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On the Hunt for Great Companies

Host: Drew Cohen
Guest: Simon Kold
Book: On the Hunt for Great Companies

1. Why Hunt for Great Companies​

  • Premise: High-quality businesses deliver predictable cash flows, lower volatility, and superior compounding over decades.
  • Quote (Kold):

    “You cannot separate quality and value… you need to determine quality to determine value.”

  • Investor Insight: Understanding quality is fundamental to avoid value traps, even in a value investing framework.

2. Simon’s Three-Part Framework​

A. Measure Quality​

  • Staying Power: Durability under stress (e.g., brand resilience during downturns).
  • Value Extraction: Capturing customer surplus while preserving future optionality.
  • Competitive Moats: Includes scale, network effects, switching costs, cultural alignment, and “pedons” (supportive yet constraining features, like Etsy’s handmade focus).

B. Predict Quality​

  • Apply the same lens to emerging firms.
  • Example: Amazon in 2003–04 showed enough signs of quality to merit a small position.
  • Note: Kold originally drafted this framework years earlier and refined it through writing.

C. Epistemology in Investing​

  • Embrace probabilistic thinking—map a spectrum of outcomes, not a fixed "base case".
  • Quote (Kold):

    “How difficult it is to know something, and how unpredictable the future can be—writing the book forced me to confront my own blind spots.”

3. Competitive Advantages & Moats​

A. Scale & Prohibitive Cost​

  • Quote:

    “If a competitor matching your price and service would earn a negative return, that barrier is prohibitive.”

  • Case: Ryanair
    • Boeing-only fleet
    • Strong airport relationships
    • Opportunistic asset acquisition during downturns

B. Expanded Network Effects​

  • More than just user-to-user growth:
    • Data Effects (e.g., Google Search)
    • Protocol Effects (e.g., Dolby Atmos)
    • Expertise Effects (e.g., Stack Overflow)

C. Switching Costs​

  • Example: Vertical software with custom integrations—customers are locked in by inertia and complexity.

D. Cultural & Incentive Moats​

  • Quote:

    “Southwest Airlines under Herb Kelleher never had a single losing year.”

  • Culture can be a durable moat when aligned with incentives and long-term thinking.

4. Case Studies & Nuances​

Ryanair​

  • Insight: Turned industry cyclicality into a weapon through counter-cyclical investments.
  • Quote (Cohen):

    “In a traditionally terrible industry, they turned volatility into a source of competitive advantage.”

Dolby Laboratories​

  • Dual Growth Engine:
    • Legacy codecs provide stable royalties
    • Atmos is growing across film, music, and gaming
  • Multi-pronged adoption needed—content creators, hardware partners, end users.

Costco​

  • Membership pricing acts as customer “insurance” — supports trust and recurring spend.

Arcosa​

  • Niche Market: Dominates Jones Act barge market with 90% share; cash flows are lumpy but enduring.
  • Insight: Market undervalues “ugly cash flows” despite consistent economics.

5. Value Extraction & Customer Surplus​

  • Under-Monetized: Preserves goodwill and future optionality.
  • Over-Monetized: Can trigger regulatory or reputational backlash.

Examples:

  • CoStar: Dominant data platform, but user complaints about pricing.
  • Evolution Gaming: Monopolistic pricing accepted due to lack of alternatives.

6. Valuation Philosophy​

  • Destination Thinking: Imagine the business 6–8 years out.
  • Scenario Mapping: Build bull, base, and bear cases across economic and multiple assumptions.
  • State Preferences: Adjust position sizing based on risk appetite.
  • Quote (Cohen):

    “Risks don’t vanish because you argue them away; you size your bets to accept their existence.”

7. Leadership & Incentives​

  • Assessment Focus: Communication clarity, long-term alignment, compensation structure.
  • Quote (Kold):

    “Half of my analysis time is devoted to assessing management’s communication and internal motivation.”

8. Cyclicality — A Nuanced Lens​

  • Cyclicality isn’t binary.
  • Semiconductors Example: Formerly cyclical, now more essential and entrenched.

You can listen to the orginal podcast from here