s very lucky. I started working for Acciona, a large industrial conglomerate, in 1991. A few months into the job I was assigned as an analyst to Acciona’s small investment management business, Bestinver. A year later when the fund manager, who was a value-oriented guy left, I took over the management of the fund.
Around that time I chanced upon Peter Lynch’s One Up On Wall Street. I also started reading everything about Warren Buffett, Benjamin Graham and other value investors. All these things allowed me to develop a clear framework very early in my career. You could say that value is now ingrained in my DNA.
You are often referred to as the Warren Buffett of Europe. How do you approach stocks?
We approach stocks the same way as an entrepreneur would. If an entrepreneur sees a company that is undervalued, he buys the whole company. We buy shares.
We look for good businesses with strong competitive advantages that are trading at a discount to our estimate of their fair value. We also follow what other value investors are doing — what they are buying and what they are recommending. We are very open to that.
How do you identify companies with strong competitive advantages?
A strong competitive advantage is one that we understand will still be there after 10 years. For instance, we look at the economies of scale, and whether new competitors will develop that scale. We talk to clients — whether they are willing to leave the company. We talk to a lot of people — the company, competitors, suppliers and customers — to understand how strong the competitive advantage is.
How do you differentiate between a company that has a strong competitive advantage and one that has only a strong brand?
Well, take the case of Sony. Sony is a good brand and everyone knows Sony. But it cannot charge 20 per cent more than its competitors. On the other hand, take BMW. It can still charge more than its competitors. So by definition, you have a good competitive advantage if you can charge higher prices and as a result of which you will end up with higher returns than the competition.
There are a lot of companies with good brands like BMW. You will find that the value of the brand does not get reflected in the balance sheet. How do you factor brands into your valuation?
Brands are extremely important to some companies. BMW, for instance, would be worth a lot less without the brand. But we don’t calculate the value of the brand per se. We value the brand because of its ability to allow the company to earn higher returns and generate higher amount of free cash flow. In the case of BMW, the brand allows it to earn 25 per cent return on capital employed. That is an extremely good return because all the other mainstream companies are earning only 10 per cent (RoCE).
How do you identify value traps?
After being in business for 20 years, I have learnt that value traps are companies with low-quality businesses. We used to buy average businesses at five times free cash flow (FCF); now we only buy high-quality businesses at 10-12 times free cash flow.
A company with a return on capital of 12 per cent, which enjoys a good position in the market but is unable to raise prices because of competition, could be an example of a value trap.
Then how do you avoid such value traps — companies that may not grow in revenues or profits?
We have had our share of value traps over the years. But lately, in the last two to three years, we have moved to high-quality businesses with high return on capital employed, and very high strength of balance sheet. We have moved away from average companies that are only undervalued.
In the case of high-quality businesses, even if they don’t grow, they tend not to be value traps. That is because they generate so much free cash flow that the value of the stock grows over time.
Are there businesses that you avoid?
Well, we stay away from businesses that we don’t understand or businesses that we think change too often, like technology. This is the Warren Buffett approach where we avoid things that we cannot forecast for the next 10 years.
Moving to valuing a stock, how do you arrive at a fair value?
If the business is good and it has a competitive advantage that is sustainable, which means that free cash flow should be stable over the next 10 years, then we apply a 15 times multiple to the free cash flow. It is that simple! For instance, Wolters Kluwer is a company with very stable FCF generation, with an enormous moat (switching costs of their clients) and it is quoted at eight times FCF.
Why 15 times?
Fifteen times is the average that stocks in the US have traded at for over the past 200 years and it translates to about 6.5 per cent free cash flow yield which seems reasonable to us.
Is 15 times the maximum that you are willing to pay?
No. We like to pay 11-12 times FCF. Fifteen times is the maximum, the target price. Take our current portfolio, for example. It is currently trading at eight times and we think that the target price is 15 times. It is very uncommon for us to buy stocks trading above 12 to 13 times FCF.
But this also depends on the alternatives available in the market. If the overall market is overvalued, we may pay 14 times. We try to buy as low as we can but you have to see what the market is quoting at.
Do you apply the 15 multiple to all companies?
Not all, but most of them. In some cases we make an exception for very high-quality businesses. Then we apply 17 times. But for the not-so-good businesses we apply 13 to 14 times FCF. As a general rule, we apply 15 times, and that’s it.
Are there circumstances in which you will be willing to pay more than 20-25 times?
No way! You never say never in life, but I can say that in 20 years we have generally not done it.
What do you do when you find yourself in a situation when stocks that you like are trading at, say, above 20 times FCF?
Well, in that case we will go for a holiday!
How long are you willing to wait for a stock in your portfolio to perform?
Oh, forever! We have been shareholders of some companies for more than 20 years and we will continue to hold those shares provided the business is growing in value every year and the market doesn’t recognise it. For instance, there is a Spanish company that we have been holding for the last 20 years. It has gone up from €15 to €400. We have made 25 times our money but we still continue to hold our shares in it because we think it is worth €600 or even €700.
When do you sell?
We sell only when we find something better. When a stock goes up 20 per cent, it becomes 20 per cent less interesting for us and we may be interested in buying something else. But sometimes a stock doesn’t move and we find alternatively something more interesting. So we sell something we like for something we like more. But it’s also relative. When a stock approaches 15 times FCF, we are more willing to sell, but it all depends on the alternatives. If the alternative is cash we will sell more slowly.
What are your views on commodities?
Commodities are really tricky. It all depends on demand and supply. We try to avoid commodities because the demand and supply situation may change dramatically and you may not even notice what is going on. Look at the gas market. All the commodities are up and gas is down from $13 to $4. You would have lost 76 per cent of your money if you had invested in gas during this commodity boom period.
There is one more thing. In commodities we look very carefully at the consumption per capita rather than in absolute terms. For instance, consumption per capita of iron or petrol in China is similar to any European country while in other commodities, such as paper, this consumption per capita is very low. Thus there is a lot of room for an increase of paper consumption in China that will have a positive effect on pulp producers all around the world.
Your views on gold?
The last time we invested in gold was 10 years ago when gold was at $300. We found a couple of companies that we were interested in, but we found that the gold cycle was very slow and we sold very early. We no longer invest in gold.
Gold is a real asset and we prefer real assets to paper money. But of all the real assets, we prefer companies with strong competitive advantages. These give better long-term returns.
