When thinking about investing legends, what names jump to mind?
Warren Buffett? He’s probably at the top of the list for most investors (and the general public) given his enormous, decades-long success.
Benjamin Graham? You’re likely familiar with this name as well, even if it’s just due to his mentorship of Mr. Buffett.
What about Bill Gross or Mohamed El-Erian? Both enjoyed immense bond investing success during their times at the helm of PIMCO.
How about legendary investor Peter Lynch, who famously generated a 29.2% annual return for 13 years while managing Fidelity’s Magellan Fund?
While Lynch is probably the best-known name to come out of Fidelity, Will Danoff, portfolio manager of Fidelity’s Contrafund (FCNTX), is arguably a more impressive investor.
While Danoff’s track record, at face value, isn’t as overwhelming as Lynch’s – Danoff has generated a compound annual return of 13% per year, beating the S&P 500 by 3% annually (although it’s underperformed in the last 12 months) – the length of his outperformance (30 years vs. Lynch’s 13) is what makes it extraordinary.
The other amazing aspect of Danoff’s performance is that the fund he is managing is massive.
The Contrafund has ~$124 billion in assets under management.
As Warren Buffett once said, “It’s a huge structural advantage not to have a lot of money.”
This week, I had the opportunity to revisit a fabulous, hour-long interview with Will Danoff.
And I want to share three key lessons that I learned.
3 Lessons from Will Danoff
1. Follow the Earnings
Danoff notes that he likes to evaluate a company by trying to determine what the company can earn in 3, 5 or 7 years. Will the company be bigger and better?
Extrapolating can be difficult, especially with technology companies, so be sure to stay within your circle of competence. You must be honest with yourself, and if you can’t comfortably project where the company will be, it’s better to pass on it.
However, if you have high conviction that the company is going to be bigger and better in five years, it could be an interesting stock.
Companies with a good brand, great management and strong cash flow growth are not going to ever look “cheap,” but that is not a reason to avoid them.
Danoff discussed Starbucks (SBUX), which went public in 1992.
At the time that Starbucks went public, the company had a mere 140 stores in Seattle and Portland. At the time it cost $250,000 to open a new store and each new store would do $130,000 in cash flow in its second year, representing a tremendous return on capital. And the company hadn’t opened stores in any other U.S. cities besides Seattle and Portland. Meanwhile, same-store sales were growing double digits. Even though Starbucks looked expensive trading at 35x forward earnings, it was clearly a tremendous opportunity.
2. Don’t Over-Complicate Things
In listening to the interview, it was amazing to me how easily and quickly Danoff was able to communicate his investment thesis for certain companies.
For example, he talked about Home Depot (HD). When he first looked at Home Depot, it had 40 stores in Atlanta, Georgia. It was opening 15% new stores per year at a high return on capital and their old stores were growing at a double-digit rate. Danoff was comfortable that the concept would also work in other geographies so the runway for growth was incredible. So it appeared that the company could grow earnings per share at ~30% per year for a long time.
This thesis is amazingly simple and was dead right.
Don’t over-complicate it!
3. Own More Great Companies
When Danoff started his career, he would focus on finding cheap companies that were improving. He would try to identify potential turnaround stocks. He ultimately realized that while turnarounds could be awesome stocks, the degree of difficulty was very high.
Over time, Danoff learned to just focus on identifying the great companies and trying to own more of them.
In addition to Starbucks and Home Depot, he mentioned Amazon (AMZN) and Google (GOOG)—the types of companies that you couldn’t imagine life without these days.
One reason that Danoff’s approach resonates so well with me is because it works so well in the micro-cap space. The companies that we recommend have very simple stories and a huge runway for growth. Most trade at “value” multiples despite growth potential.
The best part about micro-caps?
They are too small for institutional investors like Will Danoff, so we can get in before the crowd. Once they get too expensive, we’re happy to sell to an institutional investor and roll our money into the next hidden gem.
Do you apply any of Will Danoff’s lessons in your own investing?