Alex Furmanski (Unison): Why do you like Deere stock?

Tilman Versch [00:00:00] Dear viewers of Good Investing Talks, it’s great to have you back at the podcast, and it’s great to welcome Alex Furmanski of Unison Asset Management. Alex, from where are you joining us right now?

Alex Furmanski [00:00:11] Hi Tilman, I’m joining you from Miami today. Thank you for having me.

Tilman Versch [00:00:17] Now, everyone is a bit jealous about the weather you’re enjoying at the moment, so let’s maybe switch topics fast and talk about investing.

Alex Furmanski [00:00:26] Absolutely.

Tilman Versch [00:00:28] Since when have you been in the investing game?

Alex Furmanski [00:00:32] So I’ve been investing professionally for over 20 years at this point, so it’s been quite a journey.

Tilman Versch [00:00:41] And how long do you want to stay in this game?

Alex Furmanski [00:00:45] You know, it’s one of the best things about investing, as exemplified by Warren Buffett and Charlie Munger, in their 90s and almost 100. This is a perpetual game where knowledge is cumulative, and as long as you have a little bit of luck and your body and mind, most importantly, keep working correctly. It’s something that you can keep on doing forever.

Tilman Versch [00:01:17] So we already mentioned this, 20 years you’re in the investing game. What are the three learnings that have changed you as an investor in these 20 years?

Alex Furmanski [00:01:28] You know, probably the period that most shaped my philosophy was the great financial crisis. I was early in my professional investing journey when that happened. And so my aversion to risk in large part stems from my experience during that period of time. It was a difficult period for a lot of market participants. And I’m a big believer that no hard times should go by without learning many lessons.

And I clearly learn my fair share of lessons from that tumultuous period. So that was probably a good thing that it happened early in my career. The last thing you want is an episode like that to teach you lessons later in life. But you know, this is a constantly evolving game and journey, and you’re always trying to incrementally get better.

Tilman Versch [00:02:39] What are other learnings that shaped you?

Alex Furmanski [00:02:44] You know, when I started off in investing, I was more of the cigar butt approach type investor, meaning, I was looking for stuff that screened optically cheap stuff that had high free cash flow yields. You know, the proverbial, you take the last puff out of the cigar, but before it kind of goes extinct. And through hard lessons, I learned that it is much better to compromise a bit on price and focus more on quality because ultimately, an investment will return the return on invested capital that the company is able to generate on its reinvestment. And so if you’re investing for the long term, which we are at Unison, you need to find those companies that have that ability to reinvest at high rates of return for long periods of time to end up with a good outcome.

Tilman Versch [00:03:49] You already mentioned risk in your previous answer. What are the most important risk factors you’re looking into in this stage of your investing evolution?

Alex Furmanski [00:04:03] Yeah. So we define risk as permanent impairment of capital as opposed to volatility or beta, which a lot of market participants seem to focus on. And so what we do here at Unison is we’re bottom-up investors where we’re trying to ascertain with conservative assumptions what a business would be worth, kind of on an intrinsic basis, and obviously those estimates have key inputs that go into generating them. And so if you make a big mistake in your underwriting or your assessment of intrinsic value, then security could be worth much less than you thought originally, and that’s how you end up with a permanent impairment of capital, which is how we define risk.

Tilman Versch [00:05:01] And maybe let’s go a bit away from the investing topic and talk about your motivation. So, what are things outside of investing that keep you pushing even harder to achieve success in your profession?

Alex Furmanski [00:05:15] I’ve always been into sports quite a bit. I’m an avid runner, tennis player, biker, skier, anything that focuses my energy and mind on. Athletic greatness has been a great outlet for me. You know, I ran. Well, only one marathon, but a lot of half marathons. Always trying to push down my time. And I find that the resilience that gets embedded in one who competes athletically is very akin to the investing game. You know, you have some of the best and brightest minds in the world competing against you. This is a game where you’re trying to go to bed every night and be slightly incrementally smarter by reading, doing a lot of work and research, and just loving the game. And it’s very akin to sports. So I’d like to draw that analogy between kinds of investing in sports.

