5 lessons on “next level quality investing” towards a 15% CAGR
Dev Kantesaria (Super Investor Secrets)
Imagine you could only pick a stock out of a universe of a mere 50 companies.
Imagine studying a company for 7 years before taking action.
Imagine 99% of the time, you would sit on your ass(ets).
These are some of the characteristics that define Dev Kantesaria’s investing strategy at Valley Forge Capital.
Has it worked? You betcha!
Since 2007, the fund has returned 15% per year versus 10.2% for the S&P500.
Today, we’re diving deep into Dev’s process to uncover the secrets to his success.
We’ll dive into ⬇
Who is Dev?
Investment process
Current portfolio construction
Past transactions and evolution
The 5 major lessons learned today
Who is Dev Kantesaria?
“It’s true that 99.9 % of the active management industry add no value.”
Dev Kantesaria, good investing interview
Dev is sort of an outsider in the equity fund management land.
A short history:
Wanted to become a surgeon since he was a kid
Started med school but dropped out in his 3rd year
Went to Mckinsey as a management consultant for 2 years
Worked in venture capital specializing in biotech for 18 years
Started a hedge fund with a focus on public equities, mainly long-focused
When you look at his trajectory, it allowed him to develop various aspects in his circle of competence. As a consultant, he had access to C-level management. As a venture capitalist, he again worked with startups and founders specifically in the healthcare space. Venture showed him how risky investing can be, buying 10 companies and hoping for 1 big winner to outpace the other 9.
But his first love, starting at the age of only 8 years old, was business and equities. His main influence was the quality approach developed by Buffett-Munger.
Funny note: He now holds nothing within the healthcare space.
In 2007, he started Valley Forge Capital with 300k USD in funds. It has grown to 4 Billion USD in assets under management (AUM) today.
Despite the growth in AUM, only 4 people work at the fund. Dev and his partner Benjamin do company analysis and portfolio construction.
As we discussed before, every investor should be aware of his/her edge. There are 3 possibilities according to Bill Miller:
Behavioral edge
Informational edge
Processing power edge
Dev considers his edge to be behavioral:
having a long-term mindset
being excruciatingly patient.
being unemotional when prices fluctuate
In other words, having the superpower “to watch paint dry.” In addition, he says the business is all-consuming. He thinks about it all the time.
Investment process breakdown
General Approach
When we discussed Pulak Prasad’s “focus quality investing “ approach rooted in biology and evolutionary theory, it seems Dev’s approach falls into a similar camp.
His process is quite simple:
Identify the best companies in the world
Wait, wait, and wait some more
Buy on a short-term price decline
Keep monitoring, and only rarely sell
This means Dev has also maintained a certain cash level from single digits up to 20% of the portfolio. But the devil is in the details, in the nuance. You could screen for a high-quality company using Buffett’s investing checklist. But Dev adds in some additional criteria.
What is Dev looking for is the cream of the crop. That means, monopolies, duopolies, or oligopolies: huge barriers to entry, huge MOATS.
Quality usually means:
Low debt
Capital light
Pricing power
High ROIC company
Great capital allocation
Growth with operational leverage
There are 3 things Dev adds to this.
The service ideally is mission critical: For example: A credit agency like Moody’s. If you raise credit, need a rating, and let it be rated by a smaller agency, you’ll have to pay a higher interest rate on the loan. That’s the power the Moody’s has. So there is no incentive to go to another rating agency.
The service is a small cost for the user: Again using the example for Moody’s, the cost for the rating is dwarfed against the money that is raised. This is important because it allows Moody to gradually raise the price without the customer complaining or risking going away to another service
There is clear organic growth. He tends to avoid M&A growth.
On Valuation
Since he is looking for mature businesses, that continue to develop their operational leverage and should be able to expand their margins, these businesses usually generate a lot of free cash flow.
Based on the quality assessment of the company, he will calculate a free cash flow yield he would be willing to pay for the company. This intrinsic value yield has to be updated continuously.
He emphasizes it’s not about a precise value, it’s about a valuation range.
On this topic, he does not look at the Macro picture, the only chart he uses is the following:
In other words, if the current treasury yield sits at 4%+ then factoring in the current free cash flow yield and future growth has to be a lot better than the treasury yield considering the risk you’re taking.
Be prepared
Do the work beforehand.
Make sure you are prepared when the opportunity hits. When looking at larger quality companies, everybody sees them. The market knows these are great companies so the market prices them accordingly until it doesn’t. Short-term headwinds can lead to mispricings. But the window for entry is usually short. It can last from a couple of days to a couple of months. If the work has been done at the last minute, you will lack the conviction to go against the crowd.
Current Portfolio
Dev has always run a concentrated portfolio. Currently, there are 8 holdings. We’ve taken the data from Datorama and inserted them into finchat.io to get some portfolio metrics.
