Norbert Lou put 16% of his portfolio into Crocs last year. Why did he invest in Crocs?
The company's financial statements indicate good economic traits—growing sales, high inventory turns, and high returns on tangible assets. Despite this, I brushed the company aside as a benefactor of the ugly, albeit comfy, shoe trend.
But the question kept nagging: Why did Norbert Lou invest in Crocs?
I resolved to understand Lou's investment philosophy. I found a 2011 interview with Norbert Lou, seemingly the only interview he's ever done.
Lou emphasized investing in businesses that 1) earn more profits with less capital and 2) produce products that don't really change or require much, if any, research and development. Crocs checked these boxes, which I assume was part of Lou's attraction with Crocs. These reasons alone, however, didn't seem enough to stake 16% into a company profiting off ugly shoes.
Then I read the section in the interview on pricing power:
But there existed a minority of companies that could grow revenues without increasing expenses. Most did it through operating leverage, growing volume over a large fixed cost base. The rest did it through true pricing power, enjoying the rare ability to raise prices in real terms without sacrificing volume.
Oh, that's interesting.
Back to the 10Ks, and there it was: A decade ago, $1 in sales generated 2¢ in operating earnings; now, $1 in sales generates 25¢. While price increases helped somewhat, the company's immodest growth in earnings came from volumes without commensurate expenses, indicating Crocs has operating leverage. (Of course, credit is due to Andrew Ree's, the company's CEO, who is a fantastic manager with his eyes set on the long-term.)
Lou said because most companies don't have operating leverage or pricing power, people are not used to seeing it, and so they don't look for it. Until I studied Lou's investment in Crocs, I didn't look for it, too.
I now clearly see that Crocs has the characteristics of a great business, much like Warren Buffett's highly prized See's Candy (p. 6). That's why Norbert Lou invested in Crocs: Crocs is See's Candy.
And yet the market is valuing Crocs just shy of $5 billion. With the business earning $900 million pre-tax, Mr. Market is giving investors the opportunity to get into this wonderful business run by a wonderful manager at nearly a 20% pre-tax yield.
To quote Munger, that's hog heaven day.