All writings of Akre

Capital Management
Our Investment Philosophy by Chuck Akre

What is so important about the three-legged stool?

We speak a lot about “essences,” and the essence of our investment approach is perfectly
captured by the visual of a “three-legged stool.” This metaphoric three legged stool describes
what we look for in an investment: (1) extraordinary business, (2) talented management and
(3) great reinvestment opportunities and histories. I have an old three-legged milking stool in
our conference room and it is clear by looking at it that it is sturdy and durable. We believe
our stool is just as sturdy and durable based on our many years of experience!

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What was the inspiration for your investment philosophy?

It is common knowledge that the average return in the U.S. equity asset category over the last
century has been in the neighborhood of 9% or 10%. It just so happens that this figure
correlates with the rate of return on the owner’s capital and frequently with the growth in the
book value per share of the typical U.S. company. We posited from this observation that our
return on an asset would therefore approximate the return on the owner’s capital, absent any
distributions, and assuming a constant valuation. And since our stated goal is to compound
our clients’ (partners’ and shareholders’) capital at an above average rate while incurring a
below average level of risk, we needed to identify this group of superior businesses which
earn above average rates of return on their owner’s capital.

How does your investment philosophy differ from other asset managers?

There was a time when I used to answer that question by saying, “I don’t know. You tell me.”
Now, however, I believe that we are very different in at least two important ways.

First, our decision to buy or sell shares in a business is based on the same fundamental
criteria. We do not set sell price targets when we buy a security – we often say we are not
looking for the exit on the way in – because we are not looking to simply trade securities
based on their price movement. Rather we are looking to compound the capital we manage,
and have identified that investing in these “extraordinary” businesses, as we define them, is
the BEST way to achieve our goal. We begin sell discussions when one or more of the legs of
our stool is “broken or injured”. The outcomes over our years of experience clearly reinforce
this notion.

Second, Wall Street’s obsession with what we describe as the “beat by a penny, miss by a
penny” syndrome frequently gives us opportunities to make investments at attractive
valuations. We keep our focus squarely on growth in the underlying economic value per
share – often defined as book value per share – over the course of time. Our timetable is five
and ten years ahead, and quarterly “misses” often create opportunities for the capital we
manage.

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What is compounding?

A lot has been written about the power of compounding. We’ve all heard illustrations of the
extraordinary results that may be accomplished if compounding is allowed to do its work
over long periods of time. But what is compounding? How does it work?

There’s an extreme example: the story of Native Americans selling the island of Manhattan.
As the story goes, the selling party in the deal collected an estimated $20 worth of beads and
trinkets from the transaction, which took place in the year 1626.

So how does compounding play into this? Let’s say the sellers invested their initial $20 at a
rate of 9% per annum and then stuck with this investment program for the following 380
years. Today, their initial $20 would be worth more than $3,335,000,000,000,000.

I like this example of compounding because it illustrates that the rate of return on an
investment doesn’t need to be extraordinary for extraordinary results to occur. What is crucial
is having the ability to sustain an investment program uninterrupted over a very long period
of time.

In the real world of investing, “life gets in the way”. It’s rare for an investor to enjoy a streak
of decades of compounding in any investment without the interruptions of distributions and
taxes. This story simply reminds us that striving for sustained, uninterrupted compounding
over long periods of time is smart investing, and that’s precisely our goal.

Many people think of us as a “value investor” and others ask whether we are a value or a
growth investor. We’ve started to say, we’re neither, we are a compounding investor.

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What does it mean to be a compounding investor?

It means we try to invest in businesses that have the ability to compound internally over the
course of many years.

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To think like a compounding investor is very natural for people who buy small or private
businesses. The private investor wants to concentrate carefully on a few business
investments, and hopes the accountants will report back consistently at the end of each year
that equity per share has grown. Private investors don’t think about trying to dart in and out
of investments on a daily or monthly basis.

This approach is so basic, it’s often forgotten in the public equity markets. In public markets
it’s become too easy to get distracted by hour-to-hour market gyrations and all the breathless
excitement brokers and the media put on short-term news. To be a compounding investor,
you need to tune out the short-term noise.

We think hard about the ingredients required for a business to compound in value over the
course of many years. We believe these include: 1) an ability to generate above average
returns on shareholders’ capital, 2) opportunities to deploy additional capital at above average
returns, and 3) a management team with the skill and judgment to sustain the process of
compounding over a long period of time in the face of competition. You’ll recognize this is
just another way of describing our “three-legged stool” approach: Business, Management,
Reinvestment.

How does Akre’s investment philosophy demonstrate the power of compounding?

We strive to invest in businesses with these three ingredients of compounding, and to buy
them at reasonable prices. If we do this, there is no reason or need to trade in and out of these
businesses to achieve above average returns. We don’t want to rely primarily on our
contrarian instincts or our ability to play market volatility in order to generate returns. Like
the private investor, we want the businesses we buy to be growing in real economic value
each day.

We like to hold investments for many years to allow their internal compounding to do its
work. It’s a wonderful thing not to have to realize a taxable gain. The tax deferral available
by investing in businesses that compound internally is an enormous and often under-
appreciated advantage.

Yet, in the real world, businesses do change. We need to be constantly vigilant about these
changes. Some businesses are getting worse as years pass, while others are getting better, and
so our investment portfolio gradually evolves.

The Art of (Not) Selling - by Chris Cerrone

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Of our most costly mistakes over the years, almost all have been sell decisions.

The mistake, in virtually every instance, has been selling too soon. Reflecting on these
mistakes gave rise to this letter, and its title, “The Art of (Not) Selling.”

Taking a step back, our investment philosophy involves concentrating our capital in a small
number of what we believe to be growing and competitively advantaged businesses. These
kinds of businesses are rare and are only periodically available for purchase at attractive
valuations. With that in mind, we do our best to hold on for the long term, so that our capital
may compound as the businesses grow.

Holding on means resisting the temptations to sell — and there are many. We tune out
politics and macroeconomics. To the surprise of many, neither valuation nor price targets
play a role in our sell decisions.

To be clear, there may be times when we believe it is appropriate to sell. In these instances, it
is typically because of an adverse change in the business itself.

This determination to hold on is a critically important, and not always well understood, aspect
of our investment philosophy. At its core, it relates to the power of compounding. We believe
these two ideas — (not) selling and compounding — are inextricably linked. Getting the first
wrong makes the second impossible.

Allowing our investments to compound uninterrupted is our North Star.

An illustrative riddle

You are given the choice between two sums of money: one million dollars or a penny that
will double every day for 30 days. Which should you choose?

Here are a couple hints. The penny that doubles daily would be worth $1.28 after the first
week. After the second week, it would be worth $163.84.

You will probably reason that the penny would be worth more than the one million dollars.
(Why, otherwise, all the theatrics?) By just how much, though, might surprise you.

It turns out that after doubling 30 times, the penny would be worth $10,737,418.24!

This is a terrific exercise because it highlights the not-so-obvious power of compound returns
(in this case, the penny compounds at 100% for 30 periods).

I say not-so-obvious because you would have been better off taking the one million dollars
until the 27th day. But in those final four days, the value of the penny increases from less
than $700,000 to more than $10.7 million. Patience and a long-term perspective are required
to give the power of compounding an opportunity to do its magic.

Most do not naturally grasp the concept of compound interest. It has been called the eighth
wonder of the world (first by Albert Einstein, supposedly) for good reason. Most of us have
to learn to appreciate it. And even once learned, we have to remind ourselves periodically of
its wonder.

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From this riddle, we learn the importance of holding on so that we allow our investments to
compound uninterrupted for long enough that the compounding effects we saw in days 27 to
30 have an opportunity to play out in our portfolios.

Politics, the economy, and valuation

We have learned to be very careful about the reasons we sell.

We try hard to tune out concerns about politics and the economy. We read the newspapers,
and we work just down the road from Washington D.C. However, it has been our experience
that we are at our worst as investors when we allow concerns about these issues, including
elections, trade wars, and Fed policy, to influence our investment decisions.

In addition, we try to resist the temptation to sell (or trim, even) on the basis of valuation
alone. We are unfazed when our businesses are quoted in the market at prices above what we
would pay for them. It might be worth reading that last sentence again for emphasis.

Why? For three reasons…

First, when selling because of valuation, it is often with the idea that there will be an
opportunity down the road to buy back in at lower prices. In our experience, it seldom works
out this way.

Second, of the thousands of publicly traded companies, there are probably fewer than one
hundred that meet our criteria, and opportunities to buy them at attractive prices are few and
far between. Unlike average businesses that can be traded like-for-like on the basis of
valuation alone, growing and competitively advantaged businesses are just too hard to
replace.

Third, the very best businesses tend to exceed expectations. What may seem like a high price
today may be proven to be perfectly reasonable in hindsight.

Price targets

Valuation plays no role in our sell decisions, and neither do price targets.

The underlying idea behind a price target is that every business has an intrinsic value and that
the goal of an investor should be to buy at a discount to intrinsic value and sell when the
discount has narrowed. It is compelling to say that you buy proverbial dollar bills for 60 cents
and sell them later for a dollar.

With growing, competitively advantaged businesses, however, that proverbial dollar bill may
be worth a dollar now, but we expect it will be worth $1.20 next year and $1.40 the year after
that. When in possession of these kinds of businesses, we believe that you are much better off
holding them for the long-term and allowing them to compound.

More compounding math

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Let us assume you have purchased shares in a company and the price has doubled. In this
situation, it would be normal to feel an urge to sell — to cash in, secure the gain, and take
your victory lap. The following math might help you resist that impulse.

Having doubled your money once already, the next time the stock price doubles your
investment will be 4x your cost. The next time after that, 8x. Then 16x. The key idea is that
compound returns are exponential.

If your investment doubles 6 ½ times, you will have $100 for every $1 you started with.
When this happens, we refer to it as a “100-bagger.” An investment that is worth 100x your
cost is incredible to fathom. If you are fortunate enough to experience this firsthand, chances
are you will become a true believer in the power of compounding.

The times to sell

Even with the power of compounding firmly in mind, there may be times when we believe it
is appropriate and necessary to sell. These include, but are not limited to, when a business (1)
is no longer growing at an above-average rate, (2) has had its competitive advantage
impaired, or (3) has had an adverse change in management.

Slowing growth. Our foundational idea is that our returns as investors will approximate
growth in economic value per share of the businesses in which we invest (whether defined by
book value or free cash flow, and always on a per share basis). To generate above-average
returns over the long term, we believe we must invest in businesses that are growing
sustainably at above-average rates. When growth slows, we expect our returns will as well.

Loss of competitive advantage. Businesses are in a constant state of change. Changes in

technology, distribution, or regulation might whittle away at a business’s competitive
advantage. Even the most successful companies must reinvent themselves periodically to
remain relevant and adapt as the world evolves around them. The moat must be dredged
every now and then. Failure to do so may cause competitive advantage to weaken or
disappear altogether.

Management. We place heavy emphasis on identifying managers who possess equal parts
skill and integrity. A consequence of our long-term investment horizon is that we tend to own
businesses for multiple generations of management. Successors are not always up to the task.
We have learned over time to withhold immediate judgement to give new management plenty
of time to get settled in. However, at some point, we have to make a call, and a new
management team that falls short of our expectations might cause us to sell.

This is not an exhaustive list. In very rare instances, we might sell so we can free up capital to
invest in what we believe is a better business. Beware, however. Selling something you know
well to buy something new that seems better is a dangerous game. We have been bitten by
this more than once.

It is also always possible that we just change our minds. The process of getting to know a
business takes time, and we sometimes uncover new facts or form new opinions that overturn
our original reasons for buying. This usually happens with newer additions to the portfolio.

The antidote to the noise

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For the investor determined to hold on and compound, tuning out the noise is essential.

Quarterly earnings (are slide decks and conference calls really necessary every 90 days?), the
financial press (cable news, in particular), and Wall Street analysts contribute to the
cacophony.

It is important to keep in mind that the financial press and Wall Street live on eyeballs and
transactions. They are, by definition, trying to maximize the noise—to convince you to sell
what you own and buy what you do not.

In his book “100 to 1 in the Stock Market,” Thomas Phelps advised:

“Never forget that people whose self-interest is diametrically opposed to your own are trying
to persuade you to act every day.”

He wrote that 47 years ago in 1972, and it is probably truer today than it was back then. Wall
Street trading desks do not earn commissions when you buy and compound, and the cable
news channels do not attract an audience by saying “there nothing new to report today.”

Here in our Middleburg offices, our only television is in the conference room, and it gets the
majority of its annual usage during NCAA March Madness. (Our CFO is an avid Tar Heels
fan!) Cable news is not our ambient noise. We think it is bad for your economic health.

In addition, we try to develop an understanding of what really matters for each of our
portfolio companies.

We endeavor to look past the non-essential details. We want to identify the essence of each
business’s competitive advantage. It is a challenging process but the rewards are worthwhile.
We can far more easily assess the relevance of new business developments once we are
armed with our understanding of what really matters and what does not.

Quarterly earnings reports, for one thing, become much less of an event. So do short seller
reports, newspaper headlines, and analyst downgrades.

In our experience, this kind of refined understanding is the best antidote to the noise and
helps provide us with the fortitude to stay the course and allow our investments in growing,
competitively advantaged businesses to compound uninterrupted.

After all, we always try to keep in mind just how much that penny is worth after 30 days.

Chris Cerrone

Why Compounding is so Difficult - by John

Neff

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How many billionaires are there in the United States? There is no definitive count. Most
estimates put the number well below 1,000–with 927 being by far the highest estimate we
have seen. Whatever the precise number, given the power of compounding, there should be
many times the number of billionaires in this country than there are today. Assuming a 10%
annualized rate of return in the stock market over the last 100 years, a family needed to invest
$72,000 in 1922 and then simply leave it alone to have around $1 billion in 2022. We have no
idea how many families had that kind of money to invest in the stock market back in 1922,
but whatever the number, we believe it was much larger than the number of present-day
billionaires.

What happened to all those could-have-been billionaires? Why do more investors not reap the
benefits of compounding? We believe the reason has surprisingly little to do with recessions,
depressions, wars, financial crises, political crises, rising interest rates, inflation, stagflation, a
global pandemic, or most adverse macroeconomic events. The stock market’s return over the
past 100 years includes all of these terrible things. Yet, the stock market still compounded
wealth to the point where every $1 invested in the S&P in 1922 and left untouched would
have become nearly $13,800 in 2022! Our conclusion: it is not adverse macro events that
derail compounding; it is investors’ reactions to them. In short, investor behavior derails
compounding.

