Checking out at Costco

Episode Overview

• The episode explores why company culture and management incentives are critical, non-negotiable factors for successful long-term investing, moving beyond simple financial metrics.
• The hosts discuss current market topics, including the potential impact of new US withholding taxes and the recent underperformance of major consumer staple stocks.
• Using Constellation Software as a key example, the discussion highlights the power of an "owner-operator mindset" where management and employees have significant "skin in the game."
• The conversation features a deep dive into Costco as a case study for a company with an elite culture, a formidable business model, and a justifiable high valuation for a long-term compounder.

Key Concepts

• Company Culture & Incentives: The central theme is that culture is a tangible driver of financial performance. The key question for investors is whether a company's structure ensures that business profits will ultimately flow to passive shareholders.
• Owner-Operator Mindset: A preference for companies where leadership has a significant personal financial stake in the business, leading to more prudent capital allocation and a focus on long-term value creation.
• Skin in the Game: The principle of aligning the interests of management, employees, and shareholders. Constellation Software is highlighted for its practice of encouraging employees to use bonuses to buy company stock.
• Valuation for Compounders: For exceptional, high-growth businesses like Costco or Ferrari, a high price-to-earnings (P/E) multiple can be justified, and being too rigid on valuation can lead to missing out on significant long-term gains.
• Costco's Business Model: A powerful, defensive model built on a loyal membership base, immense purchasing scale that provides leverage over suppliers, and a virtuous cycle of passing savings back to the customer.
• Shifting Consumer Trends: Discussion on the underperformance of classic consumer staples (e.g., Pepsi, Diageo) due to factors like post-COVID normalization, inflation, health-consciousness driven by GLP-1 drugs, and competition from new categories like legalized cannabis.

Quotes

• At 3:01 - "We're going to talk about culture and how important that is for long-term investors. It maybe one of the most important things." - Barry Schwartz introduces the episode's featured discussion on the significance of company culture in investing.
• At 6:52 - "It used to be in the olden days... buy companies that... drink 'em, smoke 'em, eat 'em, and whatever makes you look good, those were the businesses that you wanted to own." - Barry Schwartz reflects on a classic investment theory for consumer staple stocks that may be losing relevance due to changing consumer behaviors.
• At 13:17 - "Is the money that the business is making going to end up coming to us as passive shareholders?" - Ernest Wong identifies the central question that assessing a company's culture and incentives should answer for an investor.
• At 17:02 - "Show me the incentive and I'll show you the outcome." - Ernest Wong quotes Charlie Munger to highlight the powerful connection between a company's incentive structure and its performance.
• At 23:41 - "He really cares that whether the management is careful about the cost structure of the business, right? Because it's his money." - Describing the mindset of an owner-operator whose personal wealth is tied to the company's performance, leading to a deeper focus on operational details.
• At 30:27 - "My biggest errors over the years is saying I'm not going to pay 30 times multiple for Dollarama, I'm not going to pay 35 times earnings for Ferrari." - The host reflects on past mistakes, admitting that being too rigid about valuation multiples caused him to miss out on exceptional long-term growth stocks.
• At 37:12 - "Costco is able to say to Heinz, 'Okay, if you do that, we're going to switch to French's.'" - This quote illustrates the immense bargaining power Costco wields over its suppliers due to its limited selection of products (SKUs).
• At 49:09 - "Focusing on the customer, the customer experience is probably the most, another most important thing that companies need to do." - The hosts conclude their discussion on Costco by highlighting that its ultimate success stems from a deeply ingrained culture of prioritizing the customer.

Takeaways

• Prioritize analyzing a company’s culture and incentive structures before investing, as these are primary drivers of long-term shareholder returns.
• Seek out investments led by "owner-operators" where management has significant personal wealth tied to the stock, ensuring their interests are aligned with yours.
• When evaluating a company, look for models that encourage widespread employee share ownership to foster a "skin in the game" culture throughout the organization.
• Avoid being overly rigid on traditional valuation metrics; for truly elite, long-term compounding businesses, a premium price can be justified by sustained growth and a strong competitive moat.
• Invest in businesses that demonstrate a fanatical devotion to customer value, as this creates a powerful, self-reinforcing cycle of loyalty and long-term growth.