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Welcome to another episode of the Capital Employed Podcast. For this episode we are going to read the quarterly letter from Focus Capital Management. If you like these Audible investor newsletters, please make sure to subscribe. And if you are seeking more investing ideas, make sure to join the Capital Employed newsletter where we interview fund managers who share their best ideas. We also publish a bi weekly newsletter which features a curation of the best stock pitches from fund managers, analysts and renowned private investors. Visit capitalemployed.com to join Focus Capital Management 2024 Q3 manager letter written by Mordecai Yavne Narrated by Marcus Dear Investor Starting in June and continuing through the third quarter, the fund has more than reversed its gains from the few months before, even as The S&P 500 has continued to hit new all time highs. This is made all the more frustrating by the fact that the underlying businesses that we have invested in are continuing to perform well even as the underlying performance is not reflected in their stock prices. The broader market continues to narrowly reward specific sectors and themes, especially big tech and AI, ignoring small cap and value stocks however deserving for the third quarter of 2024 the fund returned minus 13.7% compared to 5.9% for the S&P 500. This brings the year to date return for the fund to minus 24.1% compared to 22.1% for the S&P 500. We find this disparity in returns and the prolonged underperformance of the fund intensely frustrating, as I am sure you do as well. We check and recheck the theses behind our investments and we continue to see strong underlying business performance that the market is not rewarding. Sooner or later the stock prices will have to come in line with the underlying businesses. As Benjamin Graham has famously said, in the short term the stock market is a voting machine, but in the long term it is a weighing machine. True as that is, it does not make the short term less painful. As I have already said, the underlying businesses that we have invested in are continuing to improve and I would like to highlight the progress that our portfolio companies have exhibited over the year, increasing their underlying value on a steady basis over time, as the underlying business get better and better and the stock price does not respond, this creates the effect of a coiled spring waiting to burst. The more it is pushed down, the greater the force with which it will eventually snap back. As you will see, we continue to view our portfolio companies as substantially undervalued and we expect substantial appreciation in their stock prices in the future let's start with SiliconMotion. Silicon Motion has returned to growth with a vengeance. Based on their impressive performance for the first three quarters of the year and their recently issued guidance for the fourth quarter, they are on pace to have grown their revenue more than 25% over the full year. At the same time, their gross margins have continued to expand to their prior level, which with gross margins ending the year at approximately 47% up from the 42% exhibited over 2023. The NAND industry has recovered from the overproduction glut in the first half of 2023 and silicon motion has returned to its former profitability at a higher revenue plateau than before. During this downturn and recovery, they have retained and grown their market share and they continue to grow their design win share, boding well for future continued growth. On their most recent earnings call from just a few days ago, Silicon Motion stressed that their design wins are stronger than ever and that their market share is growing as Nandi manufacturers are outsourcing more and more in direct contradiction to a key risk factor that the market is overly obsessed with. They have won major design wins and market share in PCIe 5.0 controllers, allowing them to break into the high end PC market, a market which they have not participated in until now. At the same time, their MON Titan Enterprise NAND controllers for AI and data centers have won a few Tier one customers with more to come another greenfield opportunity for the company. In sum, they have been growing market share in their core markets and continue to do so with future design wins while at the same time winning significant design wins in new markets representing new growth. They will not formally announce 2025 guidance until Q4's earnings are released, but they have already indicated that they expect growth to continue, especially as they ramp up their new markets in the latter half of next year. Through all this, cash continues to pile up on their balance sheet, part of which is returned to shareholders via dividends and share buybacks as we wait for the market to catch up to the tremendous performance of Silicon Motion's business. Moving on to Kingsgate, they have finished refurbishing both of their processing plants and they are operating above nameplate capacity. They have refreshed their mining equipment, restarted operations and gold sales, and recommenced blasting and mining. In the meantime, the price of gold has shot up about 35% over the year to almost $2,800 an ounce. Looking at Kingsgate's stock performance for the year, you would never be able to tell the market remains in show me mode for this stock, refusing to give any credit for the reopening and substantial progress made until the money rolls in. Until very recently, Kingsgate has been processing low grade stockpile while the refurbishment was ongoing. With the refurbishment behind us and the mining recommenced, we expect the grade of ore being processed to slowly return to prior levels and the cash to start rolling in, at which point we do not believe the market will be able to continue to ignore the tremendous undervaluation here. And last but not least, Burford Capital has had continued successes in the legal cases they are financing. Realized gains from completed cases in the first half of the year were up 36% year over year. Their major win against Argentina in regards to YPF's expropriation, Worth