💰 How to outperform the market by François Rochon

Jan 12, 2023

François Rochon is one of the best quality investors in the world.

Over the last 30 years, he returned more than 6.000% to shareholders (15.7% per year).

All his annual letters (see PDF at the bottom of this article) are full of investment wisdom. I summarized everything for you in this article.

“Our core holdings are the same as last year. We own shares of the best businesses in the world. Our attitude is that of a museum director: we only want to own masterpieces.”

Francois Rochon — Giverny Capital Asset Management

Rochon’s investment philosophy

François Rochon is a quality investor. His investment philosophy is built on the following pillars:

In the long run, stocks are the best asset class to put your money in
Time in the market beats timing the market
Only buy companies with a competitive advantage
A lot of opportunities can be found in monopolistic and oligopolistic markets
Focus on companies with high margins and high returns on capital
Good long term prospects and a dedicated management team are crucial
The stock market isn’t always efficient in the short term. Take advantage of it
If you are right on the business, you’ll eventually be right about the stock

“My investment approach is to acquire outstanding businesses managed by topnotch people which stock looks to me undervalued.”

Things to consider when analyzing a company

In general, Rochon focuses on 5 things when he analyzes a company:

The business model: Do I understand how the company makes money? How much market share does the company have? What about product innovation…?
The financials: Does the company have a healthy balance sheet? Does the company have a high profit margin? Are most earnings translated into free cash flow…?
Management quality: Does management allocate capital efficiently? Do they have skin in the game? Are they obsessed by their product / service…?
Outlook: Can the company grow its earnings at an attractive rate (> 12%)? Is the company active in a secular trend…?
Valuation: Is the company over- or undervalued compared to its historic average? How did the intrinsic value evolve over time in relation to its valuation…?

“We measure the quality of an investment not on short term market gains but by focusing on yearly earnings growth and long term fundamental prospects.”

In this picture, you can find Rochon’s great stock selection process:

Rule of three

In his letters, Rochon mentions multiple times that it is very important to focus on the Rule of three:

One year out of three, the stock market will go down at least 10%
One stock out of three that we buy will be a disappointment
One year out of three, we will underperform the index

This framework is beautiful as it will allow you to act more rational and think on the long term.

'“Our portfolio has underperformed the S&P 500 six years out of twenty, the equivalent of 30% of the time. To be aware of this fact is vital so we can be psychologically prepared for the inevitable periods when we will have results that are worse than average.”

Owners earnings

Benjamin Graham once said: In the short run, the market is a voting machine but in the long run, it is a weighing machine.

That’s why you should never focus on how your portfolio performed in a certain year and always look at the evolution of the intrinsic value of the companies within your portfolio.

In the long run, stock prices will always follow the intrinsic value of a company.

François Rochon looks at the evolution of the intrinsic value by taking a look at the owners earnings:

Owners earnings = growth in earnings per share + dividend yield

Market performance (stock price) and corporate performance (owners earnings) are rarely synchronized over the course of a calendar year. But as more time goes by, the synchronization between the two begins to affirm itself.

You don’t believe this? Take a look at the chart below which compares the performance of Rochon’s portfolio (market) to the evolution of if its owners earnings (value):

Since 1996, the companies withon Rochon’s portfolio have grown their value by about 2474% and their stocks have achieved a total return of approximately 2817%. On an annualized basis, they achieved an intrinsic performance of 13.3% versus 13.9% for their stock market performance.

Change in multiple

Now you’ve learned that in the long term stock prices follow the owners earnings of a company.

However, in the short term changes in valuation can also largely impact stock prices:

Multiple expansion = the stock becomes more expensive —> stock price goes up
Multiple compression = the stock becomes cheaper —> stock price goes down

When in a certain year, a company increased its owners earnings by 10% but its price-earnings ratio decreased from 22 to 18, your return is equal to -10%.

Return = owners earnings +/ (-) multiple expansion (compression)
Return in example = 10% - 20% = -10%

Something similar could be seen in Rochon’s portfolio over the years:

Between 2005 and 2011, Giverny Capital increased its owner earnings by 10% per year while Rochon’s stocks only rose by 6% per year.

Between 2012 and 2014, Rochon increased its owners earnings by 16% per year while his stocks increased by 28% per year.

However, when you look at the big picture (2005-2014), you conclude that the owners earnings and stock prices compounded at exactly the same rate of 12% per year.

The key takeaway is that in the short term stock prices are heavily influenced by changes in valuation, while in the long term stock prices always follow the evolution of its owner earnings.

That’s why you should always focus on the long term. When you buy a great business at a fair price, you know that the evolution of its owners earnings will determine your return.

“To generate exceptional returns over the long term, you must own exceptional companies over the long term.”

Have patience

Patience is the supreme of quality investing.

