[00:03:00] Clay Finck:  And the earnings increase by 15%, your stock price should also go up by 15% as well because your earnings multiple has stayed the same.

So the first thing you need is for a company to grow its earnings. You want companies that are able to reinvest back into the business. If a company is paying out a dividend or doing large share repurchases, then that may indicate that the business does not have a lot of opportunities for reinvestment.

I’d much rather own a company that can reinvest back into it at 20 or 30% than a company that pays me dividends. Chris mentioned the quote in our interview that dividends are an expensive luxury, and that quote really hit home for me. It doesn’t mean that dividends are bad or share repurchases are bad.

It’s that if you want a compounder, it needs those high rates of reinvestment back into the business. Now, the second criteria for a company to reach Multibagger status is that it needs to grow its earnings for a long period of time, or in other words, it needs to have a really long runway. You can’t buy Apple stock today, assuming it’s going to go from a 2 trillion to a 20 or 200 trillion company.

It just isn’t feasible. If you’re wanting to buy a company that can grow for a really long time, you wanna find something that is in its earlier stages of its growth. Chris shared some of his portfolio holdings on Twitter and his fund, which I’m very grateful for, and every company he owns has a market cap below 50 billion.

[00:05:00] Clay Finck: Almost half of his portfolio is below 10 billion market caps. So he is looking for smaller companies, not companies that have a market cap in the hundreds of billions of dollars or in the trillions of dollars. Another thing I picked up from Chris that many people don’t talk about is looking for businesses with high insider ownership.

If the managers own a lot of stock, then their incentives are aligned with shareholders and they’re much more likely to think long-term and make decisions that are in the interest of long-term shareholders. Chris also mentioned that he spends a lot of time analyzing a company’s competitive advantage.

If a business is able to grow over a really long time, other companies are going to try to come in and eat their lunch. If the business doesn’t have a strong competitive advantage, then we probably shouldn’t own that company. We should always be mindful of valuation as well. If you’re starting from a very high valuation, then you really need those earnings to grow substantially in the future in order for the company to grow into that valuation.

[00:06:00] Clay Finck:  So once you’ve determined the businesses that you like, you need to ensure that you’re paying a reasonable price for them in order to get a decent return going forward. Chris also talks about this idea in his book of the Twin Engines, where you could benefit from both the growth of the business, but also benefit from the company trading at a higher multiple after you purchase it.

If you manage to get in early, when a business is out of multiple, say 15, and the business does well, and then the market better appreciates it, if it ends up eventually trading at a multiple of 30, then that’s a hundred percent appreciation in the stock just from the multiple rerating. In my mind, it’s really important to get the business right, and if you’re willing to hold for a really long time, and you’re right about the business, many times the valuation will really just take care of itself.

[00:07:00] Clay Finck: Assuming you aren’t paying a ridiculous price like 50 times sales or a hundred or 200 times earnings. Chris also references the work of Chuck Akre, who also falls in line with this philosophy of purchasing long-term compounders. Ari has what is known as his three-legged stool approach, where he is primarily looking for three things.

First, businesses that have historically compounded at a high rate of return. Second, businesses with highly skilled managers who have a long history of treating shareholders like partners, and third businesses that can reinvest cash flows at an above average rate of return. So very similar to Chris Mayer.

If a business has $100 invested in it and manages to earn 20% per year, the business will grow to $120 at the end of year one. When you compound that 20% over a number of years is when the magic really starts to happen. At the end of four years, the business has doubled. At the end of 10, you have a six bagger, and after 25 years you’ll have a hundred bagger.

[00:08:00] Clay Finck: Now very few businesses of course, are going to be able to achieve this, but there’s still that really powerful lesson of recognizing the power of long-term compounding. Lastly, I also wanted to mention that Chris is also very strict on investing in companies with a rock solid balance sheet. This ensures that the company won’t have any issues during your recession.

They don’t have a lot of leverage in order to generate high returns, and management is conservative and holds a lot of cash. Filters on these types of things just tend to point to a quality business that helps us narrow down the giant universe of thousands of companies, just to those very few really good businesses that have relatively low risk of permanent loss of capital.

Alright, so let’s talk about the first company, which is Topicus.com, which. I’m going to refer to these topics during this discussion. If you tuned into my episode on Constellation Software, then you’re probably familiar with topics as well. That was episode 531 where I touched on Constellation Software.