multiples of their entire market cap, continues to plod through the court system with various enforcement and discovery efforts underway even as Argentina's appeal is pending at the Federal Appeal Circuit. Although we expect that the ultimate endgame here is a settlement of some kind, we doubt that Argentina will want to negotiate until their appeals are fully exhausted, which we expect to be a mid to late 2025 eventually. In the meantime, Argentina's finances do seem to be improving under President Milei's reforms. President Milei has placed himself firmly in the pro business camp and has come out publicly for the need for Argentina to respect the rule of law and deal with the legal cases pending against it. Court time and negotiations are slower than many people like, but we do expect to eventually see a substantial payment to Burford from the YPF affair. In the meantime, interest on the $16 billion judgment continues to accrue, whatever ultimately happens. In no world do we see Burford's present valuation to be a fair representation of the underlying value of their present portfolio, their ongoing franchise and their YPF entitlement. We have also started to build a position in a new company, but as we have not finished building our position, we are not yet ready to talk about it in detail nor to name the company. We will suffice with saying that our new position is a company trading at a $350 million valuation with no debt and about $150 million of cash on the balance sheet and making about $150 million a year in net profit. If that sounds crazy undervalued to you, that's because it is. We look forward to sharing more about this company and our investment thesis in future letters. Much of our recent underperformance can be attributed to our running a super concentrated portfolio. This inherently increases overall volatility and can cause large divergences from broader market indexes, even for relatively prolonged periods. But ultimately, we firmly believe that concentration ends up benefiting investors over the long term, despite the short term and medium term pain. In the attached strategy paper, we have detailed and explained the essential value we see in concentration and why we have made concentration the cornerstone of our investment philosophy. We hope you enjoy reading it and we welcome all comments. As we have detailed above, we have strong confidence in the positions we currently hold and remain excited about our prospects for the future. We are actively searching the market for more deeply undervalued opportunities and we are intensely interested in a number of companies that we are actively researching. As always, we continue to welcome any questions you may have about our investment philosophy, our positions or the markets. And we continue to believe that despite the short term and medium term pain, by being willing to endure some short term and medium term volatility, we thereby enable long term gains that make the volatility and pain worth it. The Value of Concentration At Focus Capital Management we run a super concentrated portfolio. Indeed, focus and concentration lie at the very center of our investment philosophy. In many ways, the rest of our investment approach flows naturally from this first decision to run a concentrated portfolio, and this paper explains why we view concentration as so important and why we see it as so valuable. There are many benefits from running a super concentrated portfolio. I would like to go through the main benefits one by one and then end off with comparing the virtues of concentration to the benefits of diversification. Concentration lets you choose your most compelling investment ideas. We want to invest all of our resources into our best and greatest opportunities, and we don't want to dilute them with mediocre ideas or even merely good ideas. Naturally, your best and second best idea will be significantly better than your 20th best or even your seventh best idea. So it makes sense to concentrate your firepower on your best ideas. To steal a line from Warren Buffett, very few people have gotten rich on their seventh best idea. Concentration lets you research deeply and comprehensively. Concentration allows an investor to pour an immense amount of time, energy and research into each investment they consider. If a person invests in 100 stocks, that gives him just about three and a half days per year to research and think about each of his positions. And that's without sleeping, eating, breathing, or pretty much anything else. Realistically, such an investor can only have a passing familiarity at best with the companies in which he is invested. Having a team of analysts ameliorates this slightly, but does not really solve the issue at the end of the day, the buck stops with the investment manager and he ultimately needs to be the one to understand the company and the investment thesis. At Focus Capital Management, we strive to spend at least a month deeply researching a company before pulling the trigger on investing and often end up spending much more than that. We want to deeply understand the company and what makes it tick, its industry, positioning, the key metrics to be paying attention to, etc. It is a common occurrence for the market to react illogically to news items in both directions simply because the market does not understand the company on a deep level and is reacting mostly off of vibes. Reacting off of vibes may possibly be a defensible way of trading stocks, but that's no way to approach long term investing in companies. Concentration lets you build your conviction as a corollary of the previous point, by spending the time to deeply research and understand a company at its core. If indeed the investor chooses to invest in the company, he will be doing so from a deep well of knowledge. The investor is able to build a deep conviction in his investment thesis and not be swayed by irrelevant news or even temporary business slumps that do not affect the core thesis. Having the conviction to stay strong through the inevitable temporary price swings and even to take advantage of them is an absolutely essential component of