Tilman Versch [00:06:28] Let me take this idea of the long run and what you’re trying to do. What is your goal that you try to achieve for you and your client base in the long run?

Alex Furmanski [00:06:38] So historically, the US stock market delivers kind of call it 9 to 10% annualised returns, and this is, by the way, over long periods of time, you could go for stretches of decades without positive performance, as was the case from 01 through 2010, 2011, for example.

So what we tell clients and how we do our underwriting is we try to target at least a 12% rate of return when we’re underwriting securities, which is a nice margin over the historical result that the market has delivered. It’s important to note that we hold ourselves accountable over a full market cycle to deliver these returns because, depending on where you are measuring in the cycle, somebody might look very smart, but they might be taking an undue amount of risk. And so you know, going back to my earlier comment and lessons learned early in my career, lesson number one is don’t lose money and lesson number two is don’t forget lesson number one.

It’s very hard to come back from large losses, not only because of the way the numbers work, right? If you lose half of your capital, you have to double to get back to par, but also psychologically. If you are not in the right frame of mind to take advantage of periods of dislocation and increased opportunity because you’re fretting over your losses, that can have a meaningful impact. That did with me in the great financial crisis. I was more timid than I should have been in late ‘08, early ‘09. And part of that was I was nursing and this was on my personal account, I was nursing some heavy losses from the period leading up to that.

Tilman Versch [00:08:40] When I’m honest and think about investing businesses and investing funds, it feels a bit like it’s a commodity, and a lot of strategies sound a bit like the same. But it’s also important on the other side to differentiate, and what is your differentiator with your firm?

Alex Furmanski [00:09:02] Absolutely. I couldn’t agree more. But we’re big believers that actions speak a lot louder than words. And so despite the fact that a lot of it sounds commoditised, when you actually dig a little deeper and look at how principals in investment funds act, you find quite a discrepancy. I would say that our biggest advantage is our time horizon, and that really stems from having the right investor base. So in a world where holding periods on stocks have gone down from years to, I think it’s less than 10 months now, our holding period is going in the opposite direction. So our average portfolio turnover, I think, has been around 13%, which implies an average holding period of seven to eight years on our securities. I think that makes us definitely a minority.

There’s actually a study that was done by one of our peers, I forget who, but where they looked at this concept of concentrated value investing. And I think they defined it as having one position greater than 5% and an annual turnover of less than 30%. And only 1% of capital is in global markets. I think this was around 2019. So of the 80 trillion, only 800 billion was invested with this concentrated value investing philosophy, and Berkshire was half of that.

So despite the fact that we seem to be sometimes hear the same story over and over again but the truth is, very few market participants act in this manner, at least professionally, and I think a lot of that stems from the pressure they get from their limited partners to deliver short-term results. And so you know, whereas a lot of professionals are trying to determine if a company is going to meet or beat expectations on a quarterly basis, we’re looking kind of more three to five years ahead and asking ourselves is this company going to be in a stronger and better position in three to five years? And that ability to kind of look through the short term generates some great opportunities.

Tilman Versch [00:11:26] You also look for businesses with exceptional quality, so let’s dive into this. What is quality, and what is exceptional quality?

Alex Furmanski [00:11:38] Yeah, no, absolutely. And by the way, this is one of those terms that I think has gotten taken to an extreme, and we saw the consequences of it’s just not quality in and of itself, doesn’t give you a margin of safety. You need quality and the right price, and I think a lot of people forgot this lesson in the period leading up to 2022, and we saw the consequences of that.

And I would maybe argue a little bit. Currently, we’re speaking in late February 25, it seems to be happening to some degree again. You’re trying to marry quality and price. You’re always trying to do that. And it’s a trade-off to some degree. But to answer your question specifically, for us, a great business is one which can reinvest its excess capital at above-average rates of return for long periods of time.

And so we are keenly focused on a metric called return on incremental invested capital. And we’ve dissected the market by tiers and how the rates of this metric compare for our holdings and stuff on our watch list versus the broader market, and that is how we ultimately define quality.

Tilman Versch [00:13:01] And what is this tweak to exceptional quality?

Alex Furmanski [00:13:07] Well, it’s not. I mean, let me back up. If you look at the market over long periods of time and there was a study by a professor at Arizona State University. Looking at this, I think he looked at 100 years of stock market history, and basically a third of 1% of all public companies during that period accounted for half the value creation in the market, and 4% accounted for all of it.

And so what’s exceptional? You’re trying to buy those companies. Easier said than done. But this is a game where you really only have to be right once and not be wrong a lot, and you can end up with an extremely good track record. So for us, the journey really is to try to identify and hold those securities that make it into that short list of statistics I just cited.

Tilman Versch [00:14:08] So, where do you get ideas for such kind of companies from?

Alex Furmanski [00:14:13] So we have a process called serendipitous discovery. We get ideas from our heavy dose of reading, not only newspapers and magazines, but trade journals, company filings, all that stuff, but also from just keeping our eyes and ears open and observing the behaviour of our children, see what products and services they’re gravitating to or on a personal basis, what we’re gravitating to.

We’re big believers. And becoming users of a product or service when analysing a company, because from that vantage point, you’re really able to understand the value proposition much better. So, for example, our company that we used to own up until recently, Uber, when we were doing the our due diligence on it, my partner Daniel became an Uber driver for a couple of weeks to really understand the economics from the vantage point of the driver, there were some specific questions we were trying to answer and the best way to get the answer besides asking the drivers is actually becoming one and experience it and experiencing it.

So, really, ideas come from anywhere. We’ve both been doing this for over 20 years. So we’re very familiar with a lot of the companies that are out there, but we’re always on the lookout for new stuff.

Tilman Versch [00:15:47] Or maybe let’s take a picture of a cook. So you get a fresh idea or fresh fish on the table. What kind of aspect do you spend the most time researching or preparing it to put it in the soup you offer for your portfolio?

Alex Furmanski [00:16:07] No, absolutely, it’s a lot more on the qualitative side than the quantitative side. It’s really focused on understanding if the company in question ultimately has pricing power, right, because pricing power is the Holy Grail of investing and pricing power comes from you have an exceptional value proposition, be it a product or service that you’re providing to your customers that you know, no matter kind of almost anything that can be thrown at that business you can charge a bit more and still continue to earn those great returns on incremental invested capital.

So really our process is honed in and focused on understanding that value proposition. And obviously, these things don’t happen in a vacuum, meaning there’s competition. So a lot of our analysis, and we like to call it our scuttlebutt, is talking to competitors, to customers, to suppliers, to really get a sense of how the company that we’re analysing is positioned with. Within this ecosystem, we can get back to that question of pricing power.

Tilman Versch [00:17:25] In your research process, which investing mistakes have improved your process the most?

Alex Furmanski [00:17:32] Mistakes happen for all types of different reasons, like I’m thinking about one recent mistake, which was that we underestimated the technological disruption of a newer technology and how that would affect the company we own. So, disruption is always a big risk in investing.

You know, you might find something that has a 50-year history without much disruption, and then all of a sudden, a new technology shows up that throws everything on its head. So it’s always trying to look ahead, and not so much. Look through the rearview mirror. That would probably be the biggest one that’s that I can think of right now.

Tilman Versch [00:18:26] Is there another mistake you could share with us that influences your process?

Alex Furmanski [00:18:32] Yeah, I think the other mistake would probably be what I alluded to earlier, which was the focus on statistical achievements and not enough on quality. And that’s just a mistake that time is the friend of a good business. And so if you own a bad business, as time goes by, the probably the intrinsic value of that bad business is deteriorating, and so a lot of my investing mistakes have come from that bucket, if you will.

Tilman Versch [00:19:43] In this episode, we also want to talk about an investing idea you currently own and find interesting. We picked John Deere or Deere & Company, which is John Deere. Also like what kind of products does this company sell?

Alex Furmanski [00:20:01] John Deere is a powerhouse in agriculture. They make tractors and combines that are ubiquitous here in the US and really in many parts of the world. That’s their core business. They also have a smaller construction business, which they acquired a couple of years ago. But really, the core business is on the ag side. So it’s a company that did 38 billion in sales last year, and the ag side of the business is probably north of 2/3 of the revenue. And geographically it’s a similar split, between the US and the rest of the world, where the US and Canada are, I think, 2/3 or so of the business.

