“The ideal business is one that earns high returns on capital and can keep using lots of capital at those high returns. That becomes a compounding machine. If you can put $100 million into a business that earns 20% on capital, ideally, it would be able to earn 20% on $120 million the following year, $144 million the following year, and so on. You could keep redeploying capital at these same returns over time. But there are very, very, very few businesses like that.” 
 
                                                                                                -      Warren Buffett[1] 

Our recent annual report to our investment partners began by discussing some important numbers or characteristics we look for in an investment. I wrote:
 
“At Nintai, we manage a focused portfolio of about 20 – 25 positions, which we have held for decades. Because of that, we have specific criteria that we feel are vital to outperform the markets in the long term. Before we get into the requirements, some core beliefs drive our decision-making. First, free cash flow is a far better measure than earnings when calculating valuation. We believe earnings can be manipulated in so many ways that their utilization in valuation tools is a waste of time. Second, we believe the best measure of a wide competitive moat is the sustained outperformance of return on invested capital (ROIC) over the weighted average cost of capital (WACC). When a company can generate ROIC greater than its WACC for over one or two decades, it has a wide moat. Last, we look for investment opportunities where the company’s free cash flow grows, but its price keeps dropping. We see those opportunities as a spring getting increasingly tightened that must eventually be released.”
 
This overview briefly describes some key metrics that drive our investment decisions. But more detail might help with numbers. 
 
Two key metrics we use at Nintai Investments are a company’s return on invested capital (ROIC) and its weighted average cost of capital (WACC). We look for companies whose ROIC consistently outweighs their WACC for extended periods - usually one or two decades. I stress the word consistently because we aren’t fans where it might exceed for three or four years and then drop below for a year or two. We want to see ROIC beat WACC every year for a decade. Another number we look for is free cash flow. An investment should grow free cash flow annually for at least eight of the last ten years and continue that for the next decade or two. Eventually, that growth must, by the nature of its numbers, decrease over time as the company expands. It’s much easier to grow free cash flow 10% off a base of $100 million than $10 billion. Last, we would like to see the share price grow at a rate similar to that of the free cash flow. When the former grows faster than the latter, we can begin to see the price/valuation ratio force, which can lead us to reduce (or sell outright) our position. 
 
Purchasing a company with these characteristics doesn’t guarantee a quick gain. Charlie Munger clarified that you should likely outperform over the long term. But the difficult part is hanging in for the long term. At Nintai, we are content to wait for three, four, five, or more years if the conditions we’ve discussed are being met. If they are, and the share price continues to lag or go down, we will likely add to our position over time. 
 
Let’s use a specific example before I discuss how our model portfolio has performed over the last decade. One of our holdings is Veeva Systems (VEEV). We’ve held the stock (including in our previous firm, Nintai Partners) since 2004. Here are the first numbers we look at: free cash flow versus share price. 

​Veeva’s free cash flow has grown at an annual rate of 35.5% over the last decade. Through 2020, the stock price increased even faster. But starting in 2021, the stock price declined steadily as free cash flow maintained its steady growth (as you can see on the right side of the graph). We are happy to continue holding the stock (in this case, even adding to our position) until the markets recognize that the company’s value has increased. Why has the stock price decreased over the past five years? First, the price/value ratio was stretched in 2020. There was a case of irrational exuberance, for sure. But now? We think there has been a case of irrational depression. 
 
Here is the second set of numbers we discussed previously. (I'm sorry for the sizing issue. Excel doesn’t make this easy!)

​As you can see, over the past decade, the company’s ROIC has exceeded its WACC by a substantial margin. This demonstrates a deep and wide competitive moat, and we expect it to continue over the next decade or two. If it does (and there is no assurance it will), we should end up with a respectable long-run return to Charlie Munger's point.  
 
Let’s examine the aggregate Nintai Investments portfolio. Here, we see a tale of two returns similar to Veeva's. The portfolio's share price grew faster than free cash flow at the beginning of the decade, while it lagged over the last five years. 

​This reflects the change in market performance as the Magnificent Seven and artificial intelligence began driving returns while the rest of the markets lagged. 
 
How about the portfolio’s ROIC and WACC numbers? These show that, in the aggregate, the portfolio’s competitive moat remained deep and wide over the entire decade. In other words, the portfolio’s strength has not lagged even as its share price growth has over the past five years. 

Conclusions
 
Charlie Munger’s wisdom cut across many areas of knowledge. As he stated, he utilized a latticework of worldly wisdom. One of his remarkable insights was that return on invested on capital (ROIC) was an outstanding measure of how a company should perform (price-wise) over the long term. Comparing this against the weighted average cost of capital (WACC) should tell us whether the company has a wide competitive moat that can maintain high profitability. At Nintai, we seek out companies with high ROIC, substantial free cash flow margins, rock-solid balance sheets, and great managers keeping a hawk-like eye on these numbers. To Munger’s point, we think this will lead to long-term outperformance against the general markets. That said, it doesn’t mean the portfolio will consistently outperform. In the short term, there will be periods of underperformance. The challenge is remaining focused and controlling your emotions during these times. Investors should be handsomely rewarded over their investment career if they can do this. 
 
Disclosure: Veeva is a portfolio holding in Nintai Investment portfolios as well as Mr. Macpherson’s personal portfolio. 

​[1] “Buffett and Munger Unscripted,” Alex W. Morris, page 15, 2003 Berkshire Annual Meeting

“To be able to write, one must be able to read. Every hour of reading makes you a better writer.”