being a successful long term investor. Concentration lets you thoroughly vet and stress test the investment. The increased focus and research not only allow the investor to concentrate on better ideas and to understand them more deeply, it also actually reduces long term risk. By virtue of having the time to research the investment deeply and comprehensively, the investor can research the downside case thoroughly. This applies firstly at the outset in that the investor can vet and stress test the potential investment in a depth that would be simply impossible if the investor was running a more diversified portfolio. And this applies after the initial investment as well. By knowing what key signs to be looking out for to test the possible breakage of the investment thesis In a way, the flip side of building conviction is that the deep well of knowledge gives you what you need to be able to turn on a dime and bail if the circumstances call for it. Concentration lets you constantly monitor your portfolio. By having fewer investments to monitor, an investor can keep fully abreast of developments affecting each individual company and its future prospects. This doesn't mean just keeping on top of quarterly earnings releases, which is of course the most basic level. This includes keeping abreast of developments throughout the industry and in related companies, be they competitors, suppliers or customers. It is not at all uncommon for an investor with a deep understanding of the innards of a company to glean extremely important data from far out related news that to a person with a more cursory knowledge base, does not seem to directly affect the company concentration lets your winning investments really move the needle by focusing and concentrating on your best ideas. When your investments ultimately succeed, the the profit realized really moves the needle for the entire portfolio. If you invest in 100 stocks, then even if a position doubles, that only equates to a 1% gain for the portfolio as a whole. If you invest in only a few stocks, the gains are much more meaningful. This advantage is of course a double edged sword as losses are magnified as well if the investor chooses unwisely the Benefits of Diversification how much and at what Cost? Conventional wisdom says that an investor needs to be diversified and the vast majority of mutual funds and professional managers take this to an extreme. There is undoubtedly a clear benefit from diversification. Diversification lowers the idiosyncratic unpredictable risk from an individual investment, the risk that something goes wrong at the company with no advance notice at all, the proverbial earthquake under headquarters where value is wiped out literally overnight. Besides lowering risk of permanent loss from an individual position gone awry, diversification also lowers the overall volatility of the portfolio as a whole, making the journey less bumpy and more pleasant. There is no question that running a super concentrated portfolio increases volatility over the cycle. However, taken to the extreme that most professional money managers employ quickly goes beyond diminishing returns and becomes counterproductive. If you invest in a hundred stocks, you will indeed average out the ups and downs of each individual position, muting your overall volatility by converging on the overall market's performance. The number of so called active investors that are basically closet index funds is truly astonishing. If an investor wants to outperform the market over the long term, then he needs to have a different portfolio composition than the overall market. He needs to take a stance built on research, knowledge and conviction, and he needs to stomach the inevitable swings that his positions will incur as his thesis plays out. It can definitely be painful at times, and the investor needs the temperament and fortitude to see it through to completion. But the rewards at the end make it all worth it. Even in theory. Studies have shown that the vast majority of the benefits of diversification in lowering idiosyncratic unpredictable risk and reducing volatility are reached with about 10 investments spread across different sectors and market risks. Admittedly, at Focus Capital Management we run a more concentrated portfolio than the theory ideally calls for. That is because we view the bigger risk to be the risk of investing in something that you did not research sufficiently and which you do not truly understand. Investing, when you only have a passing or shallow understanding of the companies in which you are invested, may possibly work out with dumb luck, but is more commonly a recipe for disaster. Even if in the end the investment thesis proves correct, often the investor is no longer there to reap the benefits, as he never understood the investment well enough to build the necessary conviction to hold through the volatility. At Focus Capital Management, we view the benefits of concentration as vastly outweighing the downsides of the concomitant volatility. And if you listen to the greatest value investors Benjamin Graham, Warren Buffett, Charlie Munger, Peter Lynch, Joel Greenblatt, Philip Fisher, John Neff, Seth Klarman, and the list goes on, they consistently say the same that wide diversification is the road to mediocrity. Conclusion to recap, concentration allows you to research deeply and more comprehensively. This in turn allows you to build much higher confidence in your thesis, thoroughly stress test your investment ideas, and better monitor your investments and react to events. Most crucially, concentration allows you to mass your investments into your best ideas, resulting in better results when you are proven correct. At Focus Capital Management, we view these benefits of concentration to vastly outweigh the concomitant downside of increased volatility. It is for these reasons that we have made focus and concentration the cornerstone of our investment philosophy. Disclaimer this article is for informational and educational purposes only and should not be seen as investment advice. Please do your own research before investing in any company mentioned.