Idea Brunch with Ben Claremon of Cove Street Capital

Ben Claremon on culture, interviewing great CEOs, and his favorite small caps

Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Ben Claremon!

Ben is currently a partner and portfolio manager at Cove Street Capital, a value-oriented investment advisor based in Los Angeles. In addition, Ben is host of the Compounders Podcast, a popular interview series with successful public company executives. Before joining Cove Street in 2011, Ben worked as an equity analyst on both the long and the short side for hedge funds Blue Ram Capital and Right Wall Capital. Ben attended the Wharton School of Business at the University of Pennsylvania during undergrad and received an M.B.A from the Anderson School of Business at UCLA.

Ben, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background, your work at Cove Street Capital, and your passion for interviewing great CEOs?

As it relates to my background, I think it pays to go back long before I started at Cove Street. I have taken a circuitous path to working in investment management and I like to think my story can be instructive for people who want to get into this industry. My family is in the commercial real estate business in New York and starting when I was 14, I worked in the business every summer. Real estate was really the only thing I knew so it was basically a foregone conclusion that I would join the family business after going to college. Wharton was my top choice because it had an undergraduate concentration in real estate, a focus that most schools do not offer. So, when I was fortunate enough to get in, my path was set — or so I thought.

Having a family business to go into is both a blessing and a curse. It’s a blessing because you don’t have to do all of the recruiting for internships and full-time jobs that others do. You don’t have to go to a bunch of networking events and join a ton of clubs simply to pad your resume. On the other hand, it was a curse because it tempted me to focus solely on real estate and not broaden my horizons. There are some great finance professors at Penn and there are all kinds of investment clubs. Many of my classmates were interested in stocks and in understanding business. I was myopically trying to get my degree and start my career in real estate. In hindsight, I missed out on a lot of what Wharton had to offer academically and when it came to networking with talented, interesting people. I also didn’t really learn to hustle. All of this is to say that by the time I graduated, I had not come even close to finding my love for analyzing businesses.

After college, I moved to New York City and started working for my family. There were three generations of family members managing the properties and for sure there were differences in opinion that surfaced. Furthermore, my family was not in the acquisition or development stage, and I personally didn’t find the day-to-day management of the buildings to be intellectually challenging. It was about four years into the job that a good friend of mine, Steve Friedman of Santangel’s Review, handed me a copy of Ben Graham’s The Intelligent Investor. Steve was working for a hedge fund back then and thought that Graham’s ideas would resonate with me. In reality, the book changed the trajectory of my career. It is a little bit of a cliché but Graham’s ideas about value investing spoke to me and I quickly came to realize that I had been a value investor before I knew what a value investor was. I was probably subconsciously looking for something new but the entrée into investing and studying businesses that book gave me was really the catalyst that eventually led to me leaving the family business to get a job on the buy-side. If you are wondering what it was that drew me to investing, I think it was twofold. First, the intellectual challenge of trying to find inefficiencies and bargains within a somewhat efficient—and very hard to beat—market. Second, the idea that I could spend my entire day analyzing businesses. I am not sure I was even a particularly curious person before I was given the chance to learn about new businesses as part of my job. Investing really re-kindled something in me that I had lost but now is a core part of my personality. Jumping ahead a bit, my passion is not specifically for interviewing CEOs, although I do enjoy it. I just like hearing about different kinds of companies—how they make money, who the competitors are, where they have room to improve, etc.    

As many readers may know, getting that first buy-side job, especially without any formal investment training, can be very difficult. I was quite fortunate to find an ex-Goldman guy who was starting up his own fund, Blue Ram Capital, and needed an analyst. All I had was a college degree and a passion for investing. I am still not sure exactly why Rich Aslanian took a chance on me, but he did and I will forever be grateful. Unfortunately, my timing wasn’t great. I started in September 2007, right before the global financial system went into meltdown mode. So, after about a year, the fund wound down and I was forced to look for another job. At that point, it occurred to me that I needed a deeper education in accounting and finance, so I decided to go to business school and wound up at UCLA in 2009.

It was during business school that I started a blog called The Inoculated Investor. My goal with the blog was to keep my name out there while I was in school and to use it to meet other like-minded investors. Back then there were a ton of investment blogs out there and I had a sense that to distinguish myself, I needed some unique content. I had previously noticed that the notes from the Berkshire Hathaway annual meeting were somewhat sparse. This was before there was a CapitalIQ transcript or live streaming of the meeting. If you wanted to know what Buffett and Munger said, you either had to be there or someone had to sit there for six hours and take notes to share with you. And so that is what I did—the first year doing so by hand and then typing them up later. I launched the blog with those notes and in the process, discovered my one and only superpower: the ability to listen, process, and write/type at the same time. I think I went to the meeting three years in a row and by taking the notes, I gained a following within the value investing fanatics—people like myself.

