Auto Trader (LON:AUTO) in the UK has been a truly wonderful business for a few decades now. One of the greats.
For every pound in revenue it makes, it only spends 30-35 pence. And that’s after expensing all the research and development necessary to develop new products and offerings to grow the business. Capital expenditure is a rounding error. The remaining 65% is available for the tax office and its owners. The company takes that huge cash flow after tax and returns all of it to shareholders via dividends and buybacks. And yet it grows each year through price increases and new products. Businesses that can grow without having to retain any capital are rare, valuable beasts.
It’s no wonder that investment funds that focus on “great businesses” often own Auto Trader and businesses like it for the long haul. It sells well. “Come and invest in my fund, I buy bombed out crap companies” doesn’t quite have the same ring to it. And “great businesses” is a theme that’s worked well, especially over the past decade or so.
We’re not here to criticise anyone else’s approach. Finding a niche and sticking to it has its advantages. And there are plenty of funds out there that have outperformed Forager’s International Fund over that same past decade or so with an exclusive focus on great businesses like Auto Trader.
But our approach is significantly more flexible.
We love great businesses, sometimes. When we believe that’s where the best risk-adjusted returns can be found, we aim to reflect that conviction with a significant position in the Fund.
We owned Alphabet (owner of the Google Search engine) for many years.
At other times, the portfolio will be skewed towards more complex, less loveable companies, because that’s where we see the most compelling risk-adjusted returns. Norwegian company Bonheur (OB:BONHR) was an example of a successful investment based on an insight or two that few other investors had grasped.
And sometimes the Fund will hold a smattering of highly asymmetric investments where the downside is 100% and the upside many hundreds of percent. Individual investments like that will only ever be small, because they do blow up from time to time. But, when we recognise the best risk-adjusted returns in that space, you can bet the Fund owns some. Nutex Health (NASDAQ:NUTX) being a recent and successful example, and was loading up on Blancco (LON:BLTG) during its 2017 panic. You get the picture. The ideas in this last category sometimes smell so bad that you wouldn’t want to be in the same room when we explain the investment rationale.
When lower quality or “riskier” businesses turn out to be bad investments, we look like idiots. When we sell a good business on valuation grounds and it soars over the subsequent years, we look like idiots. But the past 12 months have shown that this flexibility has its benefits.
We first bought Auto Trader shares in early 2018 when the market was lowering expectations for the business, at least partly influenced by Brexit pessimism. It got too cheap. We trimmed over 2019 as the price rallied significantly, added again briefly during the Covid-19 panic, trimmed again over the rest of 2020 and were completely out of the stock during 2021.
Source : Bloomberg
Auto Trader is down more than 40% in the past three months.
Add in the recent panic and Forager’s International Fund, which held the stock for a little over three years total, collected more than 100% of the returns that Auto Trader provided to shareholders over the past decade. Significantly more. And we had seven years when those funds could be deployed elsewhere.
It shouldn’t surprise you to read that we’ve acquired a small position in the past few weeks.
Why now? You’ll never guess. We see compelling risk-adjusted return potential.
The market is concerned that Agentic AI poses a threat, either as a direct competitor or by siphoning off the economic pie in a way Google Search never managed to.
One of the reasons Auto Trader has been able to earn such high margins is because it never really needed Google. Customers come directly to its app or website, maybe 20% of traffic arrives via Search, most of it of the free “organic” type. So Auto Trader directly controls the eyeballs of demand, and sells those very valuable eyeballs to car dealers with little friction to outside players like Google.
That contrasts with online retailers like Redbubble and Adore Beauty, where the search engine captures much of the economic surplus. Anything that upsets that virtuous cycle of eyeballs and advertisers is a threat to Auto Trader’s mouth-watering margins. Older investors might remember that those antiques called newspapers were great businesses too until the likes of Auto Trader rocked up.
The risks are real. At today’s price, it’s our view that investors are getting well compensated for them. Auto Trader should be able to embed AI tools in its existing offering and keep those eyeballs coming back. On our numbers, the business will generate its entire current market capitalisation in cash over the next decade. It has been buying back up to 0.1% of its own shares every single day over the past few weeks.
It was the right time to start allocating chips. We’ve bought from some panicked investors, perhaps a fund that only invests in “Great” businesses. Our investment may get bigger. It’s also likely to be joined in the portfolio by other high-quality companies getting hammered for the same reasons. Put simply, when good businesses are under a cloud, it’s time for Forager to get interested.
They won’t all work. This is not an easy pitch to potential clients. Planners and advisors particularly find it hard to recommend us to their clients. We're a source of unknowable risk, not so much the risk of losing money (something all funds face) but not knowing in advance how we might lose them money, which "factor" might do the damage when we get it wrong.
That’s understandable. But it’s the strategy that works for us and our like-minded clients.
If you're interested in joining our investing community, you can do so by filling in the form below: