Chuck Akre’s ‘Three-Legged Stool’ Approach and His Top 10 Stock Picks

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In this article, we take a look at Chuck Akre’s top 10 stock picks. You can skip our detailed analysis of Akre’s “three-legged stool” approach and go directly to Chuck Akre’s Top 5 Stock Picks.

Charles T. “Chuck” Akre is a US-born money manager who founded Akre Capital Management in 1989 which, as of the first quarter of 2022, has $14.6 billion worth of assets under management. 

Akre was raised in Washington D.C. and graduated from Blair Academy. He originally planned to get into a medical school but later decided against it and switched to securities business in 1968. 

Investment Philosophy of Chuck Akre

“People say the market is overvalued but if you only look at certain names, you will always find times when those names are undervalued. That’s what we’re waiting for.”

Akre

Akre describes himself as a value-oriented investor who bets on undervalued and strong companies. His fund’s stated goal is to compound their clients’ capital at an above average rate while incurring below average level of risk.

At the core of his investment philosophy sits the observation that the average stock market return in the U.S. for the last century is 10%. The figure roughly correlates with the rate of return on the owner’s capital and also with the growth in a typical company’s Book Value Per Share (BVPS).

Akre and his team posit that their return on an asset would consequently be roughly equal to the return on owner’s capital given constant valuation and absent any distributions. This is where the three-legged stool approach comes in, a valuation metaphor used by Charles Akre to identify companies that bring above average returns on owner’s capital. 

Three-Legged Stool Approach

Charles Akre’s three-legged stool metaphor is a reference to the milking stool he keeps in his office as a symbol of his investment style. He describes the metaphor as the essence of his investment philosophy and explains that the three legs represent the three metrics he looks for in a company, namely, excellent business models that bring good rates of return, talented management and reinvestment opportunities.

He states that stocks that possess all three of these characteristics are “compounding machines” but are rare to find and should be bought at discount-prices relative to the cash flows generated by these companies. 

Akre believes that investors that look for these three fundamentals are as financially secure as a person sitting on a milking stool that is close to the ground so they won’t hurt themselves if the stool flipped over. 

Akre Capital Management

Akre Capital Management is diversified mainly in services, technology, financial and conglomerate equity securities. The fund holds securities for a long duration in order to extract the benefits of compounding. 

Akre Capital Management discussed some of its top positions in companies like Mastercard Incorporated (NYSE:MA), Visa Inc. (NYSE:V) and Moody’s Corporation (NYSE:MCO) in the fund’s Q4, 2021 investor letter. Here is what it said.

“Each calendar year’s results become its own unit of record. The year 2021 was additive to our long-term record of compounding, for which we are grateful. But compounding does not, and cannot, happen over the course of a year or two or even five. Compounding requires decades. Our approach strives to match, as closely as we can, the durability of the Fund’s investments with the duration necessary for compounding to work. Accordingly, we are not frequent “lane changers” when it comes to investing. But, every year in the life of a mutual fund has its points of interest, and 2021 was no exception. From our perspective, one of the interesting aspects of 2021 were “headwinds” presented by the share price movements of three of our top-five holdings. Specifically, as of December 31, 2020, the five largest positions in the Fund were Mastercard, Moody’s, American Tower, Visa, and CoStar Group. Combined, Mastercard, Visa, and CoStar Group represented 24.4% of net assets at the start of 2021, or nearly one quarter of the portfolio. In 2021, the net contribution from these three names to the Fund’s total return was negative 0.5%. Despite the share price performance of these three top holdings, the Fund’s resulting performance was, to us, a notable positive for the year.”

The hedge fund returned 24.5% in 2021, 4 percentage points behind the total annual return of the S & P 500 index for the same year.

With that said, we now move to Chuck Akre’s top 10 stock picks. 

Charles Akre of Akre Capital Management

Our Methodology

We’ve acquired the information from Akre Capital Management’s 13F portfolio as of the first quarter of 2022 to write about Chuck Akre’s top 10 stock picks.

