“Lethargy bordering on sloth remains the cornerstone of our investment style.” — Warren Buffett, 1990 Chairman’s Letter to shareholders of Berkshire Hathaway
I like buying small companies with a long growth runway, dedicated and involved leaders, buying at a discount to my perception of fair value, holding for the long term, and periodically adding shares at opportune prices. I embrace “lethargy with every stock purchase, vowing to do nothing unless a game-changing thesis-breaker arrives. If chosen well and left alone, the gains can be very satisfactory. My two largest individual stocks Portfolio Recovery Associates, Inc. (NASDAQ:PRAA) and Biglari Holdings Inc (NYSE:BH) — each roughly 10% of my portfolio — have both reached such status by being bought well and then left alone. Each offers lessons for investors today.
Portfolio Recovery Associates, Inc. (NASDAQ:PRAA) buys defaulted consumer debt from credit card providers such as Mastercard Inc (NYSE:MA), Visa Inc (NYSE:V), and Discover Financial Services (NYSE:DFS); it also collects bankruptcy paper and has acquired a diversifying set of fee-for-service businesses in such exciting industries as back tax collection, class action lawsuit collections, and auto-loan collateral tracking (skip-tracing). It buys debt for pennies on the (face value) dollar and then turns that debt over to its collector workforce, which collects two to three times the purchase price over the next seven years.
Simple, right? The reality is that it requires experience to appropriately value debt, discipline to purchase the debt at reasonable prices, and well-trained collectors to work the paper. Overpaying is akin to burning money, and excellent pricing models are of questionable use if the collector can’t cajole debtors to pony up. Fortunately, disciplined pricing and collection has long been Portfolio Recovery’s strength.
This is a “knowledge business,” and thus Portfolio Recovery Associates, Inc. (NASDAQ:PRAA) is heavily reliant on the expertise of its management. Fortunately, they’re a gold standard team, led by co-founders CEO Steve Fredrickson, and CFO Kevin Stevenson after the pair did similar work at a division of HSBC. Attractive about Portfolio’s management is what they don’t do. They don’t provide earnings guidance or try to manage investors’ expectations. They don’t sacrifice long-term shareholder value for near-term reported earnings. They don’t get fancy perks like country club memberships, cars, or corporate jets, and the company eschews option compensation in favor of modest restricted stock grants. Senior executives are required to own stock alongside common shareholders.
Over the years, management has diversified its revenue: adding and aggressively ramping up unsecured bankruptcy account collections, legal collections on debtors identified as “can-pay-but-won’t-pay,” and controlled expenses to maintain profitability. I first purchased shares of Portfolio in 2004. Since then the steady hand of management has increased cash collections, revenues, and earnings 25%, 23%, and 20% annually, respectively.
And because there’s no shortage of debt, and thus charged off debt, Portfolio’s growth still has a long runway. I’ve added shares over the years based on a quick valuation heuristic I developed. My method compares the company’s adjusted enterprise value (market capitalization plus net debt, less an estimate of value for the owned fee-for-service businesses) to the expected remaining collections on owned portfolios (available in each quarterly report) after all cash expenses are paid. A number below 1.00 signals a company arguably being valued as worth more dead than alive, but this mispricing level is rarely seen (and should be exploited when it is seen). My valuation ratio currently sits at 1.56, which is decent, but I do tend to prefer to add below 1.30, which would require a stock price today around $100.
This is a quality company doing good things. Buy shares and add at advantageous prices, and then leave it alone to do its work.
