Matt: How do you guard against overconfidence, or against falling in love with the particular companies you’ve identified as having that potential?
Tony: That can be dangerous, especially since we do focus on management and culture of businesses and spend a lot of time getting to know the businesses we are investing in. Really, one of the biggest things we do is take a team approach. We discuss each investment idea as a group. One person is primarily responsible for doing the work, and the rest of the team will question that person’s views. We want to take an industrywide approach to make sure that the businesses we are investing in truly do have that sustainability in front of them. The other piece of it, other than the team approach, is being aware of new issues that may change our previous analysis. A lot of times, growth investors will look at historical performance and project it out into the future. Being aware of the psychological flaws that all of us have in terms of forecasting and trying to predict things prevents overconfidence.
Matt: Do you find that specific industries increase the risk there, or is that something you have to be vigilant about regardless of industry?
Tony: Each industry is different, and generally, some industries are more innovative than others. Some are very mature. There is a different set of considerations for each industry. When you look at industrial companies, for example, some companies are making the same products they made years ago, but there are places where there are new innovations coming out. So you need to assess each one differently.
When you think about reversion to the mean, it comes down to competition. If a company is taking market share and growing faster than their competitors, in many cases, the competition is not stupid, will catch up, and will take back that market share in the long run.
We try to find the companies where they are sustainably innovating and coming up with ways to maintain their advantages. In a lot of cases, when you look at tech companies — look at Amazon or Microsoft as an example — they are continuously evolving and changing their product offering to try to maintain that advantage. In other industries, like restaurants, for example, it is very hard to find companies that sustain growth above the industry averages, because the competition is fierce, and it is difficult to have any innovation that is not easily replicated by the competition.
Chipotle is a great example of that. The biggest advantage they had, more than a decade ago, was the assembly-line approach with the customer. The fast-casual approach was new 10 or 15 years ago, and now every city has dozens of stores that have similar layouts. So that innovative approach that Chipotle had gave them great growth for several years, but it’s not a sustainable advantage over the competition.