Idea Brunch with Kevin Fogarty of Value Creators Capital
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Kevin Fogarty!
Kevin is currently the chief investment officer of Value Creators Capital, a Pennsylvania-based long-only fund that spun out of DuPont Capital Management (DCM). Before launching Value Creators Capital, Kevin was a portfolio manager at DCM. Prior to that, he was the head of telecom research at Citibank and earned an M.B.A. with Honors from Columbia Business School, where he studied value-investing principles in the Graham and Dodd tradition. Since its inception, Value Creators Capital has outperformed its relevant benchmarks with its investing strategy focused on companies with durable competitive advantages combined with prudent capital allocation.
Kevin, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Value Creators Capital?
I grew up in a rural part of western Connecticut, where in high school, I had a high level of curiosity for how businesses operated and how the global economic system worked. Although I did not know it at the time, my upbringing was actually the foundation for my interest in investing. My relatives operated family dairy farms, and my father was a mason contractor. I helped with the manual labor for both trades as a regular summer job.
My personal interests, however, lay outside of physical work. Throughout most of my schooling, math and science came quite naturally to me. So, I studied mechanical engineering in college and started my professional career as an aerospace engineer. At that time, the technology revolution was just beginning with the introduction of the personal computer, local area networks, and more powerful communications systems. Looking back, I was more interested in trying to understand the forces driving technology, business, and their impact on the world than the specific rigors of engineering aircraft landing gears.
As I was so drawn to business news generally, in the early 1990s, I started researching companies on my own. After saving up a few thousand dollars, I purchased my first shares of personal computer manufacturer Gateway 2000 at its IPO for $15 a share in 1993. The company assembled PCs in South Dakota and shipped them in signature black and white Holstein cow-patterned boxes. I knew that my engineering company had ordered PCs mail order from them for the entire office, but I had no real idea how competitive dynamics worked in this industry or whether this was a good stock to buy. However, I was hooked and decided that I wanted to find a career in the investment space.
This realization led to the most important event in my career – enrolling in Columbia Business School (CBS). While at CBS, I was able to immerse myself in the Graham and Dodd value investing program taught by legendary professors Bruce Greenwald. There were also incredible industry-leading adjunct professors and investors including Mario Gabelli, Michael Mauboussin, Paul Johnson, Jimmy Rogers to name just a few.
Starting on the sell-side and then transitioning to the buy-side, I was fortunate in the early part of my career to not only have the opportunity to analyze a variety of industries on a global basis but also experience the dot-com boom and bust cycle firsthand. Being able to apply the value investing principles in so many geographies, sectors, and market environments very much helped build my investment foundation and philosophy. Those experiences along with a decade+ additional experience on the buy-side all culminated in launching the Value Creators US Large Cap and Mid Cap strategies at the end of 2016 within the walls of DCM.
With a disciplined investment process and a successful investment performance, my partners and I decided to transition the strategies from DCM in 2023. By Summer 2024 we had our own independent firm and an operating fund with a seed investor. Our goal is to continue the successful investment strategy that we started almost a decade ago.
Can you tell us a little more about your research and investment process and how it has evolved over time? Also, two founding members of Value Creators Capital have a total of 17 years of active-duty military service – thank you for your service. Has your team’s military background influenced your firm’s research process?
Thank you for that. We have a disciplined investment process by our nature, but having military veteran experience brings an additional level of discipline and execution, helping both on the investing side as well as in our business operations.
Our investment philosophy is a bottom-up, fundamental, stock-by-stock process with three key pillars. First, we look for companies/industries that have a favorable competitive environment and a superior long-term outlook. In many instances, this means rational competition within duopolies, oligopolies, and even near monopolies. These tend to be more consolidated industries or sub-industries that have established “moats.” As part of this pillar, there needs to be a reasonable fundamental growth outlook as well. For instance, you may have a rational, consolidated industry, but if it's a dying one (like tobacco), then it's really not that attractive to us.
The second pillar is all about capital allocation. It is a cliché, but it’s important to have an excellent management team. Everyone says that, but we mean something a little more comprehensive. We mean a management team that's not only very good at operations, i.e. improving efficiency, enhancing/defending the franchise, but also savvy stewards of capital. Because, if we're invested, it's our capital. That’s extremely important to us. If you have the first pillar and a solid operational management team, then you tend to generate meaningful free cash flow. We're looking for companies that have above average free cash flow through the cycle on a normalized basis. Finally, this leads to what we believe is our biggest differentiator. Our assessment of management’s capital allocation decisions of that free cash flow. Are they truly aligned with shareholder value creation, or are they simply growing their empires or spending cash to keep up with the Joneses?
The third pillar is disciplined valuation. You can have a phenomenal franchise that generates great amounts of free cash flow. However, if the market has inexplicable expectations of long-term growth and assigns a crazy multiple to a name, we are probably going to pass. Valuation comes into our investment process quite early. With all that said, we have been described as “Value on the buy, but Growth on the sell.” We are certainly not blindly dogmatic with artificial or hard valuation metrics. We assess valuation as part of our assessment of management’s capital allocation sophistication. So, if we have a phenomenal management team in place, and the stock has been outperforming, maybe the market assigns what traditional “value” shops may consider high multiples. But, on our numbers, and our assessment, we are very comfortable continuing to hold the name despite a perception of a high multiple.
