SUCCESSFUL LONG-TERM INVESTING WITH HIGH-QUALITY STOCKS

FEBRUARY 15, 2020

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Susan Christ, CFA

Senior Vice President - Investments

Hendershot Investments, Inc.

We seek to buy:

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INVESTMENT PHILOSOPHY

• HI-quality businesses

• Reasonable valuations

• To hold for the long term

What is long term?

• High-frequency trader = Nanosecond

• Day-trader = Between Lunch and dinner

• Uncle Sam = One year

• Hendershot Investments > Decade

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Our favorite holding period is forever.

Only buy something that you would be

perfectly happy to hold if the market shut

down for 10 years.

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HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage

• Strong balance sheet

• Predictable growth

• Robust free cash flow

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COMPETITIVE ADVANTAGES = MOATS

Durable Competitive Advantage

• Evidenced by consistently high ROEs

• Opportunities for market expansion

• Pricing power

• Intangibles

• Cost Advantages

• High Switching Costs

• Networking Effect

Moats or Durable Competitive Advantages:

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Patents - Johnson & Johnson

Proprietary Technology – Apple

Strong Brand – Disney & Pepsico

Intangibles

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GEICO

Cost Advantages

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UPS

High Switching Costs

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Networking Effect

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“The key to investing is not assessing how much

an industry is going to affect society, or how

much it will grow, but rather determining the

competitive advantage of any given company

and, above all, the durability of that advantage.”

Warren Buffett

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HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage

• Strong balance sheet

with little or no long-term debt.

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The more cash and the less debt on the balance sheet,

the better we like the business. Debt-free companies

don’t go bankrupt!

Strong balance sheets

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“Companies with large debts often

assume that these obligations can be

refinanced as they mature. That

assumption is usually valid.

Occasionally, though, either because of

company-specific problems or a worldwide shortage of

credit, maturities must actually be met by payment.

For that, only cash will do the job. Borrowers then

learn that credit is like oxygen.

When either is abundant, its

presence goes unnoticed.

When either is missing, that’s

all that is noticed."

Warren Buffett on debt…

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Strong Balance Sheets

Company

Cash &

Investments Long-term Debt

Shareholders'

Equity

Apple $207.1 billion $93.1 billion $89.5 billion

Booking Holdings $11.8 billion $7.5 billion $6.0 billion

Facebook $54.9 billion - $101.1 billion

Genuine Parts $451 million $2.8 billion $3.7 billion

UnitedHealthcare $51.5 billion $36.8 billion $60.4 billion

HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage

• Strong balance sheet

• Predictable growth

• Sales

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Predictable growth

• Earnings

• Dividends

HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage

• Strong balance sheet

• Predictable growth

• Robust free cash flow

Cash flow a business generates from its

operations

less

Capital expenditures to maintain and

grow the business 20

Free cash flow =

Robust free cash flow

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Seek intelligent capital allocation by managers who use

cash flow to build value for shareholders

• Grow the business through strategic acquisitions

• Pay dividends

• Buy back shares at reasonable valuations

We seek companies with the ability to do all three!

Focus on Free Cash Flow

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Free Cash Flow Yield =

Free Cash Flow per Share

Stock Price

Compare Free Cash Flow Yield to Alternative

Investments

Focus on Free Cash Flow Yield

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Company Projected Free Cash Flow Yield

Apple 5.7%

Booking Holdings 8.6%

Facebook 7.6%

Genuine Parts 6.9%

UnitedHealthcare 6.3%

Focus on Free Cash Flow

Apple designs, manufactures and markets

smartphones, personal computers, tablets, wearables

and accessories. It also sells operating systems, services

like iCloud storage and Apple Pay, and a host of digital

content from the popular iTunes store and other portals.

Fiscal Year – Sept. 30

(000,000) 2019 2018 2017 2016 2015

Operating Cash Flow $69,391 $77,434 $64,225 $65,824 $81,266

Capital Expenditures (10,495) (13,313) (12,451) (12,734) (11,247)

Free Cash Flow 58,896 64,121 51,774 53,090 70,019

Acquisitions (624) (721) (329) (297) (343)

Dividends (14,119) (13,712) (12,769) (12,150) (11,561)

Share Buybacks (66,897) (72,738) (32,900) (29,722) (35,253)

Booking Holdings is the world leader in online travel

and related services, provided to consumers and

partners in over 230 countries and territories through

six primary brands-Booking.com, KAYAK, priceline, agoda.com,

Rentalcars.com and OpenTable.

Fiscal Year – Dec.

(000,000) 2018 2017 2016 2015 2014

Operating Cash Flow $5,338 $4,662 $3,984 $3,102 $2,914

Capital Expenditures (442) (288) (220) (174) (132)

Free Cash Flow 4,896 4,374 3,764 2,928 2,782

Acquisitions (273) (553) (1) (140) (2,496)

Dividends - - - - -

Share Buybacks (5,971) (1,828) (1,012) (3,089) (750)

Fiscal Year - Dec.