A stock can do nothing for 3 years and suddenly go through the roof. This again shows that the stock market is unpredictable in the short term but isn’t in the long term.

“The most important lessons of the past 75 years? Have patience.”

Rochon doesn’t like to sell

Rochon doesn’t like to sell stocks.

Selling your winners too early is one of the biggest mistakes you can make. A stock with a weight of 1.5% within your portfolio that goes down 7% ‘only’ represents a 1% loss in capital. However, when you sell a company that had a 4% weight in your portfolio and that goes on to rise with 200%, it will cost you 8%. You may not see it, but such opportunity costs are real.

The above is exactly why Rochon does not like to sell stocks. On average, Giverny Capital keeps their stocks for 6 to 7 years. This compares to an average holding period of only 6 months for the average investor.

Skin in the game

When you read Rochon’s annual letters, there is one thing that always comes back: Rochon wants to invest in companies lead by exceptional people with skin in the game.

When insider ownership is high and / or the company is run by their founder(s), you increase the chance that interests of management are aligned with yours as a shareholder.

Looking for companies with skin in the game? Take a look at this article: 15 Quality stocks with skin in the game.

“I like to invest with companies that exist for more than 10 years and are still managed by the founder(s).”

Re-evaluate your decisions

Do you want to improve your investment skills? Keep an investment journal.

In this journal you write down why you bought and sold a certain stock. You will learn a lot when you periodically take a look at the decisions you took and whether they worked out or not.

François Rochon also does this on a yearly basis with his podium of errors and a five-year post-mortem:

Podium of errors: the 3 largest investment mistakes Rochon made in a certain year
Five-year post-mortem: In this section Rochon re-evaluates the decisions he took 5 years ago to determine whether they worked out or not

”We believe that studying our decisions in a systematic manner, and with some hindsight, enables us to learn from both our achievements and our errors.”

A crisis offers opportunities

During the financial crisis, Fançois Rochon stated multiple times that it was the opportunity of a generation:

“We believe that the market drop – and the high level of pessimism – has created great investment opportunities, to a degree we have seldom seen in the modern history of financial markets.”

Since 1945, there have been 11 recessions. Four times, the stock market dropped by more than 40%.

Every crisis had one thing in common: they all ended.

Each correction offers opportunities. The key to successful investing is being psychologically ready for recessions and market corrections.

You don’t know when a correction will take place, but you can mentally prepare for it.

“We share the same agnosticism as Warren Buffett’s as for the capacity to predict corrections (we leave that to astrologists, market strategist and other fortune-tellers).”

The problem is that in a bull market, investors tend to forget that stocks can also go down. They buy stocks at any level without consideration of their intrinsic values. And then, after a big drop, they sell believing that never again stocks will be a rewarding source of wealth (or they wait for a “better” time to buy time, meaning when they will have gone up a lot).

Timing the market is a fools game. Be aware that 90% of stock returns happen in 1.5% of trading days.

“In the long run, the only way to lose money in the stock market is sell during corrections or recessions.”

Some extra quotes

Rochon’s shareholders letters are pure gold.

Please find hereunder a few extra quotes worth highlighting:

We know that owning stocks is the best wealth creator in our capitalist world. On the long-term, equities have generated approximately 10% per year in return.
It is worth noting that stocks have returned 1,300,000% over the same 100 years— approximately 200 times better than the performance of gold.
A duopoly is the second-best thing after a monopoly.
Our philosophy is to own companies that have a competitive advantage. So we tend to avoid enterprises that sell a commodity-like product or service.
This company has everything: a most boring primary business activity, a profitability level unrivaled in the industry, and a unique culture. Above all, the company is led by a management team dedicated to creating value with a long-term time horizon while always taking to heart its customers, employees and shareholders.
The best assets to own are productive assets—ones that are a source of continuous wealth creation. We’ve learned throughout the years that a company with a durable competitive advantage is an asset that falls in this category.
When you find an outstanding business, well managed and with good long term prospects. You should purchase it without worrying about short term events.
There is a lot to learn from our mistakes but it is a little less painful to learn from other’s mistakes.
If we continue to own companies that, as a whole, increase earnings per share by more than 10% per year on average, over many years, we believe that our overall portfolio will generate an annual return of this magnitude.
If I were a macroeconomic strategist and wanted to receive only one piece of economic data per year in order to predict the market in the short or medium term, it would be the level of Consumer confidence. The lower, the better.

Download all shareholder letters for free

Did you like this article and do you want to download all Rochon’s shareholder letters for free? Look no further:

Shareholder letters François Rochon

This document was compiled by Leandro.

About the author

Compounding Quality is a professional investor which manages a worldwide equity fund with more than $150 million in Assets Under Management. We have read over 500 investment books and spend more than 50 hours per week researching stocks.

Compounding Quality