Examples of such counterproductive behavior are well known to all of us: trying to sell
before the next recession, trying to buy just before the next bull market, “repositioning”
portfolios based on what is supposed to do better in the new paradigm, dumping stocks
during a downturn, which deprives oneself of the means to eventually recover. People do
these things because they are intuitive, because these actions appear rational in the face of
heightened concern and uncertainty. This is precisely why compounding over the long term is
so challenging and rare: it demands counter-intuitive and seemingly irrational behavior.

One of our favorite Buffett maxims is that the stock market exists to serve investors, not
instruct them. We think it speaks to the importance of distinguishing between the
fundamental performance of a business and the price movement of its stock. Investors
minding both can periodically be served by the stock market when business fundamentals and
share price diverge. Too often, however, investors are informed only by share price
movements from which business fundamentals are then inferred. These investors are not
served by the stock market. Rather, they are instructed by it and typically to their detriment
when it comes to compounding.

I would like to provide a couple of examples of divergence between fundamentals and share
price for the year-to-date period through May 13, 2022.

The first example is CarMax. In the fiscal year completed February 28, 2022, CarMax, the
business, did the following:

• Increased retail units sold by 23%.

• Increased wholesale units sold by 66%.
• Increased free cash flow per share by 47%.
• Increased its market share of 0-10 year-old vehicles sold from 3.5% to 4%, a 13% increase
in market share over the past year.

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CarMax achieved these record results while rebuilding its business to be able to offer the best
in-store experience, the best online experience, and everything in between, all while
maintaining CarMax’s unmatched transparency and fairness to the consumer.

If that sounds impressive, we agree. So how has CarMax, the stock, done so far this year?
Down nearly 30% YTD through May 13, 2022.

The second example is private equity powerhouse KKR. In 2021, KKR, the business, did the
following:

• Increased assets under management organically by 48%.

• Increased fee-related earnings by 54%.
• Increased distributable earnings by more than 100%.
• Raised $121 billion of new capital, nearly half of that for strategies KKR didn’t have just 5
years ago.
• Finished the year with $112 billion of investable “dry powder.”
• Grew book value by 25%.

Again, spectacular fundamental performance. So how has KKR, the stock, done so far this
year? Down nearly 31% YTD through May 13, 2022.

Now, we understand that stock prices take their cue from the future, not the past, and that
share price declines in 2022 have to do with concerns over worsening conditions in the near
term. But that does not obviate the point, which is that we believe our businesses continue to
become more valuable as earnings power continues to grow. It is ironic that if CarMax was
not publicly traded, if it was a private business held in a private equity fund, its valuation
might justifiably be marked higher after the year it just had. But, this irony is also the source
of great opportunities in public equities thanks to the behavior induced by ever-changing
stock prices.

Hopefully, these illustrations for CarMax and KKR demonstrate why we remain steadfast
believers in the businesses in which we invest. Our focus is on the fundamentals. We do not
infer those fundamentals from share price movements. Rather, we endeavor to let the market
serve us when fundamentals and share prices diverge. This is the best way we know to avoid
the behavior that history proves so detrimental to compounding.

The investment examples included herein have been selected based on objective, non-
performance selection criteria, solely to provide general examples of the research and
investment processes of Akre Capital Management. The investment examples should not be
construed as an indicator of future performance. The information presented above should not
be considered a recommendation to purchase or sell any particular security. There can be no
assurance that any securities discussed herein will be a part of any portfolio or, if sold, will
not be repurchased.

How We Think About Cash - by John Neff

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Cash is a controversial subject among many fund investors and fund managers. Some fund
managers wish to periodically hold or accumulate cash in anticipation of better investment
opportunities in the future. However, many fund investors believe that equity mutual funds
should operate at all times with as little cash as possible. Typical reasons cited by fund
investors for their “minimal cash” worldview include:

• cash earns virtually nothing; and

• investors use funds for equity exposure and want that equity exposure maximized
while leaving the broader cash weighting decision to them.

Such investor imperatives, combined with pressure to outperform the broad market at all
times, have predictably led to a general reluctance among equity funds to hold much cash.
Among the largest 200 US Large Cap Growth funds, the average cash weighting at present is
approximately 1.5%, according to Morningstar.

These concerns about cash range from factual (cash indeed earns virtually nothing) to
understandable. Cash is not an asset that holds, let alone increases, purchasing power over the
long term. We get it! However, we have a distinctly positive take on the role and importance
of cash and believe that fund investors can be well served by its disciplined use.

The Value of Cash

To us, the value of cash has very little, if anything, to do with the return one earns on it
directly. Rather, the investment value of cash is fortitude. In a bear market, cash is the “thin
green line” that separates crisis from opportunity. This view is expressed well by Morgan
Housel in his book The Psychology of Money:

No one wants to hold cash during a bull market. They want to own assets that go up a lot.
You look and feel conservative holding cash during a bull market, because you become
acutely aware of how much return you’re giving up by not owning the good stuff.

But if that cash prevents you from having to sell your stocks during a bear market, the actual
return you earned on that cash is not 1% a year–it could be many multiples of that, because
preventing one desperate, ill-timed stock sale can do more for your lifetime returns than
picking dozens of big-time winners.

In other words, the value of cash is not the return it provides but the behavior it promotes.
Because long-term investment success has more to do with behavior than just about anything
else, we believe investors that are willing to hold or accumulate cash when valuations are
frothy are more likely to behave better during tough times when opportunities abound. By
“behave better,” we mean sell less and/or buy more.

“Cash Drag”

We believe that cash’s “drag” on portfolio returns is routinely overestimated. Attuned

investors rarely have to wait long to put cash to work opportunistically. Consider the gap
between any given stock’s 52-week high and low share price. According to 2016-2020 data
compiled from Bloomberg for all of the companies in the S&P 500, the median gap between
calendar year low and high stock prices averaged 35%. Said differently, over each of the past
5 calendar years, investors could buy shares of any company in the S&P 500 at a median

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discount of 35% from that year’s high price. This speaks to opportunities routinely presenting
within a year’s time, hardly long enough for cash to be a meaningful drag on returns.

Reframing Opportunity Cost

The meager return on cash is often cited to justify poor risk/reward decisions. Said
differently, cash is often mistakenly used to frame opportunity cost. For example, say an
investor targets 15% annualized returns on equity investments but has “excess” cash
accumulating in his or her portfolio. The best discernible equity investment at present offers
an expected annualized return of 10%. What to do?

Many investors frame this as a choice between earning 10% on the equity investment or 0%
by keeping the funds in cash. But framing this as a choice between earning 0% and 10% is to
frame it as not a choice at all! Framed this way, the investor chooses the equity investment.
Granted, the expected return is less than the targeted (now merely preferred) 15%.
Nevertheless, 10% is still decent and much, much better than earning 0% in cash, right?

Thus is valuation discipline suspended, all in the name of minimizing cash.

We frame this differently: not as a choice between 0% and 10% but as a choice between 0%
and negative 20%. Where does the -20% come from? Over a 5-year investment horizon, the
difference between getting a 10% annualized return and a 15% annualized return–holding all
else equal–requires a 20% drop in the stock price. The table below shows that paying $62
today for a stock that will trade at $100 in five years will generate a 10% annualized return.
To get 15%, the price has to drop from $62 to $50, a decline of 20%.

Stock Price Year 0 Stock Price Year 5 Annualized Return

$62 $100 10%
$50 $100 15%

-20% Price drop required for 15% annualized return

Now framed as a choice between earning 0% in cash or suffering a 20% decline before the
stock reaches the buy price, how would you choose? Of course, framing the question this way
is also to frame it as hardly a choice at all. But consider how the choice of frame might affect
subsequent behavior. If an investor bought this stock at $62 and the price promptly drops to
$50, is the investor likely to buy more or sell it in disgust? Paying $62 in this example, the
buyer has already foregone the opportunity to make 15% annually. But selling at $50 also
deprives the investor of earning the 10% initially settled for. At this point, the investor has
suffered a 20% loss of principal and, ironically, the proceeds of that sale at $50 are sitting in
cash earning nothing, fear of which prompted the decision to buy at $62 in the first place!

The example above contemplated a 5-year investment horizon. Interestingly, the shorter the
time horizon, the less the stock price decline required to be true to one’s valuation discipline.
As shown in the table below, over a 2-year investment horizon, only a 9% price decline
separates a 15% annualized gain from 10%. The shorter the time horizon, the less excuse
there is to abandon valuation discipline in order to minimize cash.

Stock Price Year 0 Stock Price Year 2 Annualized Return

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$83 $100 10%
$76 $100 15%

-9% Price drop required for 15% annualized return

Virtually any investment with a positive expected return could be justified when compared to
cash’s 0% return. This is precisely what makes cash such a specious factor when framing
risk/reward and opportunity cost.

In Conclusion

We prefer to invest cash opportunistically, not routinely, and to do so in accordance with our
valuation discipline and not arbitrarily to minimize cash. Cash does not burn a hole in our
pocket in the absence of opportunity. In short, we do not look at cash levels to determine
whether to buy stocks; we look at stocks to determine whether to invest cash.

Our views on the role and value of cash may not be widely shared. Given the importance of
the subject to our investment process, we thought that ample reason to provide a better
understanding of how we think about cash.

What Do We Mean By Reinvestment?

The three legs of our investment stool represent the essential ingredients for a business to
compound: an extraordinary business model, exceptional people, and abundant reinvestment
opportunities. Elsewhere, we address the importance of a strong business model and
exceptional people. Here the topic is reinvestment.

The people running a successful business are regularly faced with the decision: what to do
with the cash earnings? At the most basic level, there are two possibilities. First, they can
retain the cash and invest it with the aim of increasing the value of the business. This is what
we call reinvestment. Second, they can pay out some or all of the cash to shareholders as a
dividend.

Right away, we can begin to understand why reinvestment is so critical. The ability to earn
earnings upon earnings is essentially the definition of compounding. In the long run, we feel
strongly that the rate at which the value of a business compounds will approximate its returns
on reinvestment.

With an outstanding reinvestor at the helm, even an ordinary business can become a
remarkable compounding machine. There are abundant examples, including of course
Berkshire Hathaway, which began its compounding journey as a struggling textile mill.

And yet, we so often observe dividends being prioritized by investors and pundits. The
reality is that dividends are the route to average returns, and our goal is decidedly to seek
above-average returns. Excellence in reinvestment is the route to such returns.

This is simply because markets recognize and put a high price on businesses with high
returns on invested capital. The price a shareholder pays for a wonderful business is typically

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a substantial multiple of the actual capital invested in that business. And, unfortunately for
the dividend-centric investor, it is this ratio of market price to invested capital that dictates
the returns available to shareholders on any earnings paid out as dividends.

To illustrate: If a business has an underlying 21% return on capital, but an investor paid a
market price of 3x capital to acquire the stock, then a 100% dividend of all earnings would
only yield the investor a 7% pre-tax return (the arithmetic: 21%/3 = 7%). This is very much
an average return, even though the underlying business has excellent returns on
capital. While the underlying business model may be outstanding, and while the business
may be run by exceptional people, the lack of reinvestment opportunity and a decision to pay
out 100% of earnings will cause shareholder returns to be just average.

On the other hand, if it were possible that all earnings could be retained and reinvested at the
same 21% rate, the shareholder would receive no dividend, but the capital and earnings of the
business would both grow at the rate of 21% per annum. Over the long term, if the stock is
purchased at a reasonable multiple, its market price would grow more or less in parallel with
the rate of growth in capital and earnings. The shareholder, in this example, would build
capital gains at a rate in the neighborhood of the underlying 21% growth rate, for so long as
the runway of excellent reinvestment opportunities persisted. To top it off, the shareholder
would enjoy tax deferral on the gains. If you know of any businesses that can retain 100% of
earnings and reinvest them at a 21% rate, please give us a call!

Within our portfolios, different businesses we own have different strategies for
reinvestment. Some are expert at acquisitions, and others rely primarily on organic
reinvestment such as the purchase of fixed assets and inventory that may be required to
expand sales and earnings. Some have a reinvestment strategy that enables them to be
opportunistic across a variety of asset classes and industries where these management teams
constantly assess where the best opportunities lie to reinvest capital and grow book value per
share. As written in one company’s 2013 shareholder letter: “…each day, we get to choose
from a varied menu as to how to allocate capital to continue to build the value of your
company.” Their varied menu includes capital to support insurance underwriting, the
purchase of public equities, the purchase of private equities, acquisitions, and share
buybacks. And some have never paid a dividend.

Alongside a strong business model and exceptional people, abundant reinvestment

opportunities are the key to high rates of compounding returns.

Advice for Aspiring Investors - by Chris

Cerrone
When I started at Tufts University in the fall of 2006, I thought I had it all figured out. I
would study International Relations, pass the Foreign Service exam, and begin a career in the
State Department bouncing between far flung embassies.

Then serendipity intervened. Every freshman student was assigned to a pass/fail course
taught by a pair of seniors. The idea was that the seniors would help us acclimate to college
life while hopefully teaching us something in the process.

16
Prior to arriving in the fall, we were given a list of these pass/fail courses to choose from and
were asked to rank our top three. I do not remember what my top two choices were, but my
third choice was a course entitled “A Walk Down Wall Street.” You can guess to which class
I was assigned.

And so began my unanticipated journey as an investor.

Fifteen years later, I find myself on the receiving end of requests for advice from college
students who aspire to enter the investment management business. I have been given plenty
of help along my journey so far and owe a lot to my mentors. So, I try my best to pay it
forward and be helpful.

It recently occurred to me that it might be worthwhile to write down some of the thoughts
that I share with the students who reach out to me. I believe it is important to point out that
these are only my opinions, based on my experiences. There are many paths to becoming an
investor and reasonable people can disagree about what constitutes the best preparation for a
career in this wonderful, challenging, and multidisciplinary occupation.

With that out of the way, here are a handful of thoughts to consider:

• Study hard. Grades matter. As a student, learning is your full-time job. Future employers
will want to see that you took this job seriously. For better or for worse, grades are a
reflection of how well you perform in your studies.

• Study what interests you. College is an incredible opportunity to be curious and expand
your horizons. From my point of view, engineering, psychology, philosophy, and English are
equal to or better than economics, accounting, finance, and mathematics in terms of preparing
you for a career as an investor. As Charlie Munger often points out, investors who can draw
on the big ideas from many disciplines have an important advantage. So, the ultimate
objective is to master the art of learning (also the title of a fantastic book by Josh Waitzkin).
In other words, I think spending your time in college discovering how to learn is more
important than what you learn. Most large financial firms have extensive training programs
for new hires that will bring you up to speed, no matter your area of focus in school.

