By Jason Zweig | July 11, 2016 10:15 am ET
Image credit: Edward Collier, A Trompe l’Oeil of Newspapers, Letters and Writing Implements on a Wooden Board (ca. 1699), Tate Britain
In a column this past April, I wrote about fund manager Geoffrey Abbott’s quest to read approximately three dozen letters to shareholders per day until he had gone through nearly every annual report of the top 3,000 U.S. companies. (He skipped early-stage biotechnology firms and a few others he felt he couldn’t evaluate.)
Mr. Abbott found, perhaps unsurprisingly to any investor who has ever tried to read one, that only about one in 100 letters to shareholders was a gem.
He painstakingly worked his way through the alphabet; when I last wrote about him, he was beginning the Js. He nominated 16 of his favorite letters at that point.
Recently Mr. Abbott got all the way to the end of the alphabet, and I asked him to share a second and final installment of his list of the best letters.
A few caveats apply: The entries are lightly edited for brevity, and the entries are subjective summaries. Mr. Abbott doesn’t, and you certainly shouldn’t, invest in any company just because its boss wrote an outstanding letter to shareholders.
Even so, a good letter can be a promising indicator of honest and realistic management, as Warren Buffett himself said in my original column.
Mr. Abbott’s notes on his favorites follow:
JPMorgan (JPM) – Dimon is always a treat to read, and he did not disappoint this year. His was probably the most thorough letter I read. JPM’s business is massive and complex, but Dimon does a great job explaining it clearly. He helps readers understand the company’s advantages, opportunities and challenges. And he offers a sensible perspective on his bank’s role in the U.S. economy, where public discourse tends to shed more heat than light. I think his letters are a must-read for every investor.
Markel (MKL) – Most companies report their year-over-year performance. If it’s positive, they congratulate themselves. If it’s negative, they blame factors out of their control. Markel leads with its trailing 5-year results, and its long-term focus is palpable. It has a steadfast commitment to rational business principles and a flexible, opportunistic mindset. This combination has contributed to excellent financial performance for decades.
Nelnet (NNI) – It’s rare to read sensible commentary from corporate managers about stock price fluctuations, but Nelnet seems to have a very rational framework. They print their “fair value approach” in each annual letter, explaining why they dislike seeing their stock overvalued as much as they do seeing it undervalued.
This mindset makes a lot of sense for a company that wants to attract long-term owners rather than short-term traders. Also, Nelnet’s investment hurdle rate is explicit and high, a combination that I saw only rarely.
Pool Corporation (POOL) – This letter is short and sweet, and the company’s long-term shareholder returns are exceptional (25% per annum for the past 20 years). The chairman and CEO focus on cash generation, operating leverage and returns on capital — in other words, all the right things. They also print a summary of the sources and uses of cash since the company’s inception, which gives a great bird’s-eye view of how it generates and allocates capital.
Southwestern Energy (SWN) – Southwestern’s focus on economic returns stands in sharp contrast to most energy E&P (exploration and production) companies, which seem to think they exist to increase production rather than to create enduring value for their owners. Rarely does an E&P company articulate a specific hurdle rate of return or even explain why more production is in shareholders’ best interest. Southwestern says it will invest only in projects that create $1.30 of value at a 10% discount rate for every $1 invested. While this hurdle isn’t especially high, it sets the company apart from most of its peers.
Sovran Self Storage (SSS) – One of the most concise descriptions of competitive advantage I’ve read. Management explains why zoning laws will restrict new supply in the industry and how the company benefits from significant economies of scale in a highly fragmented business, allowing it to acquire facilities from smaller competitors and quickly improve their performance.
Starwood Property Trust (STWD) – Many real estate investment trusts fixate myopically on their ability to generate funds from operation (or “FFO”), which I consider a dubious performance metric. And they seem focused more on raising their dividends over the next 12 months than on allocating capital effectively over the long run. STWD’s letter bucks these conventions. It describes a highly selective and risk-averse investment approach and explains its advantage in investment sourcing. Perhaps the best REIT letter.
Trupanion (TRUP) – This is one of the best analyses of a company’s financial performance and long-term goals that I read. The CEO does an excellent job explaining how the company allocates its resources, and I came away with a keen sense that management thinks carefully about how to put each dollar towards its highest and best use. I particularly liked the discussion of the profitability of each incremental customer. And the CEO’s candor about past errors is refreshing.
Verisk Analytics (VRSK) – Thoughtful, compelling discussions of competitive advantage are rare in annual letters. The “Long-Term Value Creation” section in Verisk’s letter is a clear and concise description of its moat, or barriers to competition It explains what makes the company unique, why it is indispensable for its customers and how it works to strengthen these advantages to drive excellent financial performance over the long run.
Viasat (VSAT) – I’ve been a fan of Mark Dankberg’s letters for some time, and this year’s was great too. He distills very complex science into simple language accessible to the layperson. His analogy between Internet data transmission and transportation of physical goods is excellent. Viasat has been in my “too hard” pile for years because of the technological complexity and pace of change, but I always learn from its letters.