We believe it is valuable to study companies that cannot maintain excellence for extended periods of time, and that this isn’t done often enough. In Part 4 of our“Anatomy of a Compounder” series, we examined the ways in which businesses stop compounding their intrinsic value at a high rate after having done so for a number of years. At Langdon, we are looking to find and invest in companies on the other side of the coin— those that can defy fading returns on capital or growth rates of invested capital. Part 5 of our “Anatomy of a Compounder”series will explore how companies driven by outstanding operators can outgrow expectations over the long-term.

A study of 64,000 companies from 1990 to 2020 across 43 countries found that only 2.4% of listed equities accounted for all performance above short-term treasuries¹. These companies are able to grow profits at a higher rate for longer than anyone could imagine. The law of large numbers is a very powerful force for companies. As a result, many financial models will fade (decrease) growth rates as they model out financials into the future. This is correct in most cases, however, there are exceptions. We have found that exceptional people create exceptions, and the market often doesn’t price these opportunities well.

Willingness and Ability

Although every company is unique, we believe that the large majority of companies who can compound at or above our mid teens hurdle rate over the long-term are what we at Langdon call “AND” companies.

“AND” companies, are companies who have proven that they can create value a variety of ways and often pursue multiple strategies at the same time due to talented management teams, strong cash flows, and low financial leverage.

What’s frequently overlooked is the people at the helm of the company and their willingness and ability to successfully create value. Ultimately, it is the people who create and grow the assets. At Langdon, we diligence both the assets and the people, separately and collectively. This is a really important point and cannot be overstated. The relationship building and networking we do within the sectors, regions, and niches we invest in is a major driver of our ability to find the companies and teams capable of delivering long-term value creation.

Every company must, at some point, identify their next leg of growth to continue compounding over time. Whether that’s organically launching new products, entering new geographies, investing more into existing strategies or accomplishing those via acquisition - both willingness and ability are critical. Those who can successfully do this, create durable value for their shareholders, and those who don’t are usually left underperforming over the long-term.

All too often, companies must make “OR” decisions, where only one of the above strategies can be pursued at any point in time.

WorldClass Compounders: Two Company Examples

Diploma PLC – A masterclass in scaling M&A

Diploma is a UK headquartered company that describes itself as a value-add distribution group. In reality, Diploma is an acquirer and operator of approximately 17 value-add industrial distribution businesses. It acquires value-add distribution businesses and allows them to operate in a decentralized manner, with experienced local business managers running them how they deem best but under strict discipline and oversight by the Diploma leadership team. A lean and efficient ~30 person headquarters helps with best practices, HR, finance and other group level functions.

Diploma has been an exceptionally high returning stock for investors, up over 40x since it listed in 1993 and > 5x over the last decade. Importantly, this isn’t just a“stock” that has done well. It is a company that has continuously reinvested its cash flows back into the business and into acquisitions to compound itsrevenue, EBITDA, earnings per share (EPS), and invested capital² at annual rates of 15%, 17%, 16%, and 19%, respectively, over the last 15 years.All the while it has maintained a return on invested capital (ROIC) of at least15% during this time frame. Truly impressive numbers that put it in the upper echelon of all listed companies globally.

Diploma focuses deeply on its operations. Consistently strong organic growth — accounting for roughly half of total growth over the last 15 years — has built a base business that now supports a focus on acquisitions. The term ‘serial acquirers’ is at this point a buzz word and a banned term in our office. Diploma is a high-performing business that focuses first on disciplined operational execution, recognizing that if it can run its existing assets well, it’s well positioned to acquire and improve good businesses. This is easy to say and extremely hard to do, as discussed earlier. The team, culture, and operational focus all support Diploma in adding value both organically AND inorganically. It’s bigger and better not bigger or better.

Diploma has extremely strict criteria for the businesses it buys. Although all businesses are distribution businesses, we believe there are few who understand what value-add means in the distribution industry better than Diploma and its leadership. It remains committed to owning only businesses that can clearly demonstrate value to their suppliers and customers — ideally through a quantifiable value proposition that reduces customer risk, saves time, saves money, or all three.

Diploma’s criteria may sound similar to many, however, without the right people implementing the strategy the words are meaningless. It is the people at the company who established the criteria and operating structure which has allowed Diploma to continually add companies to the Group. It is the people who are able to scale Diploma’s capital deployments with the size of the company, and the people who are able to convince entrepreneurs that Diploma is a good home for their business.

Diploma isa true “AND” company, driven by operators who are committed to keeping all strategies moving forward to drive value. Each year it consistently grows organically, AND makes multiple acquisitions, AND pays a dividend, all while keeping its leverage ratio below 2x.

Kinsale Capital – Winning on multiple fronts

Travelling south of our border, let’s look at an insurance company from Richmond, Virginia, Kinsale Capital. Like Diploma, Kinsale has grown tremendously since its founding. Unlike Diploma, Kinsale has grown entirely organically – yes that’s right, no deals.

Kinsale operates in the U.S. excess and surplus insurance industry, providing coverage for risks that state-regulated insurance companies lack the expertise or risk appetite to price. Over the last decade, Kinsale has been extremely effective in this area of the market, increasing its market share from 0.4% to 1.4% in aUS$115 billion industry, which translates to written premium growth of over 10xin 10 years, to approximately US$2 billion today. The 2024 combined ratio of76.4% and 2024 return on equity (ROE) of 29.2% make it one of the one of the most profitable and highest-returning companies in the industry.