• Join an investing club. Internships and entry-level positions in finance are highly sought
after. Excellent grades from a top school have become table stakes. They are required to get
the interview. To get the job, it helps to differentiate yourself. If the goal is to become a
professional investor, it is important to demonstrate your interest in investing! Taking a few
finance courses probably will not get the job done. For me, joining the Tufts Financial Group,
a student-managed portfolio of stocks and bonds carved out from Tufts’ endowment, was the
highest-return decision I made during my time in school. If your school has an investing club,
join it. If your school does not have an investing club, consider starting one!

• Manage your portfolio. The most important question I ask during an interview is “What do
you own in your personal portfolio, and why?” It is make-or-break. Surprisingly few
candidates manage a portfolio of their own and even fewer can speak thoughtfully at some
length about their investments. It is often where a candidacy ends. My advice: manage a
portfolio! Keep a journal of your investment activity. Write down your rationale when you
make an investment. Do the same when you sell. Keep tabs on your returns. Keep it neat and
organized, and be prepared to offer it to your interviewer along with your resume and cover

17
letter. Trust me, it will go a long way! One final point: the size of the account does not matter
at all. It can be a virtual (i.e. not real money) portfolio. It is a test of passion, curiosity,
insight, and judgement – not of wealth.

• Read. Reading is an incredibly important aspect of an investor’s education. Choosing the

right books will directly impact the quality of that education. Every successful investor
probably has a unique list, and I have included a short list of my own at the end of this piece.
Recently, there has been a proliferation of investing-focused podcasts as well. Many of these
are worthwhile, and I consider them another form of reading, especially since I listen to most
books on Audible while walking the dog anyway!

• Mentors. I cannot overstate how important it is to cultivate mentors. The simple fact is that
we do not have all the answers, and there are people out there with the experience and
willingness to help us. That said, I realize that it can be difficult to find good mentors, so here
are a couple tips.

First, start by identifying a few people who you respect and look up to. These can be
relatives, teachers, family friends, colleagues, or complete strangers.

Next, learn as much as you can about them. If they have written a book, read it. If they have
given interviews, listen to them. Make sure to study what is readily available before asking
for one-on-one attention.

Finally, do not be afraid to make contact. When you do, I would suggest a short e-mail that
explains briefly who you are, makes it clear that you have done your homework, and lays out
the questions you would like to explore. Open-ended requests to “discuss your career path”
can come across as lazy and insincere. Be specific with what you would like to accomplish.

One final point. It is possible to have mentors who you rarely or never speak with. In fact,
your mentors do not even have to be alive! Derek Sivers wrote an excellent essay on how this
can be done, found on his website, entitled “How about ask your mentors for help.”
Remember that your mentors are likely to be busy people and requests for their time should
be made judiciously.

• Go to the city. I live and work in a small town. Many great investors have chosen to set up
shop far away from New York, San Francisco, or London, and for good reason. That being
said, many of them started out in those cities. You probably should, too. There is tremendous
value in seeing first-hand how these centers of finance operate – how the “sausage is made”
so to speak.

Large firms, such as investment banks and large asset managers, tend to offer the best
vantage points to observe and learn. They also offer excellent training programs and the
opportunity to interact with a lot of intelligent and hard-working people. Starting out at one of
these firms will help you build a solid foundation on top of which you can build a career in a
wide variety of specialties.

In particular, the combination of investment banking and private equity has become a highly
sought after pedigree. Candidates with those two prior stops on their resume are presumed to
be hard-working, well-trained, and polished. It is not the only path to a career as a
professional investor, but it is the best path I know of today.

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I would resist the temptation to start somewhere small even if that is where you think you
will eventually end up. You might deprive yourself the opportunity to explore paths that you
do not even know exist. I understand that big city living is not for everyone. Do not worry, it
is just for a few years and you will be working most of the time anyway.

• Mistakes. There are different kinds of mistakes. Some are “acceptable” while others are not.
When you are a first year analyst working on a financial model, inputting the wrong financial
data is an unacceptable mistake. Here is a short story from my own experience.

When I was just starting out at Goldman Sachs, my team was launching coverage on the
restaurant industry. This involved building financial models from scratch for all the
companies we were going to cover, plus industry models, currency models, and commodity
models. It was a large undertaking, and I worked day and night on the task. When the time
came to review these models with my manager, he would express great dismay whenever he
discovered a mistake. He made it very clear how disappointed he was, even though, by and
large, I thought that I had done good work. One day, I mentioned this to my uncle. Really, I
was complaining to him that my manager did not seem to appreciate all the hard work I was
doing. My uncle replied, “Chris, in school 95% means you get an A. In the workplace, 95%
means you had a 5% error rate, and a 5% error rate is completely unacceptable.” This
response opened my eyes and changed my perspective. It was an important lesson about
attention to detail, and the importance of avoiding preventable mistakes. My manager was
absolutely right. Mistake-free work should be the standard. I took that lesson to heart and it
has made all the difference.

The second kind of mistakes, which are both inevitable and important learning moments,
relate to bad judgements. In this case, we are talking about misjudging businesses and people.
One of my mentors is fond of pointing out that: “Good judgement comes from experience,
and experience comes from bad judgement.” The important idea here is to learn from your
mistakes. When you make an error in judgement, revisit your decision-making process with
honesty. You do not have to beat yourself up, but you should try to be clear about the error
and extract the lessons that can be applied to future judgements. As a young analyst at a large
firm, you may not be asked to make many of these judgement calls right away. See if you can
learn from those around you or spend some of your (admittedly limited!) free time thinking
about businesses, and learn as those thoughts are proven right or wrong.

As I look back over this list, a common theme emerges and reminds me of a piece of advice I
received as a first-year analyst:

“Always aim to do truly excellent work. Often, excellent work is lost by not doing just a little
more.”

I think about that advice often. When I am preparing an investment write-up, I pause before
hitting “send” to go back through it one more time. I ask myself whether there is anything
more I can do to improve it. Can I more clearly articulate the conclusion? Is the analysis
clear? Can it be made more concise? I do the same when preparing for a meeting with a client
or a management team. This is a competitive industry and not everyone will succeed. Give
yourself the best chance by always doing just a little bit more.

That is just about it. I hope you find it helpful!

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*****

Some books recommendations to get you started on your journey as an investor:

• Money Masters of Our Time by John Train

• Common Stocks and Uncommon Profits by Philip Fisher
• 100 to 1 in the Stock Market by Thomas Phelps
• The Essays of Warren Buffett arranged by Lawrence Cunningham
• The Outsiders by William Thorndike
• The Little Book that Beats the Market by Joel Greenblatt
• The Psychology of Money by Morgan Housel
• 7 Powers by Hamilton Helmer
• Business Adventures by John Brooks
• Surely You’re Joking Mr. Feynman by Richard Feynman
• Zen and the Art of Motorcycle Maintenance by Robert Pirsig
• The Art of Learning by Josh Waitzkin

Chris Cerrone

Bottleneck Businesses - by John Neff

Over the years, we have written extensively about what we call “the three-legged stool”
approach we use to identify the compounding machines in which we have concentrated our
capital. The three legs are the business model, the people running the business, and the
reinvestment acumen and opportunities. The combination of an exceptional business run by
intelligent and rational people with the skill and opportunity to reinvest most of the free cash
back into the business at high rates of return creates the flywheel we call a compounding
machine. I would like to briefly elaborate on the business model leg of the stool by describing
a concept we refer to internally as a “bottleneck business” and how it applies to several
holdings.

We think of a bottleneck business as one that a) sits atop large, global, secular growth
opportunities fed by multiple industries and geographies, b) has those opportunities funneled
(hence the bottleneck visual) disproportionately to it because of sustainable competitive
advantages, and c) enjoys exceptional economics, often superior to the industries and
customers the business serves. An electric utility, for example, would typically fail to qualify
as a bottleneck business—despite often having a local monopoly in its service area—because
of its limited geographic scope and generally unexceptional, regulated economics.

Qualified examples of bottleneck businesses abound, however, in our portfolios, American

Tower and Mastercard, in aggregate, represent a significant portion of our investable assets.
How do these companies fit this notion of a bottleneck business?

Sit atop large, global, secular growth opportunities fed by multiple industries and
geographies.

• American Tower’s cellular tower assets across 17 countries represent the bottleneck
in the secular growth of mobile communications and data. The business spans across
countries, wireless carriers, handset manufacturers and connected devices.

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 • In Mastercard, we own a business with secularly improving odds of being involved
and so profiting from the growing share of electronic payments worldwide, a
business that cuts across countries, retailers, online, offline, and mobile commerce.

Opportunities funneled disproportionately because of sustainable competitive advantages.

• American Tower’s business is advantaged by the physics of radio frequency

(including the physics of spectrum re-use and signal propagation) and the
deployment and service efficiencies of carrier co-location on macro towers.
• Mastercard’s leading global payment network is the result of powerful network
effects having solved the two-sided dilemma of merchant acceptance and consumer
usage, as well as the need for standards and innovation in payment systems.

Exceptional economics, often superior to the industries and customers the business serves.

• American Tower’s free cash flow margin (as measured by adjusted funds from
operations) exceeds 40%, revenues are in the form of hell-or-high-water multi-year
leases with annual escalators, and maintenance capital requirements are a low single
digit percentage of revenue.
• Mastercard’s free cash flow margin exceeds 40%, its unlevered free cash flow return
on assets exceeds 30%, and over half of its revenue is tied to purchasing volumes
and so has built-in inflation protection.

By no means are “bottlenecks” the only business models we own. Other holdings owe their
place in our portfolios due more to the equally important people and/or reinvestment legs of
our three-legged stool. But my hope is that this bottleneck discussion puts some more meat
on the bone in describing what, to us, a great business model looks like.

John Neff

The Bottom Line of All Investing is Rate of

Return - by Chuck Akre
Over the years we have spent quite a lot of time thinking about the question: “What makes a
good investment?” We often get the following type of responses when we pose this question
to others:

“We believe it is successful if it pays a good dividend,” or

“We believe it is successful if it goes up in price.”

We counter with:

“Well, suppose it is a private company, and there is no share price discovery.”

Or, alternatively, we say:

21
“Suppose that the business (investment) is confronted with so many good reinvestment
opportunities that they pay no dividend.”

What are we left with in trying to answer this question?

We have concluded that the only real way to measure the success of an investment is by
identifying the real growth in economic value per unit of ownership.

We speak in terms of “per unit of ownership” because aggregate growth in economic value
can completely elude the individual holder if accompanied by commensurate growth in the
units of ownership, leaving the individual owner without any individual growth in value.

In the public markets, where we spend the majority of our time and attention, we examine the
balance sheets of interesting businesses to see if we can make general evaluations of the
growth in this real economic value per share. Sometimes it is quite easily measured by the
growth in book value per share. Other times this easy approach is altogether without value
due to the oddities of accounting rules.

Therefore, we look to investment in two businesses that lend themselves well to the
importance of growth in book value per share, and prominently display that information in
their published financial reports. In our view, growth in book value per share is tantamount to
a business’ actual real economic earnings and it allows us to establish our valuation
calculations based on this per share growth in book value. We examine what the historical
growth in book value per share has been and make an estimate of what we think growth is
likely to be over the next five to ten years, on average. We assign an estimate to the forward
year and relate it to the current share price, giving us a multiple which is often very different
from the normal Wall Street earnings estimate multiples.

Our calculation frequently suggests the business is much cheaper than conventional
methodologies indicate. We believe this gives us an edge.

In many other businesses that we own, book value per share calculations are largely distorted
by share buybacks and other accounting applications. For a strong business, book value
typically understates economic value. Warren Buffett famously wrote a piece many years ago
identifying what he called “economic goodwill,” an item which has no tangible value (and no
precise relationship to accounting goodwill), but nonetheless creates earnings. Accounting
gives us some guideposts for gauging real economic value, but we are left to figure out the
details using our own interpretation of what is actually occurring in the business.

Clearly, there are many considerations we make along the way, like the quality and
sustainability of the business, the skill and quality of the people, and the availability of
reinvestment opportunities.

When all is said and done, no matter how we arrive at the calculation of the future growth in
real economic value per share, we ask, “What is the best value and opportunity today?”
It all comes down to rate of return.

When an individual is confronted with investment opportunities across many different asset
classes – for example, art, real estate, precious metals, private businesses, or public securities
– the only way in which to make comparisons (apart from the different characteristics of said

22
investments – you can hang a picture on your wall or hang a piece of jewelry around your
neck) is rate of return. It is the only standard by which all can be measured!

Further, when thinking about investing in bank CDs, there are often small differences in the
rates being paid and the method of compounding used in the calculation, even as all the
choices are guaranteed by the U.S. government. So, again, it comes down to rate of return.

In summary, our constant goal, regardless of the opportunity type, is to establish a reasonable
expectation of an investment’s rate of growth in real economic value per share coincident
with actual experience, and evaluate each and every opportunity by this standard: the bottom
line of all investing is rate of return.

Chuck Akre

1988 Shareholder Letter - by Chuck Akre

Over the years, I have been most significantly influenced by the writings of Warren Buffet.
(Fortunately, I have been a shareholder of Berkshire Hathaway since 1977). Warren was a
student of Ben Graham at Columbia where he learned the important balance sheet value
method of investing. Every company has a value determined by its balance sheet, and you
buy a stock when it’s selling for $.50 on the balance sheet dollar and sell it at $.80. Buffet has
taken the balance sheet value as a starting point and gone on to identify “really good
business” as the place to focus. These businesses are ultimately identified by their extremely
high returns on assets and capital. When these high returns appear, Buffett contends an
economic royalty of some kind exists, and the “value” of the business is much greater than
the balance sheet reveals. Buffett has detailed the many common attributes of these
companies, and a few of them are as follows:

• They see their profits in cash.

• They are not natural targets of competition.
• They have freedom to price their products.
• They are understandable.
• They do not take a genius to run.
• They earn very high returns on capital and assets.

I am in the Buffett “camp” and accordingly try to find companies that fit these criteria. One
very important benefit of these companies is that neither poor managerial decisions, nor
adverse economic environments will upset the apple cart for too long. That is, their business
franchise will prevail in the long run. Our resulting style in the partnership is to try and find
outstanding businesses, to understand their true value, and when the price is reasonable,
purchase shares. Occasionally, the market will allow an opportunity to buy the shares at a real
bargain price and once every few years at a “steal.” The whole purpose of course in pursuing
superb businesses is to achieve superior investment results. I believe that this is the most
compelling route to achieve such results! It is a route that is magnificent in its simplicity and
accordingly has some chance of leading us to success.