10. CarMax, Inc. (NYSE:KMX)

Akre Capital Management’s Stake Value: $708 million

Percentage of Akre Capital Management’s Portfolio: 4.82%

Number of Total Hedge Fund Holders: 27

CarMax, Inc. (NYSE:KMX) is a US based, used-vehicle retailer with 225 business locations in the country as of 2021. Akre Capital Management is the leading stakeholder in the company with an equity worth $708 million as of the first quarter of 2022. It comes in at number 10 in Charles “Chuck” Akre’s top 10 stock picks.

CarMax, Inc. (NYSE:KMX) beat consensus estimates on revenue in its quarterly filings of Q1, 2022, by $111 million with a revenue of $7.7 billion but missed the analysts’ EPS estimate of $1.28 by $0.30. 

On April 13, RBC Capital analyst Steven Shemesh lowered the price target on CarMax, Inc. (NYSE:KMX) to $104 from $140 and kept an ‘Outperform’ rating on the stock. The analyst said that the company’s short-term outlook remains somewhat challenging as new car availability and other macroeconomic headwinds will inevitably put pressure on used-vehicles retail and pricings but added that CarMax, Inc. (NYSE:KMX) is likely to remain a “consistent share gainer” in a highly fragmented sector. 

Akre Capital Management has a relatively smaller share in CarMax, Inc. (NYSE:KMX) compared to its stakes in Mastercard Incorporated (NYSE:MA), Visa Inc. (NYSE:V) and Moody’s Corporation (NYSE:MCO).

Fiduciary Management published its “Large Cap Equity Fund” investor letter of the first quarter of 2022 and discussed CarMax, Inc. (NYSE:KMX) at length. Here is what it said: 

“CarMax, headquartered in Richmond, VA, is the largest and most profitable used car retailer in the U.S., selling a combined 1.596 million used vehicles annually through retail and wholesale channels across its 226 stores and omni-channel platform. The company has just 4% of a huge $750 billion market. It operates across two segments, CarMax Sales Operation and CarMax Auto Finance (CAF), together covering all aspects of auto merchandising, service, and financing. By segment, the profit is also split into CarMax Sales Operations (80%) and CAF (20%).5 CarMax Sales Operation has three primary sources of revenue: Used (78% of sales and 63% of segment gross profit), Wholesale (19% of sales and 21% of segment gross profit), and Other (3% of sales and 16% of segment gross profit).

Good Business

The CarMax brand stands for providing a large selection of high-quality used vehicles at fair prices, and it has earned the trust of customers since beginning operations nearly 30 years ago.

The company has demonstrated consistent growth and leading profitability in one of the largest retail markets in the world ($750 billion). Sales and earnings per share (EPS) have grown at +8% and +11% annually over the last decade, with return on equity averaging approximately 20%…” (Click here to see the full text)

9. Adobe Inc. (NASDAQ:ADBE)

Akre Capital Management’s Stake Value: $714 million

Percentage of Akre Capital Management’s Portfolio: 4.86%

Number of Total Hedge Fund Holders: 93

Adobe Inc. (NASDAQ:ADBE) is a software technology company based in the US. It is involved in the SaaS business, with its Photoshop software being the most popular across the world. 

Fisher Asset Management holds the most shares in Adobe Inc. (NASDAQ:ADBE), with its stake valued at almost $3 billion as of the first quarter of 2022. Akre Capital Management, on the other hand, holds an equity of $714 million in the company. 

On June 10, Mizuho analyst, Gregg Moskowitz lowered the price target on Adobe Inc. (NASDAQ:ADBE) to $530 from $600 but kept a ‘Buy’ rating on the stock ahead of the software company’s fiscal quarterly results on June 16. Moskowitz told investors in a research note that despite a higher level of macroeconomic uncertainty, Adobe channel checks “were surprisingly somewhat better this quarter”. The analyst expects Adobe Inc. (NASDAQ:ADBE) to report “solid upside” to Street estimates and appreciates the stock’s risk/reward at current share-levels. 