The reason the blog story is relevant is that in 2011 when I was about to graduate—jobless—I got an email from a guy named Jeff saying he was starting an investment firm and wanted to meet with me. It turned out that a guy I didn’t even know but who followed the blog recommended me. (Patrick O’Shaughnessy always asks his guests on Invest Like the Best about the kindest thing anyone has ever done for them. Professionally, this is still number 1 on my list.) He said that Jeff had to meet anyone who was crazy enough to sit there at the Berkshire meeting taking notes the whole time. That Jeff was Jeff Bronchick, who founded Cove Street back in 2011. I have been there since day 1 and now am a partner and the portfolio manager for our Small Cap PLUS (aka SMID) strategy. I have been running that strategy for about five and a half years now, but I also spend a lot of time working with my colleagues on the Classic Value Small Cap strategy that Jeff manages.

Overall, it has been a bit of a rollercoaster trying to navigate all of the external things that have influenced markets since I started back in 2011. And it has been a tough period for value investors. But, I am a true believer that, as an investor, you learn more from your mistakes and by managing through adversity than anything else.

You have interviewed dozens of small and mid-cap CEOs on the Compounders Podcast. What are some of the common signs of a great CEO and who are some of the public company executives you most admire from your interviews?

You are right that, through the podcast, I have interviewed executives from a wide variety of industries—from insurance to software to waste management. Before I address your specific questions, I should take a step back and mention that Cove Street has three pillars within its investment process: Business, Value, and People. In my humble opinion, it is the people assessment aspect that is the hardest, and thus many investors don’t utilize all of the tools at their disposal to try to determine whether management is a friend or a foe. While there are plenty of quantitative metrics you can use to get a sense of management’s acumen, at the end of the day the process is quite subjective and qualitative. Buffett has plenty of insightful quotes about the importance of finding a great manager but being able to ascertain who is truly exceptional can be time-consuming and be prone to false positives. So, I spend a lot of my time on the People pillar within our process. In fact, each year I guest lecture to Benjamin Graham Value Investing Program students within UCLA’s undergraduate economics department about the steps we go through—an Atul Gawande-like checklist—to assess management, capital allocation, and corporate governance. (Presentation available here.)

Accordingly, the podcast is a natural extension of our investment process. I replicate the same due diligence and preparation I do for a management meeting in order to host an interview. I will say it has been a wonderful process. I feel so lucky to be able to interact with public company CEOs, both on camera and off. Hosting the podcast has deepened my relationships with the CEOs and forced me to get much better at asking meaningful questions that will elicit substantive responses.

Now, my answer to the question about the common signs of a great CEO might be a little bit too squishy for certain people. Again, management assessment is subjective and people can’t be reduced to a single score or rating. People are more complicated than that and trying to do so would lead to an incredible amount of false precision. I am partial to people who care deeply about their employees and the company—so much so that it shows when you meet them. While the mercenary CEO who comes into a turnaround and figures out how to create value for shareholders might be a great short-term solution, what I am looking for is a company that can be a compounder. (Hence the name of the podcast.) By definition, that is a company that can sustain high returns for many, many years. As an investor, I am not looking for a 50% pop so I can sell the stock and then find something else. I want to find one of Chris Mayer’s 100-baggers. And it is really hard to achieve that if you don’t have a leader who is fully invested in the company—and that includes his or her relationship with all of the stakeholders.

Let me give some examples in a way that also answers the question about the CEOs I admire. I asked Markel Co-CEO Tom Gayner about what he has learned being a CEO that he might not have learned if he had just been a public company investor. His answer was that being a CEO has made him more patient and understanding when things don’t go right. He has developed an empathy for people and that has allowed him to become a part of the Markel family, even though he doesn’t have that last name. Or, take Mauricio Ramos, the CEO of Millicom. On the podcast, Mauricio told a story about how the salespeople in the various Latin American countries where Millicom operates have different chants that they do before leaving the office for the day. Mauricio knows the chants and will do them with the salesforce. This is all part of Sangre Tigo, an initiative that brings people together from different countries and tries to make them part of the Millicom family. Lastly, Brian Recatto, the CEO of Heritage Crystal Clean, told this incredible story about how he gives out his cell phone number to the field workers who are out there collecting used motor oil. It is a hard job, and it is hard to keep people in the job. So, Brian takes calls from people when they are struggling.

You will notice that I haven’t mentioned anything about capital allocation or the ability to get people to hit their numbers. Of course, those are important. But, if you are looking for exceptional companies and to be able to enjoy riding a compounder for years, you often need more than that. I see those other elements as table stakes. Great leaders inspire people and foster a culture that allows for retention and personal growth. And when you combine those traits with great returns on capital, the ability to re-invest in the business at high rates, smart M&A, and a reasonable valuation, that can be an explosive cocktail as an investor.

I think the takeaway is that investors should look for leaders who have an unquestionable dedication to employees and customers. Anybody can—and should be able to—sit in a meeting and talk eloquently about margins, returns on capital, world-class acquisition integration capabilities, and the company’s differentiated “business system.” You should expect that if you are partnering with them. Maybe that is enough to generate respectable returns for shareholders. But I am looking for someone that has the same passion for the company that I have for investing.