In addition to focusing on these superior businesses, Buffett also promulgated two rules for
investing to which we try to adhere. They are:

23
 • Rule #l- Don’t lose money.
• Rule #2- Don’t forget the first rule!

The practice of not losing money is significantly advanced by the selection of superior
businesses, because as we just pointed out, their royalty keeps on working in spite of general
business conditions and isolated poor managerial decisions. In the case of the former,
however, the market may offer up the shares at a true bargain price. In following the Buffett
principles to their logical conclusion, I leave defined Nirvana in investing as finding a
company with the following characteristics:

1. It is a superior business.
2. It is exceptionally well-managed.
3. The managers reinvest the naturally occurring excess capital as well as they run the
business enterprise.

Our motto in investing is “happiness comes from small improvements.” We try to find great
companies to invest in which will do well in nearly all environments. And when we buy
shares in them, we do not fuss with them because we believe that they will improve and grow
in value and that as time passes, that improvement in value will be reflected in the stock
price. The fewer investment decisions we make, the less exposure we have to making
mistakes. Obviously, these decisions that are made must be correct, which is why we spend
so much time trying to understand the quality of businesses.

Epilogue

I reread this letter for the first time in many years after my partner, Chris Cerrone, recently
reminded me of its contents. This approach has been responsible for the investment outcomes
of the subsequent 32 years. We spend our time at Akre Capital Management trying to
improve each element of our investment approach which, some time after this letter was
written, we began referring to as our “three-legged stool”: business model; talented and
honest management; and an outstanding thought process and execution in the reinvestment of
free cash flow.

Some things are timeless and meant to be!

Chuck Akre

Independent Thinking by Chris Cerrone

How is your process different?

Most investors know how to attain knowledge about a company: read annual reports, attend
trade shows, visit with management, and study key financial metrics. For many, investment

24
decisions follow closely thereafter, usually supported by colorful presentations and complex
financial models.

Our approach, by contrast, stresses the importance of wisdom by subtraction. We endeavor to

look past the non-essential details and tune out the often deafening noise. We want to identify
the “essence” of each business. So, for instance, what is it about MasterCard that enables
them to generate after-tax margins approaching forty percent? Why have the Rales brothers
been so successful buying and fixing businesses? How has Markel managed to compound
book value per share at fifteen percent for the past twenty years despite falling interest rates
and a competitive underwriting environment?

It is a challenging process but the rewards are worthwhile. We can far more easily assess the
relevance of new business developments once we are armed with our understanding of what
really matters and what does not. Quarterly earnings reports, for one thing, become much less
of an event.

We’re always surprised (and thrilled!) that we are nearly alone in this respect.

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Why Middleburg?

Middleburg has one traffic light. A few of us live on farms. We like to say that makes
everything a bit simpler. We are both philosophically and geographically removed from Wall
Street. Yet we are only a short drive from Washington and its three international airports. The
best of both worlds, we’d say.

26
Can you tell us about the culture of the team?

We’re a small team of curious, open-minded, and passionate investors. We are energized by
what we do and how we do it.

One defining aspect of the culture, in my opinion, is that we allow ourselves the space and
time to think. We manage a concentrated portfolio with low turnover. We believe we will be
in great shape if we can uncover a new investment idea or two each year. There is an
emphasis on quality over quantity.

We are very focused on the compatibility of our team. That has a couple components. First,
we are all “true believers” in our investment strategy. It is our North Star. That is important
because periodically we will do less well than we would like and it is crucial that we stick to
our knitting. Second, each of us should be prepared to change the water cooler when it is
empty, or bring in the trash bins. I happen to be well over six feet tall so I have been
designated “chief light bulb changer.” It speaks to humility, an important attribute both in life
and in investing.

We all feel privileged to work in this environment, and we believe the culture has had an
important hand in the results we have achieved on behalf of our clients.

Discerning Opportunities by John Neff

How do you find companies that you think are worth investing in?

We have no standard way of identifying prospective investment ideas. The only common
factor in our search is fervent curiosity, which drives us to read voraciously, engage actively
with management teams and industry experts, and run down the leads and ideas that result.

27
What process do you use to discern these opportunities?

The “three-legged stool” – business, management, reinvestment – describes our research

process for identifying those businesses we call compounding machines. It’s an easy process
to describe. What’s difficult to convey is how discriminating the process is. True

28
compounding machine businesses are extremely rare. Still rarer are opportunities to buy them
at attractive prices.

I think of our research process as one of constantly building and refining our sense of
discrimination. For example, I spend four days every year at two wireless infrastructure
conferences questioning and interacting with infrastructure companies and wireless carriers
from around the world, both public and private. The insights gleaned into business models,
management teams, and nuances of reinvestment have proved very valuable to our public
company investments in American Tower and SBA Communications. In addition, the
contacts and relationships we’ve built at these industry gatherings have yielded opportunities
to make compelling private company investments through our private investment funds.

How do you ensure that each opportunity follows your investment philosophy?

Through ongoing assessment of a company’s business model, management, and reinvestment

acumen and opportunity – i.e. the three legs of the stool. This question raises the topic of our
sell discipline. Some of our investors are initially surprised to learn that we do not set stock
price targets at which we would exit or reduce a position. The reason for this is simple: it’s
antithetical to compounding. Obvious reasons for this include tax and transaction costs, but
those are minor compared to our belief that true compounding machines are rare and not a
commodity to be easily replaced like-for-like. We concentrate capital in what we consider
exceptional businesses at attractive starting valuations. We fully expect these outstanding
businesses to periodically become more richly valued. We have no interest in adding to our
holdings at such times but neither are we tempted to sell unless accompanied by a negative
reassessment of the business, management, or reinvestment.

How do you manage risk?

Risk is defined differently by different investors. We do not define risk using terms like
“volatility”, “beta”, or “tracking error”, all of which stem from the convenient but arbitrary
fact that publicly traded equities have constantly changing price quotations daily. Instead, we
think of risk in public equities no differently than if we were making investments in private
companies. Sound familiar? The three-legged-stool research process for identifying
opportunities is simultaneously our first and most important layer of risk management. This is
because companies that pass this discriminating filter tend to have well above-average
competitive advantages, returns on capital, free cash generation, growth potential,
management, and balance sheet strength. In other words, along the dimensions that matter to

29
a private business owner, our businesses tend to have below average risk by being inherently
above average.

The second level of risk management centers on our valuation discipline. Simply put, we
strive to purchase these businesses at attractive-to-reasonable valuations relative to the nature
of the underlying business, its competitive advantages, and the prospective compound annual
growth rate in economic value per share. As it relates to our efforts here, volatility becomes
far more synonymous with opportunity than risk.

The last component of our risk management strategy is our willingness to let cash accumulate
when valuations of prospective and existing names in the portfolio are above what we
consider reasonable. In fact, I would point to the healthy cash weighting often found in our
portfolios as the most empirical evidence of having delivered on our oft-stated goal:
compounding our investors’ capital at above average rates while incurring below average
levels of risk.

The good news for folks who speak the language of risk differently than we do is that our
approach happens to translate favorably into the metrics that are important to you. Just know
that we do not consider those metrics either as an input or output of our portfolio and risk
management approach.

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 Chuck Akre on the Akre Focus Fund
By Robert Huebscher
February 2, 2010

Chuck Akre is the Managing Member and Chief Executive

Officer of Akre Capital Management, which he founded in
1989. For a time, his firm operated as part of Friedman,
Billings, Ramsey & Co. (FBR), and Akre was the manager of
the FBR Focus Fund (FBRVX). He has a track record of
above-average performance over the last 20-plus years
managing mutual funds, separately managed accounts and
partnerships.

He launched a new fund, the Akre Focus Fund (AKREX), in September of 2009.
We spoke with Akre on January 27.

I’m familiar with your “three-legged” investment process: choosing

companies that earn high rates of return, have management teams with
proven track records of upholding their shareholders’ best interests, and
can reinvest capital at high rates of return. How have you adjusted those
principles over the last year and a half and, in particular, have you
embraced the “new normal” paradigm and lowered your return thresholds
as a result?

Quite frankly, over the last several years, I have reduced my expectations of
return. That’s been pretty consistent with what has been going in the world.

For many years we have been looking at business where the return on the
owners’ capital [equity] was north of 20%. For the last several years we have
looked at businesses in the upper teens and higher. We are still looking for
those businesses, and we are still finding those businesses where we think that
expectation is likely to unfold. All of that is predicated on what amount of owners’
capital there is. Understanding the balance sheet of these businesses is
important. The really good businesses have very strong balance sheets, where
the majority of their capital is the owners’ capital and not debt capital.

You have a fairly concentrated portfolio of 10 holdings, a limited track

record with your new fund, and approximately $166 million under
management. What is your universe of investment candidates? US versus
non-US? Across all style boxes? Debt as well as equity?

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

We’ve disclosed our top 10 holdings and we have more than 10, but not 20
holdings. We are approximately 45% invested.

We have no boundaries on where we will go. It’s a matter of both familiarity and
our enterprising nature. In the past in our funds, we’ve held businesses
domiciled outside the US – in Canada, Mexico and Europe. We have not owned
any businesses that were domiciled in Asia. We remain interested in businesses
anywhere that we can understand the accounting and the culture. That becomes
easier as time goes on because of international accounting standards. Cultural
issues have a lot to do with how companies present their information.

In our fund now, we have several businesses that earn revenue outside the US.
The most prominent is our largest holding, American Tower [Ed.’s Note: see a
discussion of this holding here], which provides infrastructure (towers) for cell
phone, video, and data antennas. They earn 9% of their revenue in Mexico, 4%
in Brazil and a little less than 4% in India.

Other names we own that have some business outside the US are gaming
manufacturers. Overall, we don’t have a significant amount of non-US-based
revenue.

We are not constrained in a style box. We are interested in all parts of the capital
structure.

One of your holdings is the insurance company Markel. Can you talk about
how this fits into your three-legged stool paradigm and how you expect it
to earn your required rates of return?

In the property and casualty insurance industry, any company has two kinds of
capital: owners’ capital and policy holders’ capital. They have two ways to earn
money: from investments (to be able to pay claims from policy holders) and on
the underwriting of business. They measure the profitability of that underwriting
with the “combined ratio.” A combined ratio of 100% means that they write their
business at break-even.

A combined ratio below 100% means they write business at a profit. We’ve
learned from Warren Buffett that it means your cost-of-capital is negative. If you
have a combined ratio of 97% means it is -3%. A combined ratio of 103% means
your cost-of-capital is 3%.

The industry, for most of its existence, typically has had a combined ratio north of
100%, although that has not been the case in the last several years. The
industry operated their businesses at a loss.

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

Why would they do that?

Because they could make it up on the investment side. They are going to hold
their investments over a long period of time to overcome the costs of
underwriting. It’s a losing proposition unless you could overcome that with your
investment portfolio.

A couple of things have happened now. We are in a very modest interest rate
environment – a zero Fed Funds Rate. Driving your business on investment
income is much harder these days.

Furthermore, we have always been attracted to businesses that had the

discipline to be underwriting their business at a profit. That eliminates most
companies in the industry.

How is Markel different?

Markel has been public for 25 years. Across that time, we’ve studied their
reserve development. When an insurance company reports its profits for the
year, it is a function of their management’s estimates. They put a dollar of
premium on the books and they say they have reserved “x” cents against future
claims – that’s an estimate. What they say are their earnings are really just an
estimate of what they are likely to be.

In the industry, for many years there has been company after company that
every four or five years has had to make a “one-time” adjustment to its earnings.
If there was a pattern – and indeed there was – that means they were stupid or
untruthful about what their loss reserves ought to be. They would report these
good earnings and periodically adjust them because their losses were coming in
greater than that. They would call that a “one-time addition to reserves,” and
continue this fallacy that the amount they were reserving and the amount they
were showing as earnings were accurate.

Markel is one of a small group of companies that has, over a long per of years,
written their business at an underwriting profit, by and large. They say in their
literature that they set their reserves so that they are more likely to be redundant
(they had more reserves than they paid out) than deficient. When you look at
their last 25 years and make an adjustment for their company doubling through
their acquisition of Terra Nova in 2000, you will see that their reserves have been
redundant almost the entire time.

Furthermore, they have a tail in their business that is about four and a half years.
If you look over a four- to five-year period – and there is a whole host of those
periods over the last 25 years – you see that they have continued to be

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redundant over that period of time, which means they have been honest in their
evaluation of what their reserves ought to be.

Number two, their history of redundant reserves gives them the latitude to be
more venturesome in their investments. They don’t have to keep everything in
liquid cash to pay reserves. They can take a portion of their shareholders’ capital
and invest it for longer terms and higher returns in the equity market. They have
done that. With insurance company accounting, if their portfolio goes form 100 to
200 and they don’t sell anything, that change in value is not reflected in their
income statement. On top of all that, Markel has much greater leverage, in terms
of the size of its investment portfolio relative to its book value, than almost any
other company.

If you combine all of those things, what is the real gain in economic value
per share for Markel?

I’ve concluded it is the change in book value per share.

The two components of earnings are underwriting gains and losses and the
change in book value per share (for the investment component). The investment
portfolio is more than three times the size of the shareholders’ capital and all of
the operating costs are distributed to the operating insurance company
subsidiaries (there are no operating costs at the parent level). The parent only
has the costs of taxes on its income and interest on its debt; we exclude those. If
they were able to earn a 5% after-tax return on their portfolio and the portfolio
was leveraged 3x ($3 of investment for every dollar of shareholder capital) you
could see that they had a 15% return on their capital. For many years it was
actually 4x, so it was a 20% return. Part of their investment portfolio is made up
of equities instead of debt, so the opportunity to get to 4% to 5% after tax over
time increases.

Unrelated to underwriting, Markel in a reasonable environment might have a 12-

16% return on shareholder capital as measured by the change in book value per
share just based on their investment portfolio. If you add in $1.8 billion in earned
premium and 3 points of underwriting profit on that pre-tax, that is $55 million,
taxed at 35%, and you have approximately $40 million of additional income.
Markel is geared to having returns on the owners’ capital as I think about it, of the
mid-teens.

What can upset that?

A terrible year in the stock market, as in 2008. Or the last four years in the
property and casualty business, where we have seen declines in prices in the
various lines of business. Their premiums written have gone from $2 to $1.8

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

billion. Those things take away from the experience, but over the years the odds
are way better than even that this is a business that can compound the
shareholders’ capital at a number in the mid-teens or maybe higher.