Polen Capital, an investment firm, published its “Polen Global Growth Fund” investor letter of Q1, 2022 and discussed Adobe’s capital compounding. Here is what they said:

“Adobe is a prime example of the COVID-19 air pocket. Adobe continues to compound capital at high rates and exhibit increasing returns to scale. In the case of Adobe, reported growth appears to have decelerated significantly. However, when accounting for foreign exchange impacts and for their fiscal year 2021 having 53 weeks, the adjusted revenue growth was 17% year over year, which is fully in line with their typical growth rates. The 53rd week of the fiscal year 2021 added $267m to total revenue, creating an eight-percentage point difference in reported and adjusted revenue growth. We applaud management’s recent roll- out of Creative Cloud Express to tap into the non-professional market, as well as increasing price in 2022, which we expect to materialize in the back half of the year.”

8. Brookfield Asset Management Inc. (NYSE:BAM)

Akre Capital Management’s Stake Value: $742.6 million

Percentage of Akre Capital Management’s Portfolio: 5%

Number of Total Hedge Fund Holders: 35

Brookfield Asset Management Inc. (NYSE:BAM) is one of the largest alternative-investment-management corporations in the world, headquartered in Toronto, Canada. Brookfield Asset Management Inc. (NYSE:BAM) took analysts by surprise in its Q1, 2022 securities filings with a revenue of $22.7 billion, above consensus by $4 billion. 

On May 20, RBC Capital analyst Geoffrey Kwan lowered the price target on Brookfield Asset Management Inc. (NYSE:BAM) to $68 from $72 and kept an ‘Outperform’ rating on the stock. 

Brookfield Asset Management Inc. (NYSE:BAM) has an annual dividend yield of 1.19% as of June 10 and is set to pay the second quarter dividends on June 30 at $0.14 per share. The company has been growing the dividend for 12 consecutive years and has a sustainable dividend payout ratio of 23%.

Akre Capital Management is the second most bullish hedge fund on Brookfield Asset Management Inc. (NYSE:BAM) after Viking Global, which has a stake of $922 million in the company.

Aristotle Capital Management discussed Brookfield Asset Management Inc. (NYSE:BAM) in their “Global Equity Fund” investor letter of Q1, 2022. Here is what they said:  

“Canada-based Brookfield Asset Management is one of the largest and most diversified private market investors in the world. With $690 billion in assets under management (AUM), Brookfield is an owner and operator of infrastructure (19% of fee-earning AUM), real estate (17%), renewable energy (15%), private equity (6%), public securities (4%) and, more recently, credit (39%) by acquiring a majority interest in Oaktree Capital Management. In addition to managing client assets, it invests capital from its own balance sheet alongside outside investors. And though Brookfield is a new purchase for our Global Equity portfolios, we have been owners of Brookfield in our International Equity portfolios for more than a decade.

Brookfield has a differentiated investing approach from many by taking on the challenge of improving operations at the companies it owns, with less of an emphasis on altering capital structures. The investments Brookfield targets are ones they consider to be high-quality assets under the surface but have otherwise run into significant operational headwinds, such as poor management or tough industry dynamics. This can allow Brookfield to purchase assets at attractive valuations and subsequently work to improve them operationally.

The foundation of Brookfield’s investing platform is traditional private drawdown funds from which it earns management and performance fees. In addition, Brookfield has partial ownership in four publicly traded investment vehicles from which it earns fees for managing the investments and pro-rata distributions of corporate profits.

High-Quality Business

Some of the quality characteristics we have identified for Brookfield include:

  • Strong positioning from its scale and brand power, being either a leader in its respective asset classes (real estate, infrastructure, renewable energy, distressed credit) or nimble enough in more competitive markets to meaningfully expand (private equity);
  • Skilled management with a long history of operating expertise, which we view as a competitive advantage in bidding for deals and generating superior investment returns; and
  • Demonstrated, stable cash flows from long-term fee streams, as more than half of its capital is locked up for more than 10 years.

Attractive Valuation

Shares of Brookfield are priced at a discount relative to our estimates of intrinsic value. On a normalized basis, it is our view that earnings will be greater than what is currently assumed by the market.