                                                                                                -    Robert Macfarlane 

Robert Macfarlane is an excellent writer who thinks a lot about words and places and how the interaction between them tells us about our or someone else’s culture. His quote above greatly impacted me when I sat down to write my first book “Seeking Wisdom: Thoughts on Value Investing.” Constant reading (or, as Charlie Munger’s family referred to him - “a book with legs.”) is essential not only to be able to write but also to continually develop and improve your investment process. 
 
At the beginning of each new year, I frequently write about one of the top questions I receive in my daily mail call. This year, I received quite a few questions about my daily reading.
 
Before I discuss what books I highly recommend for individual or institutional investors, I thought I’d discuss what makes a book compelling (at least to me.)  Before anything else, I find a book where the writing and use of words are precise and exceptionally lyric, a rare find. Beautiful writing is a craft and something to be sought out every day. As much as Warren Buffett’s writings seem to ring of folksy wisdom (which they are), his writing is crystal clear in its messages. It cuts through any confusion and brings immediate light to traditionally stuffy topics. Such writing is the foundation of brilliant thinking. 
 
In addition to writing of such a nature, there are four additional ways a writer can provide the reader with long-standing – and applied – wisdom. These include the following:
 

• A clear articulation of evidence 
• Bringing new evidence to light
• It uses a latticework model
• Changes the reader’s process of thinking

 
The first category is essential to making a strong case for your thesis. Jack Bogle’s books were outstanding in proving, time and again, that high fees were absolute killers when it comes to investor returns. The founding father of indexing used books such as “Common Sense on Mutual Funds” and “The Battle for the Soul of Capitalism” to provide irrefutable evidence that not only was it hard to beat the markets in general, but it was nigh impossible to beat them when you paid high management fees. His discussion of costs related to high portfolio turnover was an eye-opener on how managers see the long term as a disadvantage in their business model.   
 
Another characteristic of a great investment book is how the writer brings new information to light. Benjamin Graham’s classic “Security Analysis” was brilliant in bringing forth an entirely new concept of understanding the value of an investment versus its price, which was critical to achieving excellent long-term results. His later book, “The Intelligent Investor,” was just as crucial in bringing the concept of margin of safety and Mr. Market to individual investors. The former became a handbook for professional investment managers, while the latter was written for private individual investors. Graham’s ability to bring forth new ideas in a simplified and easy-to-understand manner changed the dynamic entirely regarding investment management. 
 
Combining multiple subject matters, some with no seeming connection with investing, is another form of outstanding investment writing. Classically referred to as consilience, Charlie Munger created the term “latticework of mental models.” There have been quite a few great books covering this, including the works of Michael Mauboussin (“More Than You Know” and “Think Twice”) and Robert Hagstrom (“Investing: The Last Liberal Art”). I would be remiss not to mention Shane Parrish’s “The Great Mental Models, v. 1-4, along with his outstanding website, Farnam Street. 
 
Last but not least are books that can change the very process by which an investor looks at investing. I refer to it as how to invest rather than what to invest in. These books can have the most significant impact on your investment approach. The classics from Graham, Bogle, and Buffett are great examples. Switching from active investing to indexing and creating a value-based approach can completely change how investors allocate their capital.  However, there are other examples by lesser-known authors that are equally important. These include “Excess Returns” by Frederik Vanhaverbeke, “Investing for Growth” by Terry Smith, and “The Manual of Ideas” by John Mihaljevic. All of these are excellent editions by which to learn all new strategies and measures to improve your investment returns. 
 
While I’ve listed the criteria necessary for a great investment book, there are also some personal characteristics a successful value investor needs that complement whatever you might be reading. 
 
Always Keep Learning
A good investor has a mind that constantly thirsts for new theories and facts. I read at least two hours daily and could use two more each day. A great investor is open to all kinds of content, no matter how far away it might seem from investing. The great thing about learning is that it never gets old and, over time, can give you a significant advantage over other investors. What other fields have such opportunities? 
 
Always Question Your Hypothesis and Facts
At Nintai, we often use a process we refer to as breaking the case. In this process, we keep knocking down our assumptions (growth, free cash flow, competitive strength, etc.) until we reach a valuation that is wholly impaired. It is vital that investors be able to accept information and data that, no matter how unappealing, changes their business case or valuation. 
 
What Didn’t Work Before Might Be Great in the Future
Just because something worked in the past doesn’t mean it will work forever. It’s equally important to understand the inversion of that is equally valid. Just because a business model wasn’t a great investment opportunity in the past, things like technology innovation or regulatory changes might make the business model a better investment in the future. A great case of this is Warren Buffett’s investment in railroads. It has become an outstanding investment with changes in regulations, modal transportation transformation, and operational improvements.  
 
Keep Your Emotions in Check
Last, but most important, is the ability to keep your emotions under control. No matter what reading you do or the evolution of your investment approach, letting your emotions drive your decision-making will lead to truly awful results. 

Conclusions
 
It’s surprising how often I get questioned about what I read. As a writer, it’s a surprising amount. There is so much to learn in this world of the internet, e-books, and online learning. For those starting on their investment journey, developing a daily reading regimen is an outstanding way to understand better how to achieve better results. You will be surprised how a “latticework of mental models” will help you better understand the financial world and also help you understand the world in its entirety. Very little knowledge that you acquire will go to waste. If nothing else, you’ll be the life of the cocktail circuit, and there are worse things than that. 
 
DISCLOSURES: None