It has a history of people who think about their business properly and honestly
and share those honest views with their shareholders in the way write their
material, conduct their conference calls, and communicate in person. It’s a
business that, like so many businesses, has reinvestment opportunities, is based
on writing more business, can make acquisitions and can add to their investment
portfolio, all of which have the ability to compound our capital at these above-
average rates.

You also have a fairly high concentration in financial services, including TD

Ameritrade, Factset, and MSCI. There are a number of factors, such as
uncertainty in the regulatory environment, contraction in the hedge fund
industry, and ongoing deleveraging that will impede growth in this sector.
What makes those holdings stand out?

Let’s start with TD Ameritrade. It is one of the modern ways of delivering

brokerage services to the public, in an electronic model. Unlike E-Trade and
some others, it did not wander off the reservation with its investment portfolio and
invest in mortgage securities. It kept its investment portfolio pristine.

TD Ameritrade is the smallest of the three brokerage firms (behind Fidelity and
Schwab), but it is growing its market share off a very small base from their
advisor network. As more and more of the world’s business goes to advisors, we
think that is an interesting opportunity.

They get almost nothing from the cash on their balance sheet now, but have the
opportunity to get a nice boost to their economics as interest rates rise. They
have that rate arbitrage for these businesses.

At the end of the day, it’s just not very expensive from our point of view. We look
at free-cash-flow per share in the period ending September of $1.45, and the
stock is $17.70 today. The valuation is modest – 12x this year and 10x next
year. It’s conservatively run, its offering is easy to use, it’s growing in the advisor
channel, it has the opportunity to have a big kick if we come to a period of higher
interest rates, and the valuation is very modest. Its balance sheet is conservative
and has no net debt. We think it has the perfectly reasonable opportunity to grow
those earnings, as in the past five years, at 14-15%. If I can own that business at
10x or 12x, my experience tells me I am going to have pretty good experience.

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

What about MSCI?

There are risks that relate to the ETF business, but there are also opportunities.
MSCI is a royalty business, from the use of the indices it creates for clients that
have assets advised or investments outside the US. It’s a global brand name. It
doesn’t take a lot of capital to support that.

Their November 2010 earnings are about $1.25, and the stock is at $29.70, so
it’s certainly more expensive [than TD Ameritrade], but it’s a great royalty
business from our perspective with maybe bigger opportunities than TD
Ameritrade. Next year, we think that number will be around $1.45, so it’s 20x.
It’s probably the most expensive name in our portfolio, but we think the
opportunity is in the mid-teens. It’s a unique brand name. I’m always interested
in trying to capture the effect of brands that don’t take a lot of capital. It’s not
without risk, but it’s a pretty interesting business.

And Factset?

Factset is research tool. I have it on my desk alongside my Bloomberg, and we

are trying to figure out which we really want to have.

Factset is like TD Ameritrade – the number three name behind Bloomberg and
Thomson/Reuters. The people I talk to in our business, from a research point-of-
view, say it is better than Bloomberg and Thomson. In terms of business
models, information management and distribution is a good place to be in the 21st
century. It is delivered electronically – as are TD Ameritrade and MSCI. In the
year ending in August 2010, we think Factset will earn around $3.35, and the
stock is about $64, so its 19x this year. Our August 2011 number is around
$3.70, so it’s around 17.25x next year.

These are information management and distribution businesses. This kind of

business gets a higher multiple than old-fashioned click-and-brick businesses.
We have relatively small positions in both MSCI and Factset, and we think we
have an interesting opportunity.

Let’s turn to the macro environment. I recognize that you are a value-
based bottom-up stock picker and investor. What elements of the macro
environment concern you most? What is your biggest fear?

You’ve characterized us correctly. In the last week and a half, I’ve given two talks
to groups of advisors around the country. At the end the talks I’ve said, “What
are we concerned about these days?”

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

We are cautious. That’s whey we are 45% invested. We are cautious because
our domestic economy continues to be driven 70% by the consumer. The
consumer is confronting a lot of issues. We are north of 17% in
underemployment. One quarter of all mortgages are underwater. A trillion and a
half dollars have been removed from credit card and consumer lines of credit.
The notion of home equity lines and refinancing are things of the past. We have
20% of income in the form of transfer payments. We have deficits in excess of a
trillion dollars and likely will as far as we can see. We have 14.5% of all
mortgages either at least one payment behind or already in the foreclosure
process.

We have a host of headwinds for the consumer that makes it unlikely that the
next decade is going to look much like the last one. Do I believe we are in a
bubble? Not particularly – certainly not like we faced in 2007. We have
entitlement programs in place (and the prospect of another one) that in and of
themselves have the ability to nearly bankrupt the federal government.

We certainly face the prospect of higher taxes. All of those create significant
headwinds.

Add to that the possibility of higher interest rates, which any reasonable person
will say is at least an even-odds probability. We may be in a death spiral like
Japan has been in for at more a decade, with deflation. But the other possibility
is that our ability to pay back our debt is going to be influenced by devaluing the
dollar. If we have higher interest rates, I just have to think back to what valuations
were in the late 1970s and early 1980s. Top-quality names were selling at 5x
and 6x. If you own something now at 19x, 15x or even 12x, they become
vulnerable if you face that possibility.

We remain cautious and will try to pick ours spots. Brokerage firms and
investment management firms will shrink and the amount of money that is
invested worldwide will shrink if we have big declines in the market. If they don’t,
then they will continue to grow.

Is the fact that you are 45% invested a reflection of your macro outlook or a
lack of attractive investment candidates?

It is a reflection of our macro outlook. When the money came into the new fund,
we chose not to duplicate the fund we just quit managing (FBRVX), because
there were a number of investments in that fund that were less attractive
because of where the economy was, in my mind. I would be interested in some
of those at much lower valuations, and there are some I probably wouldn’t be
interested in.

© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

If we talked a month ago, we would have been 25% invested. We are putting
money to work deliberately and cautiously. We had a market that went up 60%
off the March low. Everything is not as rosy as the market projects.

Mohammed El-Erian has said that stock market was on a “sugar high.” That is
something that resonates with us. Last week, and even this week, reinforce the
notion that the market is running out of steam here.

www.advisorperspectives.com

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© Copyright 2010, Advisor Perspectives, Inc. All rights reserved.

 Chuck Akre and his Search for Outstanding Investments

Article here: http://www.gurufocus.com/news/150194/chuck-akre-value-investing-conference-talk-an-

investors-odyssey-the-search-for-outstanding-investments
This investor is worth studying for his focus on business models. Notice his focus on business that can
compound returns at high rates for a long time—Nirvana!
Chuck Akre Value Investing Conference Talk:
'An Investor's Odyssey: The Search for Outstanding Investments'

November-1-2011

This is Chuck Akre's talk from 8th Annual Value Investor Conference in May 2011, Omaha, right before
the annual shareholder meeting of Berkshire Hathaway. The upcoming 9th Annual Value Investor
Conference will be held May 3 – 4, 2012, again in Omaha. The conference is organized by Bob Miles,
author of several books including "The Warren Buffett CEO: Secrets of the Berkshire Hathaway
Managers."

Thank you Bob, and it‘s great to be here. My chat today is called ―An Investor‘s Odyssey: The Search
for Outstanding Investments.‖ It‘s a loose summary of my experience in the investing business. I won‘t
tell you how many years I‘ve been in it, Bob just did. I didn‘t, obviously, start yesterday. I want to thank
Bob for both asking me to come and for his comments. Some years ago Bob asked me to do a
presentation in an earlier conference he was hosting, and I turned him down. I said then that I just don‘t
do that. Of course, I didn‘t recognize what an honor it is to be included in this group, so you should treat
my remarks with appropriate suspicion. I might also add that paybacks are hell. You notice that he
scheduled me today opposite what‘s called the wedding of the century.

I‘ve gained enough weight and lost enough hair over the years to be able to allow me to write up some
thoughts about investing, so today I‘m going to share with you some of these thoughts, which
collectively have added value in my career. Many years ago when I started my investing career in
Washington D.C., I was puzzling with several questions about investing, and mind you that as Bob
suggested I came into this with a BA degree in English Literature, having also been in a pre-med
program, so I actually had a great many questions. Among the questions are, ―What makes a good
investor?‖ and more to the point, ―What makes a good investment?‖ Today we tell all of the clients in
our firm that our primary goal is to compound their capital at an above-average rate while incurring a
below-average level of risk. So I usually ask my friends this question: Which would you rather have,
$750,000 today or the outcome of doubling a penny a day for 30 days. What do I hear? Penny. So
that‘s the question. Compounding our capital is what we‘re after, that‘s what makes it a great
investment for us. What‘s the value of compounding? Well the answer in this case is simply astounding.
Doubling a penny a day for 30 days gets you, who knows, $10 million, $737,000 change.

The reason why we use the notion of compounding our capital at above average rates is that we
can think of no better method of measuring the success of any business. Think for a moment
about that, if you will. How else is someone able to judge the success of a business enterprise than
through some measurement of the growth in real economic value. Granted, we all know about the
importance of customers and employees and community, and obviously they‘re important, but
throughout my odyssey I‘ve been trying to identify and measure financial success in a manner other
than whether the share price rises or falls. In fact, in a private business one is not afforded the luxury of
share price discovery, so that some other method of measuring success must be present. I‘ve heard...
send the check to Omaha. This of course, is what happens when one is unable to compound their

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 Chuck Akre and his Search for Outstanding Investments

capital. As an aside, Albert Einstein has often been credited with the following quote: ―Compound
interest is the eighth wonder of the world. He who understands it earns it, and he who doesn‘t pays it.‖
Likewise, I read over the years that the eighth wonder line is attributed to Will Rogers. My own research
cannot connect Will Rogers to any such quote. Finally, an authority called Miller‘s Philmore Bathtub,
honest, a website which holds itself out as a prodigious checker of facts, in which was entirely unknown
to me as recently as two weeks ago, says, with confidence, that ―Albert Einstein never wrote or said
anything about compound interest.‖ So not only is compound interest/compound return poorly
understood, we can‘t even say with confidence who we should credit with these pithy statements. It
remains an enigma.

In 1972, I read a book that was reviewed in Barron‘s and this book was called “101 to 1 in the Stock
Market” by Thomas Phelps. He represented an analysis of investments gaining 101 times one‘s starting
price. Phelps was a Boston investment manager of no particular reputation, as far as I know, but he
certainly was on to something which he outlined in this book. Reading the book really helped me focus
on the issue of compounding capital. Also, from Boston, you all know Peter Lynch, who often spoke
about ten-baggers. Here was Phelps talking about 100-baggers, so what‘s the deal? Well Phelps laid
out a series of examples where an investor would in fact have made 100 times his money. Further he
laid out some of the characteristics which would compound these investments. So in addition to
absorbing Phelps‘ thesis, I‘ve been reading the Berkshire Hathaway (BRK.A)(BRK.B) annual reports
since I‘ve made my first purchase in 1977, so this collective experience moved me along to a point
where I‘ve developed my own list of critical insights and ingredients for successful investment.

Again, compound return really is the center point, and ultimately we spend much of our time trying to
identify those businesses which are most likely to compound the shareholder‘s capital at an above-
average rate. Were we simply a pure value investor, we would be regularly looking to unload those
securities, which appreciated to some predetermined notion of present value, and we would lose out, in
our minds, on the opportunity to compound our capital because of these sales. Further, we have our
operational costs and tax costs for those accounts, which bear tax liability. Continuing this quest, I
found the data, this is EBIDTA data, relating to returns in different asset classes, across nearly all of the
20th century. You all know the figures; common stocks outperformed all other asset classes on
leverage across most of this time period. You notice that Robert and his last talk had a slide that went
back to the 19th century, ended up producing the same type of data. The annual compound return
number falls in the neighborhood of 10%.

So I‘d like to have you examine these numbers, which are in ten-year intervals. And the obvious
conclusion is that both an annual return as well as a ten-year number is unknowable. So my takeaway
as it remains today is that while the number is the in vicinity of 10%, 10% itself is not precisely the point.
Might be 9 or 11, generally in the neighborhood of ten, and by the way I just tell you that as an aside I
feel exactly the same way about earnings estimates and outcomes, and that for us, the precise number
is never the point.

My next question then is, ―So what‘s important about 10%?‖ Over the years I‘ve considered a lot of
reasons for the 10% figure and I ultimately concluded that the 10% numbers bear some relation to what
I suspected was the real return on... capital, that is across all companies large and small, leveraged
and debt-free, manufacturing service oriented, hard assets, cloud assets, across all these businesses,
my surmise was the real return on the owner‘s capital adjusted for all what I call the accounting
garbage, was in the low teens. Today... suggested that they are correlated.

Throughout most of my career, it‘s been popular to believe that the RVs of all American businesses are
in the mid-teens, and again Robert‘s last chart showed it varies from the mid-teens to mid-single-digits
and so on. However, I‘m suggesting that without any academic support, that the number

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 Chuck Akre and his Search for Outstanding Investments

unencumbered by GAAP accounting is in fact lower. And you all know that GAAP-accounting does a
reasonable job helping us with these judgments, but it clearly has its deficiencies.

So now it‘s the case of intuition, perhaps common sense, that I propose the following hypothesis: One‘s
return from an asset will, over time, approximate the ROE, given the absence of any distributions and
given a constant valuation. So one of you will jump and no doubt say, … fool, everyone knows there‘s
no such thing as constant valuation in the stock market. I‘ll get the valuation in a minute, but I‘ll just say
here we‘re very stingy. When we speak of ROE, what we‘re really thinking about is the free cash flow
return on the owner‘s capital. Free cash flow in our thought process is simply GAAP net income + dna
minus all …

Of course, there are examples that are more complicated, but as a business owner this is what
interests me. How much cash does the business produce and make available to the management, for
them to make the reinvestment choices? So now I have this hypothesis, where‘s the proof? Well return
on capital really matters. I don‘t know if you can see those numbers or not but just take an example:
Start with a $10 share price, $5 book, 20% ROE produces a dollar‘s worth of earnings, you know the
metrics are easily ten times earnings, two times book, 20% ROE, we‘ll add the earnings of the book
and have another look, the new book is $6, keeping the valuation constant, providing no payouts of
earnings, apply 20% ROE, the new earnings are $1.20, ten times that is $12, two times the new book is
$12, so our point is the share price is up 20% consistent with 20% ROE. So in this example, one‘s
return does in fact mirror the ROE, where there are no distributions and the valuation is kept constant.
And this generalization has been very useful to me in thinking about … expectations. One of the
acknowledgements I think we‘ll all gladly accept is that high return businesses have something unusual
going on which in fact allows them to earn above average rates on unemployed capital. Often these
special circumstances are referred to as moats. In our firm is the properly identify what is the nature of
the moat; what exactly is it that‘s causing this good result. And to us this is a really critical point.
Because the investment business can have so many issues that upset the apple cart, being confident
about what it is exactly that‘s causing the results is a huge advantage for us. In point of fact, we have
on occasion been able to add to positions in time of turmoil, because the confidence in understanding a
business allowed us to see through all the noise in the marketplace.