(000,000) 2019 2018 2017 2016 2015

Operating Cash Flow $36,314 $29,274 $24,216 $16,108 $10,320

Capital Expenditures (15,102) (13,915) (6,733) (4,491) (2,523)

Free Cash Flow 21,212 15,359 17,483 11,617 7,795

Acquisitions (508) (137) (122) (123) (313)

Dividends 0 0 0 0 0

Share Buybacks (4,202) (12,879) (1,976) 0 0

Facebook, Inc. operates the world’s leading social

networking service through its flagship Web site, Instagram,

WhatsApp and Messenger. The company’s Web-based tools

allow users to connect and communicate with each other.

The company had about 2.45 billion monthly active users at

9/30/19 and generates substantially all its revenue from

selling advertising placements to marketers.

Fiscal Year – Dec.

(000,000) 2018 2017 2016 2015 2014

Operating Cash Flow $1,145 $815 $946 $1,159 $790

Capital Expenditures (232) (157) (161) (110) (108)

Free Cash Flow 867 658 785 1,049 682

Acquisitions (462) (1,495) (462) (163) (288)

Dividends (387) (395) (387) (368) (347)

Share Buybacks (181) (174) (181) (292) (96)

Genuine Parts Company is a distributor of automotive replacement

parts in the U.S., Canada, Mexico, Australasia, France, the

U.K., Germany, Poland, the Netherlands and Belgium. The

Company also distributes industrial replacement parts in the

U.S., Canada, Mexico and Australasia through its Industrial Parts

Group. S.P. Richards Company, the Business Products Group,

distributes a variety of business products in the U.S.

Fiscal Year - Dec

(000,000) 2019 2018 2017 2016 2015

Operating Cash Flow $18,463 $15,713 $13,596 $9,795 $9,740

Capital Expenditures ($2,071) (2,063) (2,023) (1,705) (1,556)

Free Cash Flow 16,392 13,650 11,573 8,090 8,184

Acquisitions (8,343) (5,997) (2,131) (1,760) (16,164)

Dividends (3,932) (3,320) (2,773) (2,261) (1,786)

Share Buybacks (5,500) (4,500) (1,500) (1,280) (1,200)

UnitedHealth Group offers a broad spectrum of

products and services through two distinct platforms:

UnitedHealthcare, which provides health care coverage

and benefits services; and Optum, which provides

information and technology-enabled health services.

We seek to buy:

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INVESTMENT PHILOSOPHY

• HI-quality businesses

• Reasonable valuations

If you pay too high a price, even for a great

company, your returns won’t be so great.30

After identifying a HI-quality company,

the most important part of the investment

equation is to only buy it at a Reasonable

Price... as the price you pay will determine your

return.

Reasonable Valuation

Intrinsic value = present value of the future

discounted cash flows that can be taken out of

the business over its lifetime.

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Reasonable Valuation

We’d rather buy a great business

at a fair value, rather than a fair

business at a great value

The three most important investing lessons are:

1. Think of a stock as part of

business and seek to own a group

of high-quality businesses.

2. Use the stock market to serve

you, not to instruct you.

3. Always buy with a margin of

safety.

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Wisdom of Great Investors

Benjamin Graham

The market is a pendulum that

forever swings between

unsustainable optimism (which

makes stocks too expensive) and

unjustified pessimism (which makes

them too cheap). The intelligent

investor is a realist who sells to

optimists and buys from pessimists.

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Wisdom of Great Investors

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Mr. Market’s emotional roller-coaster

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Be fearful when others are greedy.

Be greedy when others are fearful.

Wisdom of Great Investors

Warren Buffett

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The investor’s chief

problem—and his worst

enemy—is likely to be

himself. In the end, how

your investments behave is

much less important than

how you behave

Wisdom of Great Investors

Benjamin Graham

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A lot of people with high IQs are terrible

investors because they have terrible

temperaments. You need to keep raw,

irrational emotion under control.

Wisdom of Great Investors

Charlie Munger

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Neuroeconomic Insights

• Uneasy coexistence

between our primitive

brain and advanced

neural systems

• Adrenal glands v. Neocortex

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Know your emotional triggers…

then understand rather than follow your emotions.

Fear v. Greed

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Understand rather than

follow your emotions.

Price fluctuations have only one significant meaning

for the true investor. They provide him with the

opportunity to buy wisely when prices fall sharply and

to sell wisely when they advance a great deal.

Ben Graham

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Wisdom of Great Investors

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The best way to measure your

investing success is not by

whether you’re beating the

market but by whether you’ve

put into place a financial plan

and a behavioral discipline that are

likely to get you where you want to

go.

Wisdom of Great Investors

Benjamin Graham

In the short run, the market

is a voting machine, but in the

long run it is a weighing machine.

Ben Graham

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Wisdom of Great Investors

The three most important words in investing:

“Margin of Safety”

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Wisdom of Great Investors

Rule #1: Never lose money.

Rule #2: Never forget Rule #1.

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Wisdom of Great Investors

1. If the business fundamentals deteriorate and the

problem doesn’t appear temporary.

2. If the stock price moves significantly ahead of

underlying business value, trim the position.

3. If we see a substantially better investment

opportunity.

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Selling Criteria

“If the job has been done

correctly when a common

stock is purchased, the time

to sell is almost never.”

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Wisdom of Great Investors

With HI-quality stocks sporting free cash flow

yields significantly higher than low-yielding bonds,

investors should follow the cash to build an

investment stash!

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