Overall, our challenge lies in finding companies satisfying these three pillars… at a reasonable price. Sometimes, when a company checks all the boxes, it's already been discovered and is appropriately valued.
We have identified over 200 companies that generally meet these criteria. We create detailed three-statement models for each where we estimate an intrinsic value and subsequent debatable range of said value. From there, we build the portfolios around our best opportunities rather than tight constraints around relative sector weightings. Our long-tenured portfolios hold roughly 40 names each. We also have two very concentrated portfolios that hold 10- and 20- names, respectively.
In terms of evolution over time, the investment process has not changed. However, we have refined how we apply it. We have learned that franchise durability is paramount – and that savvy capital allocation alone may not be sufficient to drive long-term outperformance.
In a fast-changing world, how do you ensure the durable competitive advantages of your portfolio companies are actually durable? Have you ever seen technology or other forces disrupt what seemed like a strong moat?
This is a great question. History has shown that competitive advantages normally do not last forever. We are constantly thinking about the sources of competitive advantages and where there might be vulnerabilities or any change in industry structure or technology shifts. We also evaluate management’s understanding of its distinctive competitive advantages and what actions they are taking to strengthen, defend, or maintain their moat.
Regarding your second question, yes, we have seen technology or other forces disrupt what seemed like a strong moat. Cable television is a prime example of this. Comcast and other leading franchises appeared to have monopolies and pricing power in many geographies. These franchises seemed irreplaceable, especially when combined with unique content. However, the technology landscape rapidly changed with the advent of streaming and online options. This resulted in heightened levels of competition broadly across the industry, and, to some degree, morphed into a much more commoditized product.
The risk of moat deterioration is extremely important in investing and something our team is quite sensitive to in our research process.
You have outperformed the market while managing a diversified large-cap portfolio that somewhat resembles the overall S&P 500 index. Some of your investor letters also compare your positions relative to their S&P 500 weighting. Why did you opt for this portfolio construction approach, rather than a more concentrated portfolio with more index deviation?
The short answer to your question is we have both approaches to portfolio construction now that we are an independent firm. Our primary US Large- and US Mid-Cap portfolios have their roots in institutional asset management and were the flagship US equity strategies for DCM. They were designed to be much more concentrated than the historical funds managed within the pension fund which had very low tracking errors vs. the benchmark. Both are concentrated with approximately 40 names each; however, each also designed with risk controls that the pension fund required at the time, but also controls that many institutional investors might desire today.
We have long believed that further concentration would provide even better returns, but it would involve greater risk and volatility – as we all know, there is no free lunch. One of the first strategic decisions we made as an independent firm was to start the even more concentrated strategies. So, for the past 18 months, we have managed two all-cap “conviction” strategies, one being a 10-stock portfolio and the other a 20-stock portfolio. Both reflect and concentrate the very best ideas we have across our universe.
Many great investors credit their success to mentorship. Who have been the most impactful mentors in your investing career, and what key lessons did you learn from them?
The mentors and investors who have had the greatest impact on my investment approach have been Berkshire Hathaway (both Warren Buffett and Charlie Munger), Bruce Greenwald, and, more recently, the writings of Will Thorndike.
One key attribute I learned from studying Berkshire is PATIENCE. It is an uncommon trait and very difficult to maintain, especially in the fast-paced, transaction-focused Wall Street environment where many measure performance in days or weeks versus years. Having patience can be a lonely place at times in the investing business.
As with countless others, Buffett and Munger have each been a huge influence on me. Both emphasized, much like my parents, a sense of honesty and ethics in their businesses, which ultimately bears fruit over time. The three specific investment analysis concepts I’ve gleaned from them are: 1) the idea of a competitive advantage or economic moat, 2) sustainability or durability of the franchise, and 3) the importance of capital allocation.
Bruce Greenwald’s coursework has significantly influenced my approach as well. In his book “Competition Demystified,” he provides an excellent framework and insights into analyzing both the sources of competitive advantages and their sustainability over time.
Finally, over the past 25+ years, I have learned that capital allocation is a significant driver of long-term value creation. This concept of assessing the reinvestment rate on retained earnings/free cash flow is something Buffett has preached for decades. However, Will Thorndike’s book “The Outsiders” provides some of the best historical case studies you can find in one place. Most notably is his comparison of Henry Singleton of Teledyne with Jack Welch of GE.
A quote from Buffett summarizes these thoughts very neatly:
“The heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in areas such as marketing, production, engineering, administration, or sometimes institutional politics. Once they become CEOs, they now make capital allocation decisions, a critical job that they may have never tackled, and which is not easily mastered. To stretch the point, it’s as if the final step for a highly talented musician was not to perform at Carnegie Hall, but instead to be named Chairman of the Federal Reserve.”
As you could probably guess, Buffett’s annual reports, “Competition Demystified”, and “The Outsiders” are required readings for the Value Creators Team.