Now it’s time to go fishing. The pond I want to fish in is the one where all the fish are the high-
return variety. Naturally, if my returns are going to correlate to high ROEs, then I want to shop among
the high-return, high-ROE businesses. In our firm we use this visual construct to represent the three
things that we focus our attention on. This construct in fact is an early 20th century three-legged milking
stool and before I go on to describe each leg to you I want you to see that the three legs are actually
sturdier than four, and that they present a steady surface on all kinds of uneven ground, which of
course, is their purpose in the first place.

Leg number one stands for the business model of the company. And when I say business model,
I‘m thinking about all the issues that have come into play that contribute to the above average returns
on the owner‘s capital. Earlier we called this the moat. You know the drill: Is it a patent, is a regulatory
item, is it a proprietary business, is it scale, is it low-cost production, or is it lack of competition? There
are certainly others but for us, it‘s important to try to understand just what it is about the model that
causes the good returns. And what‘s the outlook? In our office we often say, ―How wide and how long is
the runway?‖

Let me tell you a quick story. About 25 years ago I had an intern working with me and I gave him a box
of articles I‘d saved relating to businesses which had caught my eye but which I had done no work. And
he came back some days later with a piece on a company called Bandad, which was located here in
the Midwest in Muskoteen, Iowa, and my intern explained to me that we should look at the business

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 Chuck Akre and his Search for Outstanding Investments

that had 20% ROE, low valuation, growth opportunities and so on, and I said ―What business is it in?‖
And his reply was that it was in the tire business. And so I said that‘s interesting, why don‘t you go look
at all the returns in capital and all tire companies? And he did and he came back and he reported that
all those companies had returns on the owner‘s capital in single-digits. So here we were with a
business which described itself as the largest independent truck-and-bust tire recapper, but our quick
return analysis said no way, it can‘t possibly be in the tire business.

So our mission therefore was to discover what was the real source of the earnings power for the
business, allowing them to have such returns. Well if you went to Musketeen to meet with the CEO,
who by the way, greeted us with his feet on the desk eating an apple. I won‘t bore you with all of the
bizarre history – and it is indeed bizarre – but we concluded that the company‘s tie to its independently
owned distributers and service centers was at the core of its business value. And those independently
owned business men were incredibly loyal to Bandad, especially because of the outstanding way that
they‘ve been dealt with by Bandad during and after the 1973-74 oil embargoes. It turns out that each of
these independent business men who typically work from 6 a.m. to 8 p.m., unlike their Goodyear stores
who had managers who worked from 8 a.m. to 6 p.m., were enormously grateful for what the company
had instituted called the power-fund during the oil embargo. They put this in place to collect all of the
excess profits that the company made when the price of oil began to decline, and they made a deal
with all of these independent managers that they would return money to them in direct proportion to the
sales. You know, they bought the tire tread, which was an oil-based derivative, from Bandad, and used
it during the recapping process. So, the independent businessman wasn‘t allowed to go buy a new
Cadillac, but he could buy a new shop, build a new shop, get new equipment, whatever, all through this
power fund that Bandad had put in place. And so this power fund in fact really lost its economic
underpinnings and the company ran into difficulty and years later, it was later acquired actually, in 2007
by Bridgestone. We owned the shares for several years and had a very profitable investment, but sold
them when we lost confidence in the business model. It was unique, but my point is, simply trying to
understand what it is that‘s causing the good return, and how long is it likely to last. It was a profitable
investment for us, but not a great compounder. Another quick story along these lines relates to
Microsoft (MSFT), during the early years. According to Bill Gates‘ first book, ―The Road Ahead,‖ he and
Paul Allen tried to sell the company to IBM some years earlier and they were turned down. And so...
hindsight my inescapable conclusion is that neither party of the proposed transaction understood what
was valuable about Microsoft. In my mind it‘s a huge irony at least because in my point of view
Microsoft became the most valuable toll road in modern business history. But here again, even the
people running the company at an early stage did not understand what it was that made it
valuable. And it wasn’t even visible to them. So my point here is simply that the source of a
business’ strength may not always be obvious. Therefore, understanding that first leg of the stool,
the business model, has its own level of difficulty. It‘s also where the fun is, I might add, and we believe
it is absolutely critical. As I said, we spend countless hours at our firm working on these issues every
week.

The second leg of stool is what we describe, is the Peevol model, and what we are trying to do
is to make judgments about the focus around the business. We often ask ourselves, do they
treat public shareholders as partners, even though they don’t know them? My good friend Tom
Gaynor who you heard from yesterday describes it this way: He said do they have equal parts skill and
integrity? What we‘re trying to do is get at is this: What happens at the company level also happened at
the per-share level. My life experience is, once someone puts his hand in your pocket, he will do so
again. And presumably, we‘re examining the company in the first place because we already determined
that the managers are killers about operating the business. And because we run concentrated
portfolios, we literally have no time to mess with those managers about who we have real questions
about in our real experience.

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 Chuck Akre and his Search for Outstanding Investments

Here‘s another story: About 30 years ago, I owned a very, very, very, let me emphasize, very tiny
interest in a company called Charlotte Motor Speedway, which over the years has come to be called
Speedway Motorsports. And the principal shareholder then, and possibly still is, is a person who had a
negative history with the SEC. The agency had barred him from having any association with the
company for a period of several years. And this was perhaps 35 or 40 years ago. At any rate, this
majority shareholder returned to the scene, and by the mid-‗80s had accumulated 70% of the stock of
Charlotte Motor Speedway, and he … tendered for all of the minority shares that he didn‘t own. When I
joined … in Charlotte, North Carolina, which after discovery was successful in getting us a settlement
that was several times the proposal going private price. This issue confined the CEO, which in all
likelihood caused him to settle with a long list of misbehavior including improper valuation, failure to
include corporate assets, a lack of independence of outside opinions, and so on. Quite naturally he
demanded that a settlement be sealed and it was. I‘ve never since held a position in any of that CEOs
public or private companies, because he had indeed put his hand in my pocket.

Following my Charlotte Motor Speedway experience I bored down a new holding in International
Speedway (ISCA), and I discovered that it was in fact the best out of the three public companies
involved in NASCAR racing. And my experience in International Speedway was a good example of our
approach. When we first invested in ISCA in 1987, the metrics were as follows: The ROE was in the
mid 20% range, the income margin was over 50%, book value per share had a CAGR 28%, there was
no leverage, it had a modest valuation, it had attractive growth prices, and there was huge, over 50%,
insider ownership. We owned shares in International Speedway for a good many years, and had good
experience of compounding our capital at generally between 10 and 20 times our cost, depending on
when the shares were purchased. We later sold all of our shares when we became concerned with the
management‘s approach to all aspects of the business. The CEO had died, and other family members
were running the show, and in addition we were concerned about the runway for their business, as
times were changing. So our sales decision was judgment relating to the second leg of the stool, the
management model, as well as our view of the business model itself.

We refer to the third leg of the stool, which quite obviously gives it its stability, as something...
as the glue that holds the opportunity together. My next question, therefore, is does an
opportunity exist to reinvest all the excess cash generated by a business, allowing it to
continue to earn these attractive above average returns? My experience tells me that the
reinvestment issue is perhaps the single most important issue facing any CEO today. As it is one place
where value can be added or subtracted quickly and permanently. So this really relates to both the skill
of the manager, as well as the nature of the business. One of my favorite questions to ask a CEO is,
―How do you measure the ways in which you are successful in running a business?‖ And I can tell you
that very few ever answer that they measure their success by the growth in economic value per share.
Not surprisingly, we hear that the increase in the share price is the answer, rather simply say chief
incorporate goals established in conjunction with the board is the answer, and some say that
...accomplishments relating to customers and employees and the community and the shareholders are
all the answer. Personally I‘m deterred in my view that growth in real economic value per share is the
holy grail. Just look at the opening pages of the Berkshire Hathaway annual report, and what do you
see? You see a record of growth in book value per share, for 40 years. Forty years. Incidentally, in
Berkshire that number, you know, is 20% a year for 40 years, and so it‘s no wonder that Warren shows
up here as the top of the Fortune 400 list.

After we‘ve identified a business that seems to pass the test in all three legs we refer it as our
compounding machine. And as we describe it, our valuation discipline comes into play here and we
describe it here as simply we are not willing to pay too much. Volatility is not part of our analysis of risk;
rather we view it as an opportunity generator. What we say for our purposes is that risk involved the
exposure of permanent loss of capital. Occasionally, we view it more narrowly. And we‘re watching for

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 Chuck Akre and his Search for Outstanding Investments

a possible deterioration in the quality of the business, or any of the three legs of our stool. Is the
economic moat getting smaller, are the managers behaving badly in some way, or is the reinvestment
opportunity diminished or being abused?

Theoretically, if we have the three legs correctly identified then our only risk is the loss
associated with the dying value of money. In practice, it never happens exactly this way. But we
believe firmly that if we‘ve identified the key ingredient for both preserving and enhancing our capital,
we‘ll be in good shape.

Another story, if you will. Many years ago, I owned a position in the list company that was based in
Long Island, New York. Now you don‘t see many, or even any list companies that are in the public
market because they mint money. A list company, as you may know, collects and sorts data about
people and subsequently sells the list to various users. A good example is Gillette, which collects data
about high school senior boys. And the reason was, that their research showed them that while a boy
was still at home, his mother purchases razor blades. And once he graduated from high school, with
the likelihood that he was going to leave home, he would begin making choices about what razor
blades to buy. So Gillette would buy these lists of high school seniors and mail them free razor blades,
getting them used to a brand before… now this company, which was called American List, was run by a
founder who had some years earlier sold a controlling interest to a New York private equity firm. And
the CEO was a very decent guy, and in exchange for partial interest he had sold he was able to put his
money into double digit-return bonds, and he was in investment heaven. At any rate, the company had
50% net margins. Either because the New York firm had control of the CEO, or because he was so risk
averse, or perhaps he wasn‘t imaginative enough. The CEO could never find a place to reinvest the
excess capital he generated in order to compound the shareholder‘s capital. So he paid it out in
dividends long before we had a 15% dividend tax rate. Incidentally, someone else by the name of Dan
Sneider, had a public company those days and he purchased all of American List. My great regret at
the time, of course, was that I didn‘t have a vehicle to purchase all of American List. It was a pure send-
a-check-of-Omaha kind of business. The opportunity ended up simply being... money lost for us, as the
reinvestment portion of the triangle was missing. Even that loss was offset by the rich dividends.

At our firm we have this quaint notion that in certain economic environments and in certain stock market
environments both of which we have an abysmal record of predicting, we are well served by owning
things which were a modest valuation, at least to start. There‘s an old Wall Street ad agent attributed to
Goldman Sachs...which says, ―Something well bought is half-sold.‖ Taking a completely different tact, if
we had properly identified the compounding in machines and had bought them at modest valuations,
we would be set up for the famous Davis double play. That is, the business... will compound our capital
at an above-average rate, and we‘re in line for an increase in market valuation, but double play indeed.
So we have shared our experience relating to business models which fade, core executive behavior
and reinvestment.

Now let‘s look at a business success that we‘ve had. Incidentally, our compliance folks have asked that
we make sure you understand that not all of our investments turn out as well as American Tower. I‘m
about to discuss, and not to mislead you, we have indeed had others which have not done so well. This
first slide gives the share price detail from the time it was created out of American Radio in 1998 to the
market bottom in 2002. And between those periods, we have bought and sold shares and essentially
broken even on our transactions. By June of 2002, we had accumulated a half million shares at the cost
of $5, and as we like to say, we were proud of our holdings. By September the share price was $2, and
we got on a plane and went up to Boston to see the CEO, and founder, Steve Dodge. The market was
focused on $200 million convertible debt issue, by the way out of a total of $3.3 billion in dollar debt,
which was to come due in November of 2003, more than a year later. It was payable both in cash and
in shares of the company‘s option. As a shareholder, my risk was massive delusion.

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 Chuck Akre and his Search for Outstanding Investments

So Steve Dodge, the CEO, discussed his thought process about handling the debt issue in the
following year. Further, we could take a full measure of both his pride and his anger relating to the
share price and the market action, and we came away believing that the debt issue would be managed
successfully. Along with an increased level of confidence in the business, we were better prepared as
the market tanked in October of 2002. Market liquidity disappeared. Many of you will remember and the
shares traded at an inter-day low of 60 cents per share, finishing the day on October 9th at 71 cents per
share. The circle on this chart, marks the point at 80 cents per share where we took a larger position,
several million shares yet still not significant to our assets. So what was the market seeing in 2002?
Among other things, the company had a ratio of debt to EBITDA greater than 16 times. You can see on
the right hand column, 16.4 times. Not unexpectedly, it was showing huge net losses in income as well.
You can see that in 2002 alone, it lost $350 million. What did we see? We saw a basic business model
in its simplicity, which is more towers, more tenants per tower, and more rent per tenant. What else did
we see? Well we saw that tower level... margins were about 90%. We saw that cash flow margins were
approaching 50%. The 2010 experience for American Tower was EBIDTA to margin itself was 68%,
and the free cash flow margin was 46%.

So back to the basic business model. Tower count remained flat in 2004, and the company improved its
balance sheet. Beginning in 2005, tower count began to rise both domestically and outside the U.S,
and from 2005 to 2010 tower count grew by 133%. What happened after 2002? Well beginning in 2003
EBIDTA began growing again. In 2005, free cash flow turned positive, debt to EBIDTA fell to below 6
times in 2005, and from over 16 times to just 4 times in 2010. Free cash flow reached 46% of revenues.
So this is what I call the ―aha‖ event. Return on invested capital from 1997 to 2010, that should be
1998, was 30%. Compound return on investment from the market low in October 2009 was 66%. While
the return periods did not exactly overlap, the point is the same. The difference, the excess return is the
very definition of the Davis double play. So an important observation to us is that price matters
enormously. The starting price has everything to do with your compound return, and here we see that
the difference between buying the shares in February 1998, March of 2000, October of 2002, and
January of 2003, and if you can‘t see the chart very well, from February of ‘98 to present, there‘s an
11% CAGR. From March of 2000 to present, it‘s a 3/10% cagr, from January of 2003 to present, it‘s a
38 and a half percent cagr, and by the way, from the market bottom, October 9th, 2002, it‘s a 66% cagr.
So that is indeed the Davis double play.