[00:09:00] Clay Finck: Full disclosure, I do own shares in Constellation software that were acquired in February of 2023 at just under 2,400 Canadian dollars. Topic was a result of a spinoff from consolation software back in early 2020. The company trades under the ticker, TOY.V Topicus is practically a carbon copy of Constellation Software and they have a very similar business bottle.

Topicus specializes in the European market specifically, and it looks to me that Constellation owns roughly 30% of the shares of Topicus. So for those shareholders in Constellation, they’re already getting exposure. Topicus, the company trades on the Canadian stock market, and at the time of this recording has a market cap of around 5 billion US dollars.

Like Constellation software. Topicus is a serial acquirer of vertical market software businesses, which are very high quality businesses that tend to demonstrate characteristics such as sticky revenues, strong customer relationships, and their services provided to customers are really critical to the operations of their business.

[00:10:00] Clay Finck: These VMs businesses tend to offer their services in a very niche market, and these businesses tend to sell for around five to 10 million US dollars, Topicus, so they’re in these very small markets, which means that the competition in such markets tends to be low, and these businesses are too small for a private equity firm to be interested in purchasing them.

I find Topicus is to be a company that is worth diving into for a number of reasons. First is that they’re simply taking the approach that Constellation took in other markets and they’re applying it to the European market. Constellation has shown that this strategy of being a niche serial acquirer can be very successful as long as you have the right managers and you’re doing the right approach.

Because Topicus is smaller and has a 5 billion market cap relative to constellations, 41 billion, it’s been said that buying Topicus today could be similar to buying Constellation back in 2010. Of course there are no certainties in this, and just because Constellation has been so successful doesn’t mean that topics will replicate that success in the years to come.

[00:11:00] Clay Finck:  But I find it exciting to have a company that may have the potential to do even half as well as Constellation has to date. The reason that Constellation Software has been so successful is because they have a world-class management team that are exceptional capital allocators. They have a decentralized culture that allows for autonomy among the managers.

They have a reputation of being great perpetual owners of V M S businesses, and they have perfected the formula of making V M S acquisitions that are value accretive to their shareholders. Now, let’s turn to talk more about Topicus specifically. Topicus started around the same time as Constellation back in the late nineties, and they had pretty similar beginnings.

A family out of the Netherlands had a nest egg of capital from selling their business, and they wanted to use that capital to start acquiring VMS businesses. For years. They operated under the name total specific solutions. Essentially, the pitch to businesses was, if you sell your company to us, we’ll let you continue to run your business.

[00:12:00] Clay Finck:  In addition to that, they’ll also provide you capital should you need it, as well as administrative services such as HR, accounting, or legal support. Then the businesses can focus more on what they do best, which is serving their customers. From 2006 through 2012, TSS completed eight acquisitions, and from 2008 to 2012, revenues increased from 67 million euros to 201 million euros, which is a 31% compounded annual growth rate.

Quite impressive. The businesses that were acquired provided highly customized services to their customers, which led to very sticky revenues because it was such a headache for these businesses to switch. In 2010, Robin Van Poelje, I’m going to butcher this name. He became the CEO in TSS, and he is the CEO of Topicus.

[00:13:00] Clay Finck: Today, in 2013, Constellation Software wanted to purchase TSS to which they came to an agreement on, as long as the founding family of TSS remained 33% minority interest, and Robin could remain CEO. So, at the end of 2013, Constellation officially acquired TSS, which Topicus is today. Constellation was happy to have TSS under their ownership as they had a dominant position in certain Dutch verticals, highly customized products, and decentralized business model managers who think long term and are very similar to constellations managers.

And of course they had a great reputation as serial acquirers. It took a couple of years for TSS to become a hundred percent aligned with Constellation and get the right people on the management team. But once they did acquisitions for TSS just started to take off, like I mentioned, from 2006 to 2012.

[00:14:00] Clay Finck:  Topicus completed eight acquisitions. In 2015, they completed 2 2016 they completed 10, and then by 2020 they had completed 17 acquisitions. So from 2006 to 2012, they’d completed a total of eight, and in 2020 alone, they completed 17. Looking at the geography a little bit here, in 2018, 80% of their revenues came from the Netherlands, and by 2020, that had declined to 62% as they started to make more acquisitions in other countries in Europe.

While under the ownership of Constellation, TSS increased revenues by 20% annually and grew their EBITDA margins from 18% to 33%. Then in 2020, Constellation announced that they would be spinning off TSS in conjunction with a large acquisition of another Netherlands-based vms business called Topicus.com.