His 4 biggest holdings are:
Fair Isaac and Company (FICO): A monopoly on consumer credit scoring in the United States
Moody’s (MCO) and S&P Global (SPGI): A duopoly of credit rating agencies in the United States
Mastercard (MA) and Visa (V): A duopoly in credit card networks
The remaining positions are:
Intuit (INTU): Its software package Quickbooks is a monopoly in the United States
ASML: A monopoly of EUV lithography machines in the semiconductor industry
Aspen Technology (AZPN): Software for asset management in different industries
How does this concentrated portfolio stack up against the S&P500?
Past growth for Valley Forge Capital has been faster on all metrics. The portfolio shows very high ROIC and high free cash flow margins as you would expect.
But the valuation at this time is a lot higher than the overall market.
Past Transactions
Here’s how the portfolio has evolved since 2016 (from Gurufocus.com)
Some noteworthy transactions:
Q4 2016: Buy Equifax to sell once more in Q2 2017
Q3 2017: Buy Fair Isaac Corp
Q2 2019: Steady increase in Mastercard (not only due to price appreciation)
Held Adobe for 3 years. Sold out in Q1 2022
Bought tiny position in ASML Q3 2022, still holding
Q2 2018: Increase in Visa. Selling it down over the years
Q2 2021: Held Amazon for 2 years
Increased stake in Mastercard during COVID (MA went from 339 per share to 211 (an almost 40% drop (in 1 month) It took 2 months to close the gap once more (not fully)(FICO had a similar drawdown)(then went sideways for 2 years)
It’s not that he never trades. Instead of selling and buying, we see trimming and adding. Here’s an overview from Datorama:
What he considers his biggest mistake ⬇️
Dev has never invested in the magnificent 7 (although he was a venture capitalist during the tech bubble).
Why didn’t he?
Lots of CAPEX spending down the drain (think Google, Meta)
Sometimes bloated Stock Based Compensation, yes buybacks, but SBC can be generous
The most important one: Just as we mentioned with Buffett, very difficult to look into the future. Tech changes alot.
However, the mistake he admitted, is he underestimated the strength of their business models. Their business is so strong, that even despite these negatives, they still generated enormous amounts of cash over the last 10 years.
He did have Amazon in his portfolio for some time. Maybe he’ll invest in one of them if there ‘s a big drawdown in the future, who knows.
5 Major Lessons from Dev
So, what are the best lessons from Dev’s approach?
For a quality investor, the window of opportunity arises suddenly and closes quickly. Be ready and decisive when it arrives
Preparation is everything. You need to know your companies before an opportunity happens. If not, you will not have the conviction to buy when the whole world is selling
If you manage to land one of the best companies in your portfolio at a great price, you need to keep monitoring what happens within the company. Besides that, just keep sitting on your ass(ets)
Anybody can screen for a ‘quality company’. But the true quality is more nuanced. You need to dig deeper, look for subtle signs of pricing power
You don’t rise to the level of your goals. You fall to the level of your systems. Did you miss Nvidia? Dev did too. Have no regrets. Keep implementing and developing your process. Stick with it.
I do not want to detract from Dev Kantesaria and Pul Prasad’s success. It requires great temperament to do what they have done. But they had 2 things going in their favor. You could call it luck, but as Seneca says, luck is when preparation meets opportunity.
They both started a fund in 2007, and since they use a quality approach, quality investors, especially when starting out, absolutely LOVE a crash. Well, the mother of all crashes arrived in 2008, and they bought in heavily. (I’m not saying it’s easy because you’re going against the crowd at that moment).
They both had big winners early on which helps a lot with the funds growth. Usually, people bet their money based on past performance (which may not be the best way)
Imagine you’re given 1 Billion USD in cash to start a fund. You receive that cash today. Are you seeing lots of high quality opportunities in the market?
Maybe a crash will come, maybe not. If the next crash happens in 2034, I guarantee that you could be the best quality investor in the world, you won’t be able to replicate Dev and Prulak’s performance.
Reading and listening to Dev’s story was fascinating.
As always, may the markets be with you!
Kevin
Further reading and listening
I’ve compiled a list of articles and podcasts if you want to dig deeper.
Articles
A great interview with Dev by Barron’s
10 lessons from Dev by a fellow Substacker
Some deeper info on FICO
Podcasts
YouTube video by Good Investing Talks
Discussing Buffett’s core principles:
https://www.theinvestorspodcast.com/episodes/buffetts-core-principles-w-dev-kantesaria/
For the Dutch-speaking: Jong Beleggen - De Podcast
https://jongbeleggendepodcast.nl/163-grote-beleggers-dev-kantesaria
Great content 👏🏼👏🏼
This is the first time I've read your content, and I'm impressed. I really like the thorough breakdowns.
I'll keep reading.
All the best!