Kinsale focuses primarily on low limit and lower cost policies, with an average premium of ~$16,000 per year, and typically handles more complex risks where there is less competition. It also places a strong emphasis on quoting 60% of the submissions it receives from its broker partners and on delivering quotes as quickly as possible (hours vs. days or weeks), further differentiating itself from competitors. In addition, Kinsale’s focus on technology enables it to integrate more data into its decision-making process and operate its business with remarkable efficiency. For context, they have close to a 30% expense ratio advantage vs. their peers which helps to drive close to double the ROE of their top quartile peers.

Kinsale boasts best in class underwriting metrics, is the low-cost operator in its industry, AND is extremely capital efficient for an insurance company. This is all obvious by studying financial statements, however, what is not obvious is the fact that all of this was created by several deliberate decisions made by founder, Mike Kehoe, and the founding leadership team at the company. They have for the most part been working together now across 3 companies over 30+ years.

It was the conviction of the founding team, backed by extensive research that has set the company on their strong upwards trajectory. It is the result of truly understanding the people, who have carefully built the asset, that gives us confidence in Kinsale when it says it would like to “offer solutions for all tough-to-place E&S accounts across the U.S., no matter what coverage or sector of the economy.”

As seen in the chart below, the company is extremely adept at entering new verticals. Its largest business line today is one that didn’t become a material part of the business until 2019, displaying their willingness to continue to advance multiple strategies. In addition to continually launching new lines of business, Kinsale is now paying a dividend and regularly buying back stock.

In true “AND” company fashion, Kinsale has been able to successfully launch new products at high returns AND return capital to shareholders, while maintaining industry leading growth. One of the things about Kinsale that we believe is often misunderstood or overlooked is its multiple of book value versus its earnings multiple.

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Most would say no self-respecting investor should ever pay 5-7x book value for an insurance company. But what happens when that insurance company has been so disciplined with its startup capital and operating expenses that paid-in capital is US$360million and pre-tax margins are sustainably over 30%? That seemingly egregious trailing book multiple of 7x appears to reflect how efficiently it’s able to turn a dollar of revenue into earnings and how little startup capital was needed for it to scale to last year's US$375m of earnings. Its P/E of 26x is not cheap, but at a 25-30% ROE, it de-rates very quickly to approximately 15xin three years. This is a classic example of a fair price for a wonderful business that we believe has a very talented and experienced team with a sustainable competitive advantage — one we are buying at its lowest cash earnings multiple in its short decade of history.

How to Find Quality Compounders

If it seems as though there are many similarities between companies who defy the fade and those who don’t, then that is correct. It is easy to say you can, and even to believe you can, but actually delivering on that over long timeframes is exceptionally hard.Entering new markets and making platform acquisitions comes with a very high degree of difficulty, that is why there are so few people and companies who manage to execute on it consistently, and at high rates of return. There is no shortage of companies who are attempting to continue growing at high rates by making the uncomfortable decisions of growing their businesses larger or in a different manner than anyone thinks. As such it’s not terribly difficult to find companies who are making an attempt, but it’s very hard to find the teams and companies who will do it successfully.

We constantly hold ourselves accountable to our mantra of “Trust but verify.” It is absolutely critical to independently verify everything a company tells you about their growth plans, historical performance, and market positioning. Why is this important? First and foremost, the human element of what we do means people will make mistakes or cater to the ‘hindsight narrative,’ and part of our role is to catch those mistakes and dig into hindsight fact versus fiction. Secondly, incentives are not always optimally aligned. Methods of verification can include speaking with trusted industry sources or former employees, meeting with competitors, customers, and suppliers, and auditing management’s track records — all of which frame our ‘on the ground research.’ Having the right people with the right temperament, incentives, and motivations plays an enormous role in creating value. TheLangdon team earns this access and knowledge by building meaningful relationships, asking questions others don’t, and truly understanding the key value drivers of every company we look to invest in.

Finding and Building Relationships with “AND” Companies

Despite sounding good on paper, and seeming obvious in hindsight, modelling sustained high rates of growth can feel quite uncomfortable – and for good reason! It is incredibly rare, and only a small subset of people and companies manage to achieve it over time. Even more challenging is how unlikely they seem at the time! Think Alimentation Couche Tard, Dollarama, Kinsale Capital, the list goes on of businesses that surely can’t 10x in our lifetimes and proceed to go on to do even better.

That’s exactly what we’re searching for at Langdon: “AND” companies. By focusing on a concentrated portfolio, we only need to find a few of these exceptional people and businesses each year. Our approach – relentless, independent verification of businesses(both strategies and tactics) as well as people – ensures that we can own what we do for as long as possible, compounding returns in a tax efficient, long term manner.

Ultimately, the ability to sustain high growth of invested capital and high returns on capital is what separates the rarest compounders from the rest – finding and building relationships with the companies and the talented people behind the success story is what drives everything we do at Langdon.

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1 Bessembinder, H., Chen, T.-F., Choi, G., & Wei, K. C. J. (2020). Long-term shareholder returns: Evidence from 64,000 global stocks. SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251

2 Equity + Debt – Cash = Invested Capital

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