In your interview with Richard Sosa, you emphasized the importance of investing in companies with good or improving culture. What are some of the ways you determine a company’s culture and what are some of the items on your red flag checklist?

Without any doubt, the culture part is the hardest aspect to put your finger on. What you would really want to do is sit for a week in the lunchroom with the company’s employees and be a fly on the wall for all of the Board Meetings. Maybe then you could be confident in your assessment of the culture. But you aren’t going to be able to do those things so you have to find other ways to make what amounts to an educated guess. I do have my own management assessment scorecard that I go through for each company. I use it as a checklist in which I try to identify outliers—either very good or very bad things. Within the checklist, there are questions about corporate governance and compensation but all of those things have some relationship with the overall company culture as well. I try to get a holistic perspective on culture and that process inevitably begins with looking at the top of the organization.

So, where do I start? An easy place to start is by reading conference calls. Does the company single out a specific employee on each call? Do they talk about safety on every single call? Do they thank their employees before ending each call? These may seem like little things, but you should take note when companies consistently do these types of things.

Next, I think the proxy statement can tell you a lot about what a company thinks is important. Compensation drives behavior and if you want to know what behaviors are valued, why not pay close attention to the details located within the proxy? Does the company reward execs for quarterly EPS growth or based on free cash flow and return on capital over a three-year period? Again, if you are looking for a compounder, you want the executives and all of the employees to be aligned around a longer-term time horizon. The proxy also has information on total compensation, perks, and execs’ golden parachute that you can use as data points.

After that, I usually turn to our friends at Tegus who source former employees for us to speak with. While you must always be aware that former employees may have some bias, I find these calls to be the most insightful when it comes to culture. If you ever read a call that I have done on the Tegus platform, you will see that the second question I ask—after the “tell me about your background” question—is about whether or not it was a good place to work. I also ask questions about the CEO’s strengths, weaknesses, and management style. One data point is never enough but if you talk to enough former employees, I think you can get a decent sense of what the culture was like.

I could go on but let me pause and say that I adhere to what I would call a mosaic style of investing. I liken the research I do on a company to painting on a canvas. Each nugget of information or data point becomes a dot on the canvas and the goal is to collect enough dots to be able to step back and eventually see your Monet. It may require a lot of data gathering before you are confident about what you are seeing. But especially when it comes to culture and management assessment, it pays to keep digging. That includes going to Indeed.com and Glassdoor and looking at reviews. It includes keeping close tabs on turnover within the C-suite. And it includes tracking management’s objectives over time. If a company is consistently missing its targets and/or moving the goalposts, the company may have a lack of accountability.

If people are interested in seeing my management assessment checklist, feel free to reach out to me. I am happy to share it. That checklist includes a list of red flags that we have found to be, at times, signs of a bad culture or a management team you don’t want to partner with. Here are some examples:

• A CEO who doesn’t even live in the city where the company is located

• Someone who treats his or her assistants and secretaries badly

• A leader with a large corporate jet allowance disclosed in the proxy

• Constant restructuring and layoffs, even in good times

• Compensation that consistently appears egregious relative to the size of the company and the compensation of its peers

• 2 pages’ worth of related party transactions in the proxy

• The majority of equity compensation is time-vesting without any performance requirements

Let me finish with what not to do when it comes to trying to assess culture. Don’t ask a CEO if the company has a good culture. The answer will inevitably be yes. Instead, ask the CEO what values he or she tries to embed in the culture and how he or she takes those values off of a whiteboard in a conference room and drives them down into the field. The best answer to that question came when I interviewed Ben Gliklich, the CEO of Element Solutions. What you want is a CEO who can talk about culture as gracefully as Ben talks about the 5 C’s within Element Solutions’ culture.

What are some interesting ideas on your radar now?

The world is a little scary out there for sure. Inflation, rising interest rates, and the Russian-Ukraine conflict are having a short-term impact on markets. Thankfully, I am trying to look 3-to-5 years out at a minimum. So, while it is impossible to ignore the weirdness in the world when I am trying to handicap what the future is going to look like, my base case is that great companies will continue to grow even if the macro environment is not particularly helpful. Ideally, they might even be able to prosper and take share from competitors that are not as well run or are unable to adapt.

If people are interested, in the recent past I have done presentations on Viasat, Lumen, Lionsgate, Millicom, E.W. Scripps, and Skechers. These are stocks Cove Street owns and, in most of these cases, has owned for years. They, also represent over 30% of the portfolio I manage. We still think these stocks are materially undervalued—so no changes there. (The various presentations can be found at covestreetcapital.com.) But, why not talk about some new ideas that we recently added to the portfolio?

First, IPG Photonics (NASDAQ: IPGP — $5.11 billion) is the global leader in the production and sales of fiber lasers. The company essentially invented the category and has a technological lead (aka moat) that is unlikely to be eroded any time soon. The company does indeed face competition from low price, low-quality manufacturers in China—and that has put pressure on margins over time. However, IPG has rightly pivoted away from the fiercely competitive Chinese cutting tool market to attack end markets where the customers are less focused on price.