Tilman Versch [00:20:52] What is Deere doing better than the competition in the market?

Alex Furmanski [00:20:56] So the moat on Deere really stems from scale first and foremost, so they have the largest dealer network in North America. And the second largest globally. So basically, what this means is if you’re a farmer and you’re on your multimillion-dollar tractor and it’s the middle of harvesting season and you have a problem that needs to get fixed, the last thing you want is to have a lot of downtime.

And so having the ability to get your tractor serviced and repaired in a quick manner is critical, and so Deere has nearly 1,500 dealers versus CNH, which would be the next one at less than 500. So that’s a very important reason for their advantage over competitors.

Scale also allows them to invest a lot more in R&D than their competitors. Just for reference. So like I said, Deere did 38 billion in revenue. AGCO and CNH, which are the number two and three combined, had a 25 billion last year. So that gives you a sense of how much more they have to spend on R&D, and this translates into that.

So since ’99, Deere has invested nearly 30 billion into R&D, which is greater than the market cap of CNH and AGCO combined. And so this R&D has delivered some of the best technology out there, which really addresses the needs of farmers to make their operations more efficient.

So let me take a step back. If you look at the total spend on a farm, the equipment is about 10% of a farmer’s spend, around 30% is land, and 60% is labour, seeds and fertilisers and other inputs. So going back to what I was talking about in pricing power, really what you’re doing is if you improve the technology on the tractors, combines, et cetera, and you’re able to reduce the other 60% bucket because you have these cameras and sensors that allow the spraying to be very specific as opposed to over a general area.

Then you can save the farmer on fertiliser, seed cost and all that stuff. And so that is the value proposition that John Deere brings to the table, and they’re able to have better technology than their peers in large part because they’ve spent a lot.

Tilman Versch [00:23:57] So with this idea of excellent quality put on Deere, what does this business make an excellent quality business?

Alex Furmanski [00:24:07] Well, ultimately, to us it goes back to return. So this is a business that can generate mid-teens returns on incremental invested capital over a full ag cycle, which we believe is pretty attractive for such a dominant and established company that has been around for over 200 years. Obviously, it’s not the highest rate of return, but again, we got a trade-off. Stability and visibility vis-à-vis returns. So you know, we think that the risk-reward of owning John Deere or starting to buy it when we did in August of last year is pretty compelling.

Tilman Versch [00:24:50] How comfortable are you with the recent multiple expansion of John Deere?

Alex Furmanski [00:24:56] Well, listen, as you can probably surmise, John Deere and ag equipment manufacturers are heavily tied to ag prices which are notoriously volatile. So just to give you a sense, in the current cycle, corn prices went down 50% in the last downturn, which was 2013 through 2016, they went down 70%, and since we invested in August of last year, I think corn prices are up nearly 40%. So when you talk about multiple expansion. I would argue it depends on what earnings estimates you’re using because, really, the price of corn went up significantly.

And by the way, that’s just luck on a short-term basis. If you step back historically, these ag cycles last about two years. You know, when we invested originally into Deere, I think we were 18 months or so into the current ag cycle, and after doing deep work and talking to a lot of participants, we didn’t really believe that this ag cycle was going to be more pronounced or deeper than others.

So that gave us some comfort that we were closer to the bottom. Obviously, we didn’t know exactly where the bottom was and that corn prices would increase materially soon after we purchased it. But a lot of the price action in the stock since then has been driven by corn prices and broadly commodity prices increasing significantly.

We still think that, when we look at our estimates on a mid on a mid-cycle basis, which is really what we used to underwrite Deere, we’re still getting kind of north of that 12% IRR that we talked about. So there’s still value in Deere despite the run in the stock.

Tilman Versch [00:27:05] What is your holding horizon for the company?

Alex Furmanski [00:27:11] Ideally, forever. That’s what we really try to target with all our holdings. Unfortunately, price fluctuates a lot more than value, and so every now and then we have to get rid of a security because the price runs too much ahead of its value. But we’ll see what happens with Deere, and our holding period is ultimately going to be determined by the stock price and the value at which it trades.