Compelling Catalysts

Catalysts we have identified for Brookfield, which we believe will cause its stock price to appreciate over our three- to five- year investment horizon, include:

  • Owing to its quality assets and efficiently run structure, Brookfield is well-situated to take advantage of the continued institutional shift toward real assets;

  • High demand for capital in renewable energy feeds into Brookfield’s competencies and market position. Very few competitors have both the scale and expertise to capitalize on this trend;

  • Brookfield’s recognized leadership and experience investing in infrastructure can provide a strong competitive advantage to bid and operate assets that are increasingly sold by governments to pay down debt; and

  • Improved penetration in retail channels, as Brookfield’s scale can provide a distinct advantage in this still largely untapped market for alternative managers.”

7. Roper Technologies, Inc. (NYSE:ROP)

Akre Capital Management’s Stake Value: $784 million

Percentage of Akre Capital Management’s Portfolio: 5.3%

Number of Total Hedge Fund Holders: 38

Roper Technologies, Inc. (NYSE:ROP) is a diversified corporation serving customers in over 100 countries. It comes in at number 7 in Akre’s top 10 stock picks. The ROP conglomerate has four lines of business. These include industrial technology, scientific imaging, radio-frequency technology and energy systems. 

The stock currently has a consensus ‘Buy’ rating based on 7 analyst opinions at Wall Street. Roper Technologies, Inc. (NYSE:ROP) beat consensus estimates on revenue by $42 million in its Q1, 2022 results.

On May 24, Barclays analyst Julian Mitchell lowered the price target on Roper Technologies, Inc. (NYSE:ROP) to $500 from $557 and kept an ‘Overweight’ rating on the stock. The analyst argued that risk/reward profiles are improving for the multi-sector industry. 

Roper Technologies, Inc. (NYSE:ROP) is a multi-sector company unlike some other stocks in Akre Capital Management portfolio like Mastercard Incorporated (NYSE:MA), Visa Inc. (NYSE:V) and Moody’s Corporation (NYSE:MCO).

Baron Funds, an asset management firm, discussed Roper Technologies, Inc. (NYSE:ROP) in its Q1, 2022 investor letter titled, “Baron Asset Funds”. Here is what the letter said:

“Outperformance of the Fund’s investments in Communication Services, Financials, and Industrials and lower exposure to the lagging Consumer Discretionary sector added the most value. Strength in Industrials was driven by diversified technology company Roper Technologies Inc. (NYSE:ROP). Roper’s stock held up better than the broader market after its fiscal year 2022 guidance exceeded Wall Street expectations.”

6. KKR & Co. Inc. (NYSE:KKR)

Akre Capital Management’s Stake Value: $869 million

Percentage of Akre Capital Management’s Portfolio: 5.9%

Number of Total Hedge Fund Holders: 54

KKR & Co. Inc. (NYSE:KKR) is another alternative-investment-management company in Chuck Akre’s top 10 stock picks. 

On May 19, Deutsche Bank analyst Brian Bedell lowered the price target on KKR & Co. Inc. (NYSE:KKR) to $79 from $81 and kept a ‘Buy’ rating on the stock. Bedell told investors in a research note that equity market decline has created fresh opportunities for buying asset management securities. He further added that stocks are pricing in a 55% chance of recession, making the risk/return for a 12-18 month holding period across most of the group “very attractive.”

Like Mastercard Incorporated (NYSE:MA), Visa Inc. (NYSE:V) and Moody’s Corporation (NYSE:MCO), KKR & Co. Inc. (NYSE:KKR) is another finance stock in Akre Capital Management’s portfolio.

Vulcan Value Partners talked about KKR & Co. Inc. (NYSE:KKR) in their Q1, 2022 investor letter. Here is what was said:

“KKR & Co. Inc. is a global investment firm that manages multiple alternative asset classes. The company’s operating profits grew approximately 45% during the fourth quarter of 2021 and roughly 55% for the year. In contrast, its stock price declined over 20% during the quarter. KKR generates robust free cash flow, and its value growth has been strong throughout the last year. It is unclear to us why KKR’s stock price has declined. However, we feel the company is positioned for long-term success and are pleased to own it with a discount to our estimate of its intrinsic value.”

To see rest of the stocks in this list go to Chuck Akre’s Top 5 Stock Picks.

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Disclosure: none. Chuck Akre’s “three-legged stool” Approach and His Top 10 Stock Picks is originally published on Insider Monkey.