Now, if you will, just get to the point that I enjoy most, let‘s have some questions.

Question: What‘s your biggest investment mistake?

Akre: Umm...I‘ve often said, Bob, that my biggest investment mistake was not buying enough of
the ones that were really good. And, that‘s looking at it from kind of a different way. Like every other
speaker who‘s been here since yesterday afternoon, 2008 is made an indelible impression on me, and I
think of my clients and I have a adjusted the way that I look at things to try to better incorporate my
world view into my overall security selection in portfolio construction, still very much a bottom-up stock
picker, but just trying to be wiser about the process. A great story along those lines: In 2005, in our
office, we hired a consultant who‘d been a commercial vendor to the national homebuilders in Chicago.
And we said, as it‘s related to the housing industry, this is 2005, look, we don‘t even know what the
question is, but we just feel like there‘s some bad stuff out there, would you do some work for us and
help us understand this? And he came back with 120 graphs of information. And it didn‘t resonate with
us in a way to allow us to preserve our capital in the market experience in 2008 in our mind, in ways
that I would have liked to. After all, we‘ve gone through the 2000-2002 experience, up across that
three-year period. And here we were in 2009, with significant decreases in value in our portfolios. The
experience of the balance of 2009 to 2010 has showed us very clearly, that market decline wasn‘t as

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bad as it felt; it felt awful. But, we‘re just trying to be better at that. But the other way I answer, as I
started, is simply not owning enough of those that are really great.

Any other questions? Yes, sir?

Question: So you‘re thinking in the summer of 2008 with the financial... in motion... imagination... what
were you thinking at the time, from summer 2007 to summer 2008, what was your thinking?

Akre: Well, my thinking between the summer of 2007 summer of 2008 was not nearly as good as it
ought to have been, because I didn‘t see the train wreck coming, per se, even though my instincts were
on the right track. I went to back to ‘05. We in fact, in our offices – our offices are 45 minutes west of
Washington D.C., out of the country. We‘re in a town with one traffic light, and between our town and
Northern Virginia, every major national homebuilder in the country was building houses, and we
actually, in early 2007 and ‘08, we actually referred to it as ground zero for the national homebuilders.
We had some analysts going out on a weekend and posing as buyers and trying to get data, what sales
were in every place, and we still didn‘t bring that in to our overall portfolio construction and risk
management and all that sort of stuff. So, it wouldn‘t do you any good to know exactly what I was
thinking, because it didn‘t have a good result.

Yes, sir.

Question: What is really exciting today... a thousand baggers today?

Akre: Well, we‘re looking for them every day, and of course, it‘s simple arithmetic. And what I mean by
that is, is the higher compound return on capital that you can get, the more likely you are to have a... by
the way, I don‘t mean this any other way than...when I mention that I first bought Berkshire Hathaway in
1977, my recollection was that my price was $120. So I‘ve got a thousand bagger on those, by the way,
two shares, that I bought at that point in time, and the great thing about compounding is that in order for
it to be a thousand bagger it was only a five hundred bagger just halfway before there, and a 250
bagger and so on. We are very interested in a couple of very large cap companies here, that have been
under duress, and that‘s Visa (V) and MasterCard (MA). And these are extraordinary businesses.
We‘ve done an enormous amount of work in this space, what looks like a very simple business on the
top is hugely complicated below the surface, and not transparent. And the thing that has bothered these
businesses of course, is being... and the... amendment, and the... which is not yet settled. But I will just
say is that the businesses have net margins which are north of 30% today, and so lots of bad stuff can
happen to them, and instead of being truly extraordinary businesses, they just become very terrific. And
they‘re selling at pretty modest valuations, both on the kinds of growth and the kinds of return on capital
they have, and when I say modest I‘m talking about sort of 16 times free cash flow, something like that.
That‘s a great example. Something that everyone in this room could go buy.

Yes, sir?

Question: You made a critical point about the importance of adjusting the price you pay for what you
get, the quality of the business. I was wondering if you would give a little bit of insight as to how to
mentally run through that process, in terms of quality of the business, potential compounding, all those
factors come together in deciding what price is too high and reasonable?

Akre: Sure. So quite obviously, growth is an important part of what we do. In order to create value we
have to have growth. In order to get businesses that can compound the owner‘s capital at, let‘s say,
20%, you know, you have to have a hefty level of growth in order to do that. So, it‘s really just going
through the mental process over and over again about the three legs of the stool. And we recently had

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a business in a portfolio whose name I won‘t mention, but it had a great international royalty business in
our judgment. And, of course, royalty businesses are something Warren talked about for 40 years, and
the royalty in someone else‘s economic activity. And, stock was probably appropriately valued in the
high teens, free cash flow maybe... but when we continued to do work on it, what we discovered was
that in our minds, the CEO was making very poor reinvestment decisions, producing a huge amount of
cash as we expect, but making poor reinvestment decisions in a way in which he was unable to sit and
talk intelligently about the reinvestment process. He made comments that said, he was making those
decisions because his group of shareholders demanded X, or demanded Y, instead of what it would do
to the economics of the business... so, let‘s reexamine the issue of the three legs of the stool, is hugely
important, and I gave you examples of several companies that we‘ve owned and sold because one or
more of the legs changed over a period of time, and so as we have discovered, nothing‘s forever. We
saw Warren spend much of the last two decades acquiring businesses which were designed to benefit
from GDP plus growth in large scale consumer businesses, whether housing materials, or furniture, or
all kinds of things like that, and it appears that he shifted now to buying industrial and, that sort of stuff,
he‘s had a whole... but we all go through those things, and you know, none of us are very good at
predicting in advance where we ought to be, and then we run into the experience in the last decade,
where in the last decade we had two major market declines. Two in one decade, and the second one,
of course was a doozy. Charlie has commented in print in last year‘s meeting that we were within days
of a total collapse of the financial system worldwide. None of us can protect against that, and so when
Robert was talking about Buffett‘s call in the market bottom of October of 2008, and it kept declining,
the analysis is simply, these things are so cheap that I have to buy them here, and if I‘m wrong, it‘s
because we‘ve had a total system of collapse, and it won‘t make any difference. You know, that‘s a
really interesting kind of take away from that. That‘s my take away from it, but any other questions?

Question: Identify compound machine, trying to buy when they‘re cheap. When do you sell them? Is it
only when the legs get weak, or is there some...to what you‘re selling?

Akre: Well that‘s a great question, and it‘s one every appropriately asks us, and the answer is first of
all, if the three legs are intact, if we believe the business model is going to continue to compound our
capital at these high rates, and we recognize that number will go up and down for normal business
experiences, but their... we want to hang on to the business, because the really great ones are, A, too
hard to find, and B, too hard to replace. Every now and again we fool around with taking a little bit of
something off of the table because we think it‘s gotten too rich. My sort of life experience is that if I sell
a stock at $30 because it‘s too rich, and I set in my mind that I‘m going to buy it back at $23, inevitably,
it trades to $23 and an eighth, or $23 and one, or whatever it is. Oh yeah, whereas if it trades at $22.98,
you know it trades 300 shares there, or something like that, and I never get back. And then the next
time I look, instead of being $30, it‘s $300. And I missed it up. So the really great compounders are
really hard to find and identify, and you know, I talked about International Speedway. Robert H. actually
wrote a book about that whole experience with NASCAR racing, and it was an extraordinary business. I
mean the family that controlled the company owned NASCAR outright. And, the dynamics of the
growths of this business were just unbelievable, and as I repeated those financial characteristics of the
company who bought it, it was great. And then the management beyond Bill Franks Jr. just overplayed
their hand, and got too greedy, and you know, the economy changed and the business, we were
fortunately gone by then. Another business that is way more controversial that I didn‘t mention, that
we‘ve made 10, 20 times our money on in recent years is a company called Penn National Gaming
(PENN). And it‘s in a business owning and operating casinos. It was a regional operator. It wasn‘t not in
Las Vegas. It was not in Atlantic City. And we took our position way down in that company some while
ago because starting about three years ago, visits per casino were down, and plays per visit were
down. And to go to that question that I answered to Bob, our view is that the consumer is constrained.
And is going to stay constrained. And we‘d love to be able to... our way out of this economy but with 9%
unemployment rates, it‘s not going to happen. And with, I think, north of 80% of all households have

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 Chuck Akre and his Search for Outstanding Investments

every dollar of income spoken for it. And with higher food and energy prices, which are not deferrable
expenses, there‘s less to go around everywhere else. And so, at the same time, Robert H., the lowest
expectation group in his chart was somewhat discretionary, yet in our portfolio we owned Dollar Tree
(DLTR), and Ross Stores (ROST), and TJ Maxx (TJX). Consumer discretion items. But those three
businesses are businesses whose model is trying to help the consumer who‘s trying to stretch every
dollar go further. They sell stuff for less. And they sell a lot of stuff that people need. And they do it for
less. So we‘ve had good success in those names in this environment, and you know, the financial
characteristics of those businesses are all terrific, and the valuations are modest. The balance sheets
are basically net debt free, and the returns on capital are in the high teens, and compound growth and
economic value per share in the high teens, mid to high teens, you know. So, we look around at all of
these and when the business models stays intact, we tend to stay there, and we try enough to
understand when they don‘t. But that‘s really hard. I‘ll just finish those up.

I grew up in the Washington area and for years, if you‘d ask me or others in Washington, D.C., ―What‘s
the best public company here?‖ people may have well said the Washington Post. And friends like Tom
Russell who will be here later and others and I used to talk about this around a decade ago. We‘d say,
you know, circulation‘s declining in all the major newspapers, but it‘s a modest number. It‘s two or three
percent a year. It‘s really not hurting the economics. Look at these things. And then about five years
ago, they just went off the cliff. Went completely off the cliff, for something that most people didn‘t
expect, which was the Internet completely disintermediated their economic edge... and so, there was a
huge change in economic model, business model, which had been intact for 70, 80 years, and in one
day, bam, for reasons which snuck up on most people. And so, I made that point in the beginning, how
important it is to try to understand what‘s causing that good result and how difficult it is to understand,
and why you have to constantly keep looking at it, and keep asking the question, having this curiosity
about these things. Yes, sir?

Question: What you said about being from the Washington, D.C., area – how do politics play into your
environment as far as your decision making and changes that are coming up, and you know, from a
living standpoint or changes in administrations and the... long-term look at the process.

Akre: All right. Well, of course, it‘s the business of Washington. Actually, you don‘t really want to get me
started on politics. It doesn‘t add in to our process much at all. I mean, in our... in Visa and MasterCard,
we‘ve had people... and so on, that related to that area, you know, flip a coin on their advice. It is what it
is. We just try to deal with things which we know.

Long-term trends, or banking area, lending process?

Well from a political point of view, we‘ve had periods in the United States where personal tax rates were
90%. You know, from a political point of view, right now we have a time where our tax rates on both
capital and dividends are the lowest they‘ve been in over a century, maybe ever. Who would have
predicted that? Yes, sir.

Question: Can you talk about how your early investment career and how you came about to the
philosophy you‘re using now, were there early... and you talked to us about that, perhaps that
transition?

Akre: Sure, picture a piñata party, blindfold on. As I said, my undergraduate studies was in English
literature, pre-med student, so I had all kinds of questions and I had no preconceived notions when I
got into the investment business, and the firm that I joined, when I joined it in 1968, there hadn‘t been a
single most important brokerage firm in Washington, D.C. It brought everybody like Geico, and did all
the financials to the drug stores and the utilities and it had gone through a change where the principal

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owner had died, and so in going through a change, it actually at a time, Merrill Lynch had one office in
Washington, and this sort of stuff. The business was changing dramatically and this firm didn‘t change
a lot, and in a kind of perverse way, it allowed me to pursue the stuff that I gravitated to, which was
trying to figure out how to be a good investor, and what was a good investment, and so it was just a
very slow, you know, I‘m a charter member of the slow learners, and it was a process that slowly led
me to the point where instead of trying to manage money from brokerage clients, I began to manage
money for fee-paying clients in the mid-80‘s, so it took a long time…when I was operating as a broker.

Question: So did you learn primarily by reading about Buffett?

Akre: Yeah, I have a very... and I‘m curious, and I try to read and learn from people that I perceive to
be smart and successful, I was telling the guys in the office a story yesterday, that I‘d read about this
fellow named Henry Zenzy, once who had studied under the legendary... I can‘t even remember who
that was, who... one of the great wholesale, OTC brokerage firms. He‘d been very thoughtful and
specific in parts of the business that he wanted to go and learn specifically, then he came out and took
a lot of his money and invested it in commercial laser company in Springfield, Virginia, and I said ―Aha!‖
He‘s on to something. So I invested in that laser company, which went to zero. So even the coattail
investing has its pitfalls. You have to have your eyes open all the time, and, I have this motto, ―In life as
well as in business, which is every day, I‘m lucky if I have learned something new, and I‘m doubly lucky
if it hadn‘t cost too much.‖ Yes, sir?

Question: Yeah, you mentioned several people/clients in moats, and I wondered, what lasts the
longest?

Akre: Well I have no idea. I mean, I don‘t. Obviously, what we all know in this room is that when you
have a business that has very high returns on capital, it attracts competition. And so, the best way to
have one is... that‘s protected by patents, and as Warren used to say, is fattening and you know, I think
he used to use some other things in his examples, but you get the idea, that people want badly and
protection from competition between one another, they‘re all unique, they‘re all interesting... I can‘t tell
you which one‘s going to last the longest. Yes, sir?

Question: Inquiring about an appropriate level of portfolio concentration?

Akre: Well, only as it related to what I do, and we currently have four positions. I‘ll speak about our
private partnership, not our public mutual fund. We have four positions that are between 10 and 20%
each, the largest of which is 20, 21%, so we have another three positions that are about between, 7 1/2
to 8%, and the few beyond that, don‘t make a lot of difference. And so they‘re sort of what I call
workbench, and they‘re either going to get larger or smaller. And we, you know, the point is, if we have
a high level of confidence in the three legs, and we want to make sure that we have enough capital
allocated to that that is going to have an important effect on the portfolio. Remember, I started this
whole presentation by saying that the hypothesis is, my return on an asset will approximate the ROE, or
the period of years, given the absence of distribution and constant valuation. So, if I own a business
that‘s got a 20% ROE, 20% free cash flow return on the owner‘s capital, and I find that by their
reinvestment they are compounding value at something like that, and I think that the runway is long and
wide, I want to have a lot of capital there. If, on the other hand, I‘m uncertain about how the business is
going to behave or if I‘m uncertain about both the reinvestment history as well as the discussion by…
then I don‘t want to have as much capital, you know, but we‘ve always run concentrated portfolios, and
as Robert pointed out, our returns on the upside… higher, and quite possibly they‘ll be more negative
on the downside... Net-net, just like averages, are returns over a long period of years, over 20 years
have been significantly above the market average, after all fees, incentives, and everything else. So
that includes 2008 experience.