[00:15:00] Clay Finck: Topicus.com, the business that merged to become what is the separate spin-off, took a slightly different approach than TSS in Constellation in that they were willing to spend more money internally to achieve organic growth, and they encouraged innovation in the development of new products. But at the end of the day, their overall revenue growth and return on capital is similar to that of TSS before the two merged together.

I suspect that the Topicus operating group will eventually become more acquainted with being open to doing more acquisitions rather than putting focus on internal organic revenue growth with the spin-off. Topicus would then have essentially three shareholder groups. There was Constellation, which owns 30.35% of shares. The original founding family’s investment vehicle owned 39.3% of shares, and then public shareholders would own the other 30.35% of fully diluted shares. I’m sure public shareholders sleep well at night knowing two-thirds of the shareholder base thinks very, very long term.

[00:16:00] Clay Finck:  Mark Leonard and his team at Constellation have a long history of being great stewards of shareholder capital. The investment firm that owns the other portion is very similar in their mindset of how they think about their ownership in Topicus. Now, Topicus has the head office which oversees their three operating groups. Each operating group has a number of business units under them that have full autonomy, but it’s the operating groups in the head office that end up making the capital allocation decisions.

The majority of the free cash flows end up getting redeployed into acquisitions. And since Topicus is a smaller company, they should have a much easier time at deploying all of their free cash flow through acquisitions. In 2022, they added revenues of 1.3 billion Canadian dollars. For reference, one Canadian dollar is about three-fourths of a US dollar.

[00:17:00] Clay Finck: So 1.3 billion Canadian dollars in revenue translates to around 960 million US dollars in revenues for 2022, up over 22% year over year. Since I love Constellation so much, I really like that Topicus is essentially an extension of Constellation. Constellation owns 30% of the shares. They used to be a part of Constellation, so they know the formula really well, and they’ve learned from some of Constellation’s mistakes, such as paying out special dividends instead of using that capital to make larger acquisitions at slightly lower hurdle rates.

I see it as a benefit that Topicus is in the European market. The European VMS market is more fragmented than, say, the US, and there’s less competition with private equity firms for getting deals. The reason the VMS market is more fragmented is because there are barriers between countries that make it difficult to expand from one country to another. There may be a language barrier, differing regulations in different countries, different payment systems, and so on. So the European market is more fragmented than the US, which means that there are a lot more opportunities for businesses to acquire a dominant share of their specific niche to foster future growth.

[00:18:00] Clay Finck: I envision Topicus acquiring companies in similar niches in other countries, then sharing best practices between companies, or potentially even expanding existing businesses into new markets. The other positive with the European market is what seems to be much less interest from private equity firms. As I mentioned, research from McKinsey indicates that most of the growth in private equity is in the US, while Europe is still fairly stagnant. Even when you look at Europe, it’s more developed in the UK, which means that Topicus probably won’t have too much competition from private equity in continental Europe.

[00:19:00] Clay Finck: This creates a ton of opportunity for Topicus. While a lot of money flows to the US, this means that there’s a plethora of small businesses in Europe because they haven’t received that capital that would have been received had they been in the US. Another critical piece to consider with Topicus is their organic revenue growth. Historically, Constellation’s organic growth of their existing businesses has been under 2%, while Topicus’s organic growth has historically been over 10%, which is quite impressive given that the majority of the cash flow is used for acquisitions rather than reinvesting internally.

Topicus may have many opportunities to acquire small VMS businesses and offer them capital to grow organically at really high rates because the company didn’t have access to much capital prior. This is a win-win for both Topicus and the acquired companies. These structural advantages in the European market may mean that Topicus may have a chance at growing potentially even faster than Constellation did over the past decade. When you look at the data within Constellation, you’ll see that these structural advantages also exist within Constellation.

[00:20:00] Clay Finck: When you’re looking at Europe specifically, the revenue growth rate within Constellation for the European market was just over 20% annually from 2015 through 2020. While the revenue growth rate in Canada was only 17%, the US 12%, and then other regions actually was over 30%, but it’s a smaller portion of their business.

Remember that roughly half of Constellation’s revenue comes from the US. So I see Topicus operating in Europe as a really good advantage to have from a shareholder’s perspective and in the business’s perspective as well. A lot of the competitive advantages that apply to Constellation also apply to Topicus as well.

The products within their businesses have that high switching cost, sticky revenues, and there are little incentives for their customers to want to switch to a competitor. Their decentralized business structure allows them to continue to grow at a rapid rate with the right incentives put in place, and then continue to scale the number of acquisitions they do year after year after year.

