Idea Brunch with Todd Wenning of Flyover Stocks
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Todd Wenning!
Todd is currently the author of Flyover Stocks, a publication focused on highlighting quality businesses with talented management that have been overlooked by the market. Todd was previously a senior analyst at Ensemble Capital, an adjunct professor at Xavier University, and an analyst at Morningstar. Todd is also active @ToddWenning on Twitter.
Todd, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Flyover Stocks?
Thanks so much for the invitation, Edwin. I’ve been in the industry since 2003 and recently crossed the 20-year mark. I didn’t know it when I started my career at Vanguard, but this industry was the perfect fit for someone like me, who has a liberal arts background. There aren’t many professions that allow you to pull inspiration from various sources – art, philosophy, history, etc. – and apply them to your daily work.
I started writing about investing in 2006 after I joined The Motley Fool as a financial editor, where I fact-checked the articles that were coming in from internal and external writers. The Motley Fool was the Substack of the 1990s and 2000s in that it gave investors of any age and experience level a platform for writing and learning, whether it was on Fool.com or on the community message boards. There are several successful investors and writers who came out of The Motley Fool from that era, and I was fortunate to be part of the community.
Being given the “keys to the car” at 25 years old and having my work published and widely distributed by The Motley Fool forced me to really think through what I thought before I wrote it. If I’m going to make a certain statement, what points might someone disagree with and how can I address that objection? In some cases, I found that I agreed more with the counterpoint and would have to rethink my position on the issue. Doing that for a few years helped accelerate my growth as an investor.
Eventually, I worked on two of The Motley Fool newsletters: Motley Fool Pro with my friend, Jeff Fischer, and Motley Fool Dividend Edge, which was a UK-based newsletter focused on dividend-paying stocks.
While I enjoyed writing the newsletters, I wanted to learn how to do deep, institutional-level research and I knew that Morningstar had been a route some former Motley Fool writers had taken. Working at Morningstar was a great bridge to the institutional side of the business. I covered 24 companies, mostly in the paper and packaging sector, had more management access, and got to speak with quality-focused buy-side clients. Being steeped in the Morningstar economic moat and equity stewardship methodologies daily for over three years was a tremendous experience.
I then moved to the buy side, joining Johnson Investment Counsel, a large independent RIA in my hometown of Cincinnati, Ohio, where I was a generalist analyst for the SMID-cap strategy. In 2017, I joined Ensemble Capital, where I worked on the firm’s moat-focused concentrated equity portfolio.
I view Flyover Stocks as my platform for writing about investing and working through ideas about interesting companies, portfolio strategies, business models, and more. Circling back to the start of this, I don’t know what I really think about something until I write it down. The way the words are assembled is just as important to me as the concepts themselves.
You put a big emphasis on leadership in your investment process and greatly prefer management with a long-term orientation as outlined in your recent post “Too Many Professional Managers, Not Enough Stewards.” Can you tell readers a little more about what you believe makes a great public company CEO? Who are your favorite CEOs today?
Most investors have heard Buffett talk about economic moats, but he’s also said that while you need a moat, you also need a knight in the castle who is trying to widen the moat.
Why does a knight matter if there’s a moat? It’s because a moat isn’t a static thing. It either widens or narrows a little bit every day. It’s only after those daily actions at a company compound for a while that we, as outside investors, notice that something has changed.
We can all point to stories where companies had moats – Kodak, Blackberry, Sears, etc. – and were disrupted by competitors armed with new technologies or ways of doing things. In fact, most competitive analysis is focused on external threats like these, but I would contend that moats erode from the inside out. Management teams who fail to foster strong internal cultures, make poor capital allocation decisions, or are resistant to change can set up circumstances in which an external threat can capitalize on moments of weakness.
As a result, it’s critical for investors who think about moats to also think about management.
