Why we finally put a ring on MSCI
Audio Brief
Show transcript
In this conversation, analysts discuss Canada's lagging economic performance compared to the U.S., delve into Costco's exceptional business model, critique the limitations of the P/E ratio, and highlight MSCI as a high-quality 'toll road' investment.
There are four key takeaways from this episode.
First, Canada's real GDP per capita has stagnated since 2015, creating a significant economic divergence from the United States. This ongoing underperformance increases the likelihood that the Bank of Canada will cut interest rates sooner than the Federal Reserve.
Second, Costco exemplifies a superior business model built on immense customer trust and loyalty. By consistently delivering value through low gross margins and high employee wages, Costco establishes a powerful competitive moat and significant latent pricing power.
Third, the P/E ratio is often an unreliable valuation metric because it ignores a company's debt and capital structure. Relying solely on P/E can misrepresent the true quality and risk profile of a business, making high-quality, low-debt firms appear deceptively expensive.
Fourth, MSCI operates a highly profitable 'toll road' business model by creating and licensing stock market indexes to financial institutions. This generates recurring revenue with exceptional 70% margins, high brand recognition, and significant switching costs for clients, making it a durable long-term investment.
Ultimately, the discussion emphasizes looking beyond simple metrics to identify businesses with robust competitive advantages and a long-term strategy for sustained value creation.
Episode Overview
- The hosts discuss Canada's lagging economic performance compared to the U.S., driven by flat real GDP per capita, and how this might lead the Bank of Canada to cut interest rates sooner than the Federal Reserve.
- The conversation features a deep dive into Costco's exceptional business model, highlighting its immense customer loyalty, strategic e-commerce growth, and why simple metrics like the P/E ratio fail to capture its true value.
- The hosts critique the over-reliance on the P/E ratio as a valuation metric, explaining that it ignores crucial factors like a company's debt and capital structure.
- The episode introduces MSCI (Morgan Stanley Capital International) as a high-quality "toll road" business, detailing its powerful, high-margin model of licensing stock market indexes and the rationale for investing after a recent stock price decline.
Key Concepts
- Canadian vs. U.S. Economic Divergence: Canada's real GDP per capita has stagnated since 2015, creating a gap with the U.S. economy and increasing the likelihood of an earlier interest rate cut by the Bank of Canada.
- Costco's Superior Business Model: Costco builds a durable competitive advantage through immense customer trust, high employee wages, and low gross margins (~10%). This long-term focus fosters loyalty and gives the company significant latent pricing power.
- Limitations of the P/E Ratio: The P/E ratio is a "levered" metric that can be misleading because it doesn't account for a company's debt. A low-debt company like Costco may appear expensive on a P/E basis but is fundamentally a higher-quality, less risky business.
- MSCI's "Toll Road" Business: MSCI operates a high-margin business by creating and licensing stock market indexes to financial institutions. This creates recurring revenue with high brand recognition and significant switching costs for its clients.
- Investing in Quality at a Reasonable Price: The strategy of monitoring high-quality, superior businesses for years and waiting for a temporary industry slowdown or stock pullback to provide an attractive entry point for investment.
Quotes
- At 6:00 - "There was an interview with one of the... lead protesters of the boycott Loblaws movement, and she was clarifying that the boycott was not just for Loblaws... it was for all of the supermarkets in Canada except for Costco." - Ernest Wong illustrating the immense trust and goodwill that Costco enjoys with consumers.
- At 16:58 - "If life was that easy, then... you go on like Yahoo Finance stock screener, you search for stocks that trade at 10 times earnings, you buy those, and then you short those that trade at 30 times or higher." - Highlighting the absurdity of relying solely on a low P/E ratio as an investment strategy.
- At 19:51 - "Everything that they've done in their business is optimized for the long run." - Explaining Costco's business philosophy, including high employee pay and low customer prices, as a strategy to build long-term value.
- At 26:19 - "So MSCI stands for Morgan Stanley Capital International... It came from Morgan Stanley." - Introducing the new featured company and explaining the origin of its name.
- At 33:50 - "MSCI's index business has 70% margins, which is probably the highest that I've seen like anywhere... If you compare to Google, for example, which some people say is the perfect business model, Google's like 40-50%." - Emphasizing the exceptional profitability and quality of MSCI's core business.
Takeaways
- Look beyond simple valuation metrics like the P/E ratio and analyze a company's debt, capital structure, and long-term business strategy to understand its true quality.
- Building deep customer trust through consistent value delivery, as Costco demonstrates, is a powerful competitive moat that can insulate a business from broader industry pressures.
- Businesses with "toll road" characteristics—such as high recurring revenues, high margins, and significant switching costs—are exceptionally durable and represent prime long-term investment opportunities.
- Patience is key; a temporary stock price decline in a high-quality company, often due to short-term industry headwinds, can present the ideal entry point for investors.
