA from UCLA. He has held positions with Empire Valuation Consultants, PwC, Management Consulting & Research, and served as a captain in the U.S. Air Force.
We hope the episode expands your thinking a bit.
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