One thing I’ve come to appreciate is that companies need different management skill sets depending on where they are in their lifecycles. Most commonly, companies need visionary founders early on to keep pushing boundaries until they’ve discovered a blueprint for success. At some point, once growth slows, those companies need “optimizer” CEOs to execute the blueprint for success. You’re seeing this play out in many parts of big tech today, where activists have started pressing for more thoughtful spending and operational efficiencies. If that gets taken too far, however, a more visionary-like CEO may need to come in and reinvigorate the culture and growth engine.
Visionary and optimizer CEOs have different attributes and skills, so you need to know which one you’re looking at when you start evaluating them. There’s a rare set of legendary CEOs like Jeff Bezos and Sam Walton who possessed both visionary and optimizer skills.
Value investors tend to bristle at visionary CEOs. Visionary CEOs can be quirky and unpredictable, but that’s also what powered them to create a company from scratch. If you believe in their mission and what they’re building, you must come to terms with the fact that there will almost assuredly be more quirky and unpredictable decisions that come along with it. Some things will work, some won’t. From a position sizing perspective, investors can control for that risk with smaller position sizes, but I think it’s unwise for investors to dismiss these sorts of leaders out of hand. At the very least, you can learn a lot following them!
Optimizer CEOs are more warmly accepted by value investors, as they are about driving wider profit margins, more cash flow, returning cash to shareholders, and so on - things that make the company easier to forecast. It’s also easier to quantify their progress and success. The classic book Outsiders by William Thorndike is full of examples of successful optimizer leaders. To be sure, these are rare breeds, as well. If they were common, there wouldn’t need to be a book highlighting a few examples.
Most of the time we’re operating somewhere in between the two extremes. The way I evaluate management teams is through the lens of stewardship. Are they focused on long-term value creation – ideally beyond their own tenure – or are they part of a revolving door of professional managers brought in by the board to boost the stock price in the short term? Investors who are interested in taking long-term ownership stakes in a company should be focused on the former, as they provide the best chance of compounding value over many years.
I think this is one of the reasons that founder-led and family-owned businesses have such a great track record as a group in the public markets. They are intrinsically motivated by the business and are concerned with its legacy and impact on all the involved stakeholders like employees, communities, and suppliers. Founders who establish virtuous cultures can pass that pedigree down to future generations. A great example of this is Costco (NASDAQ: COST) founder Jim Sinegal. Even though he’s no longer a member of the board, the culture he established there remains the operating system for the business.
Two CEOs earlier in their tenure that I think investors should learn more about are Jeff Liaw at Copart (NASDAQ: CPRT) and Hal Lawton at Tractor Supply (NASDAQ: TSCO). Both appear to have a stewardship mindset and are leading competitively-advantaged businesses.
What characteristics determine whether a company is a “flyover” stock? How are you able to come up with off-the-beaten-path ideas in an industry with so much groupthink?
From 2013 to 2015, I wrote a series of articles for Morningstar.com called “Seeking Small Cap Moats,” where I looked for companies we didn’t currently cover as a firm but had attributes of a competitively advantaged business. Companies with persistently high returns on invested capital are doing something worthy of investigation. In the article series, I aimed to highlight some of those companies.
When I recently looked back at the 16 profiled companies, six had been acquired, and three had generated over 400% returns through mid-August 2023. Some of the better performers were Badger Meter, Exponent, and Winmark. A few, like Culp and Dialight, turned out to be flops and I attribute that to me misevaluating the moats. But overall, I viewed the success of the group as a sign that there’s opportunity in finding companies with economic moats that are undercovered in the market.
Sell-side analyst coverage tends to follow institutional interest and when there’s a lack of sell-side coverage, there’s a better chance to develop an analytical edge than there is with a large cap that has 50 sell-side analysts and countless buy-side analysts poring over every detail.
I’m particularly drawn to companies that have weird names – Badger Meter, for example – or operate in “flyover country” where Wall Street analysts are unlikely to venture. Jack Henry is a classic illustration of both attributes – an ambiguous name and operating out of Monett, Missouri, which has a population of around 10,000 I believe. It makes banking software and is one of the best-performing stocks of the last 25 years.
If you can confidently follow a stock that doesn’t have a lot of media or analyst attention, looking for flyover stocks like these can be a fertile hunting ground.