Tilman Versch [00:27:43] Maybe to sum this part on Deere up, how would you describe your investment thesis in a short summary?

Alex Furmanski [00:27:53] Listen, so number one, why is this company great? It’s because it has scale. What does the scale allow it to do? Number one, it allows it to have a much broader footprint of dealer networks, which leads to less downtime and better service for its customers.

And number two, it gives the wherewithal to invest a lot more in R&D than its next two competitors, which are CNH and AGCO. And the statistic I said was, since 1999, the company has invested nearly $30 billion into R&D, which eclipses the market cap of CNH and AGCO. So we believe that you know, this scale advantage is the hardest one to replicate. And we believe that Deere continues to be ahead of its competition. I would encourage your viewers and listeners to take a look at some of the videos that Deere has on its website touting its technology. It’s pretty impressive.

You know, some fun facts, like, for example, there’s machinery moving on the third of the Deere surface. And in their last Investor Day presentation, they were talking about how large-scale farms can operate these days, in large part because tractors and combines have become a lot more automated and efficient.

And they were talking about how a farm that’s 40% larger than Manhattan is operated with only 20 workers and 34 machines. And so that efficiency, that in large part comes because the technology is so great, because the R&D spending is so high, is a very attractive proposition to farmers.

Tilman Versch [00:29:59] Maybe let’s jump to one last topic, portfolio construction. How do you think about portfolio construction? What is your framework for building your portfolio?

Alex Furmanski [00:30:10] So we typically have around 20 or so positions, and we usually try to size positions at 3, 5 or 7%. There’s no magic to why it’s three, five, and seven other than that it makes positions big enough that they’re impactful. It’s very hard to find good investment ideas. You know, Deere was the only idea we added to the portfolio last year, and so we are extremely selective.

And so at that time of sizing, that is usually impactful, that if you’re right, you’re going to make good money. And if you’re wrong, it’s not going to be fatal. So that’s generally how we size positions. Another thing we take into account when sizing positions is that our biggest positions aren’t necessarily the ones where we can make the most; it’s the ones where we think we can lose the least.

So it’s a bit of a different way of framing how you size positions, and that goes back to the risk aversion I was talking about earlier. So that’s generally how we approach portfolio construction. One other thing I will say is that in our mandate, we have the ability to hold cash in lieu of finding great opportunities.

And cash has been building for us in large part because the securities that we’ve we hold a lot of them have appreciated. We’ve exited some of them, and so cash has just naturally built up because we haven’t been able to redeploy some of that cash into great ideas at the moment.

Tilman Versch [00:31:56] So your framework is more anxious than aggressive. How do you build your portfolio?

Alex Furmanski [00:32:05] Yeah, listen, we’re paranoid about a lot of stuff, but this is a business and a game where you also have to know when to be aggressive. And so we are pretty good contrarians to a large degree, meaning you know, because both my partner and I have lived through several market cycles already, we know kind of how it feels when there’s a lot of blood on the street and that’s when the kind of muscle memory kicks in and pushes you.

Even though your gut is kind of telling you, know, the best decisions tend to be where your gut is kind of spinning, and you’re a little bit unclear about whether you should be pulling the trigger. Those usually end up best decision, so I don’t want to come across as are we’re afraid to act when the time is right. We’ve become a lot better.

Tilman Versch [00:33:05] So, as the second last question, where can people follow you if they’re interested in your work?

Alex Furmanski [00:33:12] So we have our website, unisonam.com where we share interesting information and you can sign up for our monthly reads newsletter where on a monthly basis we share some of the more interesting stories that we come across in our in our learning journey, that’s probably the best place and both myself and my partner are also on Twitter, although I’m not that active. I do tweet every now and then. Those would probably be the best places to follow us.

Tilman Versch [00:33:51] Thank you very much for your time, and thank you very much for the audience sticking with us and listening to this episode and bye-bye.

Alex Furmanski [00:34:00] Bye, Tilman. Thank you very much.