Moelis’s John Garrett on how the investing greats have guided him

This study has led him to plans trips around investing. After making the pilgrimage to the Berkshire Hathaway AGM last year, or the “six hour MBA”, Garrett will be back again in May and is taking his 14-year-old son along for the ride.

Following the classic principles has led Garrett to develop some counter consensus views for the $200 million small cap fund he has been running full-time since late last year.

Nick Scali

Furniture outlet Nick Scali for one, which is a business he likes and has held a position in since October 2018.

He says he understands the bearish thesis on Nick Scali: the end of a housing boom meaning less people are buying furniture and a negative wealth effect dragging on household consumption.

“But you don’t get an opportunity to buy really high-quality businesses at attractive prices unless ordinarily maybe something’s not quite right,” he says.

As other investors begun moving their money out of equities in late 2018 thanks to a fast falling market, Garrett saw it as an opportunity to build his position.

“We started buying it in the mid to high fives, it might have even traded under $5, we kept buying it,” says Garrett.

For industrial companies, Garrett generally holds a 3.5 to 4 per cent position size, at cost.

The main reasons he likes the business are because the chief executive owns a large portion of shares and “has got my back”, it’s trading well below its historical average price-to-earnings ratio, and he doesn’t think the business will be disrupted.

“It’s got a very high return on incremental capital. So every time they open a store, their payback period is sub-six months in terms of the capital they’re putting out.”

Ultimately for Garrett though, it comes down to the question of quality and longer-term value creation.

“We think it’s a high quality business that looking out three to five years is going to be worth more money.”

He has already made some money out of it thanks to a 24¢ dividend and some good profit results, including an interim result in February that saw an 8 per cent rise in profit. “It wouldn’t be double digits but it’s been OK.”

An idea from The Economist

Another stock he likes is outdoor advertising company QMS Media, an idea that came to him after reading an article in The Economist about how digital billboards are so successful internationally.

When he began to think about why they are doing well, of course Garrett turned to the wisdom that had guided Berkshire’s Charlie Munger, an author named Robert Cialdini.

Munger gave Cialdini a share in Berkshire, attributing his book Influence to making him hundreds of millions of dollars.

Reading this author’s newest book Pre-Suasion, Garrett came across a passage about how the human mind can only focus on one thing at a time which is difficult when faced with change.

“And I look at these billboards and they are powerful because you’re driving along the road and before it used to be static, and now something flashes up and it’s change.” This led him to confirm that QMS had a good product, the first test for a good business.

“Then the process is well let’s go back and have a look at what they’ve done over a period of the last five years,” says Garrett.

For QMS, “everything that the CEO said that he was going to do, they pretty much hit all the numbers”.

He started buying the stock at 90¢; it closed at 71¢ on Friday.

Despite this, Garrett still believes in its long-term growth prospects. He says that in private transactions, comparable media companies are being bought for 12 to 13 times the EV to EBITDA multiple, QMS is sitting at 5.5 to 6.

“I sit there and I say OK, here’s an opportunity. I can buy a stock at like [a] 40 or 50 per cent discount to where the private market is,” says Garrett.

He is still trying to figure out why it is trading below private market multiples.

Perhaps part of the reason the share price hasn’t recovered from its 2018 high of $1.16 is that poor market performance at the end of 2018 caused asset allocators to rush out of small caps, selling their positions at any price. They haven’t recovered.

“When you’ve got to sell stuff and you have money pulled out, you might not sell what you want to sell, you sell what you can sell,” says Garrett.

“A number of the stocks that we bought in November and December, we started buying and they kept falling and some of them would’ve fallen 10 per cent after we bought them,” says Garrett.

He is still hopeful in his decisions. “You make a lot of money in bear markets, you just don’t know it at the time.”

Things to avoid

Garrett tends to avoid industries he doesn’t fully understand and feels he doesn’t have an “edge” in such as technology and biotech stocks, to name two.

“The problem when you pay 60 times earnings is you get a big potential for a really bad outcome,” he says, referring to some of the platforms businesses that have seen stratospheric share price rises since listing.

“If people have got it growing at 60 times it means that people think there’s going to be a lot of growth and not many companies can grow at high rates of return for long periods of time, that’s a fact.”

After 14 years at UBS where he worked in REITs, general equities, sales trading and eventually in hedge fund advisory, Garrett began at Moelis Australia in their hedge fund advisory business.

Although his father was a stockbroker at JBWere in Adelaide, he says this didn’t light the equities fire within.

“You can do anything but be a stockbroker,” his mum told him as a youngster. So he went into real estate, studying a Bachelor of Business at the University of South Australia, including a focus on property valuation.

His first gig was at Jones Lang LaSalle (then Jones Lang) in Adelaide, with a goal to always come to Sydney.

Garrett’s love for the great investors has led him to do his part in fixing the problem that most business schools don’t study Buffett and Munger, “the two greatest investors of the last 200 years”.

This year, he has become an adjunct professor at the IE business school to address this problem, teaching a course on investing.

He hopes to instil in his students respect for the core principles of investing. If he’s successful, maybe Australia will have its own Berkshire Hathaway before long.

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