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 Chuck Akre and his Search for Outstanding Investments

Thank you very much.

http://www.gurufocus.com/news/150194/chuck-akre-value-investing

Answers from GuruFocus' Q&A with Chuck Akre; Discusses LAMR, AMT, MA, MKL, PENN, ARO
Jun. 06, 2011 | Filed under: LAMR, AMT, MA, MKL, PENN, LEXG, ESV, ROST, TJX, ARO,

Recently, GuruFocus readers asked successful investor Chuck Akre their investing questions. In his
comments, he discusses LAMR, AMT, MA, MKL, PENN, LEXG, ESV, ROST, TJX and ARO.

We will also be hosting a follow-up Q&A with Chuck. If you have further questions for him, post them in
the comments below, and he will reply.

1. I have a couple of questions for Chuck on Lamar (LAMR).

What does he think the ultimate ratio of digital billboards to total billboards will be for the
company? I have heard anywhere from 3%, 5% or 10% over the next decade. Also, does he think
smart phones hurt billboards or enhance them? I believe this important because an iPhone is
really just a mini personal billboard. It could hurt the overall appeal of billboards or could be
used to interact with them. Lastly on capital allocation, the Reilly’s seem very capable but at the
top of the last cycle they paid a special dividend and bought back stop at prices above today’s
stock price. Do you think they learned a lesson and that capital allocation going forward will be
different? Would love to hear his thoughts. Thanks.

[Akre] Three questions: a) I have no idea what the ratio of digital boards to the total will be, but I do
know that there is a very large upside opportunity. B) Smart phones are indeed mobile boards, and
again I have no view on whether they will supplant fixed boards, or rather enhance them through a
mobile link of some sort. Lots of possibilities. C) Certainly in hindsight the special dividend and share
repurchase was fuzzy thinking. More recently the option strike repricing (although the dollar amount
remained constant) continues to reflect poorly on a corporate governance philosophy. Fortunately the

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business seems to be run reasonably well. I am told that Brent McCoy‘s role at the firm is to oversee
capital allocation issues, and so we might expect improvement.

2. How much do you think your returns would have increased in 2008 if you considered the
macro picture into your stock selection?

[Akre] Munger and Buffett said at the 2010 annual meeting that they would not be attracted to any
manager who went to cash during the crisis. However, they held 20% to 30% cash during the crisis,
giving them great opportunities and reducing their exposure to the downside. Our returns of course
would have been better if we had had the insight and courage to go to cash, but we did not. What I
have said is that I want to better incorporate my ―world view‖ into my security and portfolio decisions,
with a view that we might better. What the balance of 2009 and 2010 have taught us is that things were
not a s bad as they felt at the time, as portfolio values have recovered nearly all the lost ground. It just
felt awful going through the ―troubles.‖

3. I also own Markel (MKL) shares and I really like the company and consider it a permanent
holding (unless it trades at 3x BV).

What is your estimated range for the BVPS growth rate over the next 10 years?

What’s your opinion on the companies that comprise Markel Ventures? Have you verified the
prices paid? How about the quality of the individual businesses and their competitive
advantages?

[Akre] I think under their current structure (especially investments to book value) they should be able to
compound book at a low- to upper-teens annual rate. I have not examined the Ventures businesses
closely as MKL has had limited disclosure. I have spoken with the CEOs of several at various functions
and they are the types you would expect. Several are growing rapidly, and several are the types I call
―send the check to Omaha.‖

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4. I noticed you scaled back your position in Penn Gaming (PENN). What are your thoughts of
this company going forward?

[Akre] Peter Carlino (CEO & chairman) is the best in the business at compounding the shareholders‘
capital! We continue to believe that the triple head-winds (competition, taxes and sluggish economy)
just make it more difficult now.

5. As a student dreaming of a career like yours, I was hoping that you could give me some
advice on finding some good topics for writing a thesis/essay about. Of course, I'm looking for
topics that would help me in a stock-picking career.

[Akre] Compound returns!

6. Recently I have been watching stocks with absolutely no company revenue take off on "paid
promotions." Most notably LEXG went from $0.10 to over $10 and back down. Jammin Java was
similar in its performance to a high of $6.35 from below $1. What do you consider to be the
single most important factor in considering investing in stock, technical analysis, due diligence
or news? If news is the most important, how can one "predict" that a stock will run, or is it
simply risk?

[Akre] Fundamental analysis is the most important. One needs to know what one owns as an investor.
Of course if speculation is your game, you can try anything.

7. I'm planning to take CFA and learn to become a good value investor. I'm about to start my job
at PwC and after three years to enter into an investment bank and was wondering, will auditing
help me achieve my goal? Thank you.

[Akre] Accounting is the language of business, so anything you do to improve your understanding of

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accounting is valuable. I don‘t personally believe that an investment bank role will help you become a
better value investor, as their focus (rightly so) is on creating transactions.

8. In a past shareholder letter, you expressed concerns about the so-called recovery (high
unemployment and weak consumer). Would you please share your current view on this topic
and how it relates to market expectations moving forward? Also, would you relate this same
question to your expectations for the portfolio's performance?

[Akre] I continue to believe that the current high levels of unemployment and underemployment will
continue to hold back recovery. This backdrop quite logically will affect the investment climate. Further,
I have no prediction about how any of our investments will perform over the balance of the year (or
even next year for that matter), but I do know that each will gain in economic value per share both this
year and next. How the market values that is unknown.

9. Now that you are beginning to think of the macroeconomic factor, what are the most key
factors you are looking at?

[Akre] I have always tried to be tuned in to what is happening in the world around me, but since the end
of 2008, I have been trying to better integrate that view into individual security selections.

10. Having lost a bundle this year on a delisted stock, I have to be very cautious of both
company-specific risk and macroeconomic risk. In your opinion, should a risk-averse investor
wait to see if the FED ends QE2 in the next weeks/month before deploying cash that is quite
limited? I am also of the age (mid-50s) where I should have a much smaller percentage invested
in riskier equities compared to someone 20 years my junior. I am thinking of staying in cash for
at least a month, then venturing back depending on the outcome of FED changes before the end
of summer. I will never make up for the 90% downside I experienced, but if I catch a bottom in
commodities just after a QE3 (if such happens) or after the market is finished worrying about
the ramifications after QE2 ends, 2012 might be a good year for another oil stock run since it is

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a presidential election year.

[Akre] Perhaps your personal financial goals aren‘t suited to your plan of speculation, and at the same
time you cannot reach your goals without speculation. If that is the case you have a real dilemma. As
an investor, I have found very little success at trying to time my portfolio purchases and sales around
macroeconomic events. Instead, I try to understand the business (using my three legged stool model)
and make purchases when the valuation is attractive.

11. My first question is on portfolio management. You run a very concentrated portfolio with a
very low turnover — 24 stocks with 75% of assets in top 10 holdings with an average turnover of
12%. How do you manage to maintain such a low turnover concentrated portfolio when your
assets are growing, without compromising the price discipline required of a value investor? Put
another way, I imagine that when a new position is initiated, the margin of safety is large. But,
say, as new assets roll in over time, your top 10 positions have moved up. Then adding to these
positions lowers the margin of safety, and adding a new position dilutes the portfolio
concentration. You have managed such a portfolio very well. Can you give us your thoughts on
this topic?

I recently heard you say that you believe that MasterCard (MA) has the potential to be a 5-10x
bagger over the next decade. Can you tell us more about your thoughts on MasterCard and why
it has the potential to be a multi-bagger?

Can you tell us about another one of your favorite multi-baggers that you held in the past but
you do not hold anymore or is now a smaller position? Why did you decide to lower the position
size (or eliminate the position)?

Lastly, can you tell us about one of your larger positions in the past that did not work out as
expected? What went wrong?

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[Akre] You have hit on a very important issue which affects all portfolio managers, and that is how one
puts cash to work, especially when valuations are less attractive. And further, you correctly understand
that the margin of safety is lower when the valuations are extended. My experience is that I have tried
several methods, a) allocating funds across the portfolio, b) placing funds in only the top few that are
cheapest, and c) holding cash for extended periods. The results…They have all had their pluses and
failures. One simply has to continue to look for the characteristics which attract them and strike when
they are attractively priced. It certainly distorts the relative concentrations in the portfolio, but that is the
outcome of a dynamic portfolio.

Re: MA. I do not recall saying that MA was a potential 5 or 10 bagger; however, I do believe that is
possible. Examine the net margins of both V and MA and dream a little. So the key then is
reinvestment. It will be very hard to find things to spend their money on that have the types of returns
that they already developed internally!

See question #4.

12. Teenage clothing is a tough business. Significant market shares are gained and lost based
on merchandising decisions. How did Aeropostale fit the "three-legged stool" model of Akre
Funds? Can you tell us more what attracted you to this business?

[Akre] We believe the shares are remarkably cheap. The company has no debt and a very long history
of success in the preteen and teenage. They will either get the current issue straightened out or they
won‘t. If they do not, I believe we are well protected in our purchase price, and if they get it right, we will
be well rewarded.

13. Hi Chuck, I am just beginning to know about your new fund and your positions and the
three-legged stool in investing. I would appreciate to know more about it.

1) How you can define the integrity and capability of management by reading their writing and

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watching their actions? Do you often talk to them or use a scuttle-butt approach (like Phil
Fisher)?

2) How do you decide that the company has reinvested the excess cash profitably with high
return?

3) For the famous position of your fund in American Tower (AMT), I have scanned their
performance over the last 10 years using Morningstar. Their return on equity is not high, the
long-term debt level is nearly double the amount of equity, and now the free cash flow stays at
$670 million. It definitely is not very attractive at the first look. How do you calculate the return
on owner's capital for AMT? And with this price valuing the company at $21 billion, is that too
expensive? What's the calculation to determine it?

[Akre] First question. Investing is about gathering data points (good MBA word) and digesting them in
your own neural network. If you have prepared yourself well, then the outcome (your judgment) will be
useful. Charlie and Warren are always talking about lifetime learning. This is what I mean by preparing
yourself well. So, after a while, you begin to recognize aspects of human behavior which you‘ve seen
before. You learn to pick it up from conversations, speeches, writings, etc.

Second question. It is an outcome from simple observation. You can do either a precise calculation, or
an approximate calculation based on the information the company supplies.

Third question. Re: AMT — the incremental returns on capital are off the charts at AMT. For example
once beyond 2.1 tenants per tower, the returns on incremental capital are in the 90% range. Second,
we have actually had a change in management at AMT, where the founder, Steve Dodge, and at least
two CFOs have moved on to other opportunities. The business is so good that it has prospered under
new leadership. The current chairman and CEO, Jim Taiclet, is world class. Third, their reinvestment
has been a mix of adding new towers, both greenfield and by acquisition, and the balance has been
used to strengthen their balance sheet, and then pursue share repurchases. The net result has been a

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growth in economic value per share which we calculate to be a mid- to upper-teens rate since 2002.
The proof is in the growth in the business‘ cash flow, tower count, etc. Its current valuation is at the top
end of our appetite, and the company is in our mind one of the best business models extant today.

14. I know that you are a "bottom-up" investor, but do you think that there are any companies
that you would look at more closely due to the "baby boomers" shifting their money into
retirement accounts or spending their money?

[Akre] The investment management business is one of the best businesses to own.

15. Quite impressed with your approach to investing where you look at growth and value both.
My questions are:

1) How does a retail investor conduct the kinds of research you do in terms of talking to
management, suppliers, competitors etc.?

2) If you have a business that historically generated high returns on invested capital and is
available for a reasonable or cheap price, but the management has made some expensive
acquisitions in the recent past and its re-investment efforts have either failed to produce results
or the management appears clueless about this, would you pass on such a company? What
would you recommend to management of such a company? Buy back shares like crazy? Pay
out 75% of FCF in the form of cash dividends? I am sure you can guess many names that fit this
description.

3) What kind of moat, pricing power, competitive edge do you see in the discount retailers in
your portfolios like Ross Stores Inc. (ROST), TJX Companies (TJX) and Aeropostale (ARO)?

4) Coming to American Tower, which has been a multi-bagger for you, does valuation come into
the picture in terms of selling... or as long as you see the growth and re-investment

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opportunities, you are a patient share holder?

5) Why did you sell Ensco Plc. (ESV)?

[Akre] Question one. It may be a little more difficult for an ordinary investor to get access to all the
things you mention, but the financial filings are always going to get you most of the way home. You also
certainly have the opportunity to check with suppliers, etc., just as a so called professional would.

Second question. We are always trying to understand how the management thinks about the
reinvestment issue. We will make observations, and occasionally unsolicited suggestions. But human
behavior comes into play, and if they just don‘t ―get it‖ we move on, or reclassify the opportunity.

Third question. The moat for the discount retailers you mention is shallow and narrow, and in our mind
consists of a rock-solid balance sheet, and a well-developed merchandising skill.

Fourth question. See Q #13 above.

16. Can you tell us how you get comfortable with Lamar's huge indebtedness of 5x
Debt/EBITDA? As management is reviving back its capex to 100 million, it seems unlikely that
paying down debt is a high priority going forward.

The long-term opportunity from digital billboards is huge — only 1,200 off the 146,000 billboards
are digital today. Lamar can easily get to 5% or 7,300 of these boards being digital over the next
few years. That is about 6x. The economics of digital are amazing with about 10x higher
revenue, break-even in less than a year, and very high incremental EBITDA margin relative to
traditional billboards. So, when the local advertising markets recover, they will be ready. My
question is — is this similar to your take on Lamar? And if so, what is Mr. Market missing here?

[Akre] Re LAMR.The business can easily support a leveraged balance sheet. The management has in

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the past chosen to leverage up the business through a share buyback and a special dividend. In
hindsight, it was a poor decision, as they nearly broke a bank covenant in 2008, and the refinancing to
remedy was (is) very costly. But the facts remain that it is a wide moat business; advertising spending
in the US is growing again (albeit better in the national than local markets), the digital opportunity is
very attractive, and the shares are modestly valued by the market. I suspect that the market is reacting
to two things at least. One, that the management has a spotty record on reinvestment, and two, that the
―local‖ market is lagging the national ad market in recovery. Also see answer #1.

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