[00:21:00] Clay Finck:  And then they have the reputation and culture, as I’ve mentioned before, to continue to attract those deals from businesses that are looking to sell. And then similar to Constellation again, their high earners are paid cash bonuses that have to be invested in shares and invested for a minimum of four years.

This is great for two reasons in my mind. First is existing shareholders aren’t diluted from the bonuses that are paid out. They’re paid out in cash. And then second is that managers are incentivized to act in the best interest of shareholders. And since Constellation is a 30% owner, Inus, Mark Leonard, and the brilliant managers at Constellation are likely going to ensure that operations are run well within Anus.

Shareholders of Topicus have their wealth tied to Mark Leonard, who I personally see as one of the best capital allocators I’ve ever come across. As I mentioned in the episode on Constellation, the company thrives during recessions. Their revenues from existing businesses are sticky and they don’t decline too much, if at all, during a recession.

And then second, during recessions, there’s more potential to make really attractive acquisitions as companies may become desperate to sell. And then during recessions, there isn’t really too much competition from firms looking to make acquisitions. Back during the great financial crisis, for example, Constellation’s organic revenue declined by 3% in 2009, and then 2% in 2010, and then it increased by 7% in 2011, which shows the resilience of the businesses Constellation owns as well as Topicus.

[00:23:00] Clay Finck: Finally, turning to the valuation, I pulled some data from a website called Quick FS. The market cap shows around 7.2 billion Canadian dollars, which equates to around 5.3 billion U.S.D. 

Quick FS shows they produce cash flows of 282 million Canadian dollars for 2022, which means that the price to free cash flow is roughly 25, which is lower than Constellation’s.

The price of Topicus shares in Canadian dollars as of recording are around 88. This is a slightly more attractive valuation than Constellation software. During my episode on Constellation, the price to free cash flow was around 30. Constellation is also much more well-known, and it has a longer track record of being a public company.

And given the specific advantages for Topicus, I would say their valuation is definitely more attractive, but there may be more risks and more unknowns with their long-term success solely operating in Europe and maybe just things I’m not seeing in the business. I believe a multiple of 25 is a fair valuation for a company that’s this early in its growth cycle.

Over the past three years, revenues have grown by 29% annually, and then with the increase in 2022 being over 22%. If free cash flows grow by 20% over the next three years, then paying a price to free cash flow multiple of 25 today is equivalent to paying 14.4 times the free cash flow for 2025, 3 years from now.

If that growth continues through 2027, then you’re paying 10 times 2027 free cash flows. Of course, it’s going to be really tough for them to continue to grow at this really high rate. None of this, of course, is a recommendation to buy or sell Topicus. I’m just sharing some of the information I’m seeing. There are, of course, risks.

There’s the possibility that Topicus simply can’t do what Constellation has done so well for many years, and that the strategy isn’t successfully implemented in Europe, or there’s the possibility that Constellation may sell their shares of Topicus, and then they lose that really valuable connection that they’ve built over the years.

Transitioning to the second compounder I wanted to talk about today. It is Copart, CPRT is the ticker. Copart is another business that is owned by Chris Mayer in his fund, and he mentioned it a few times during my conversation with him. John Huber is another really great investor I look up to a lot that owns Copart as well.

Before I get into my analysis, I wanted to share a clip of my interview with John Huber on our millennial investing show from May 2022. I specifically asked John about the types of competitive advantages he looks for in a business, and he brought up Copart as a prime example of a company with a strong competitive advantage in a number of different ways.

[00:26:00] Clay Finck: Here’s the clip with John: “Barriers to entry are really important. That’s something I spend a lot of time thinking about. Copart is a company that I really love. And, um, Copart actually is a business that exhibits all three of those advantages – economies of scale, network effects, and barriers to entry. And it’s got a network effect because what Copart does, most people don’t know, it’s not a household name.

What they do is essentially they operate junkyards. That’s the easiest way to think about it. So if you can visualize a junkyard, that’s what Copart does. And they run salvage auctions. So if you crash your car and you total your car, Geico will take the car and send it to Copart to sell on Geico’s behalf.

And so Copart works with insurance companies to sell these salvage vehicles to dismantlers and other dealers and, in some cases, the general public that might want to buy these cars. And oftentimes these cars get shipped overseas to different buyers, and they get repaired and go back on the road.

But Copart is a great business because it owns the land. And so there are economies of scale because it can spread its growing revenue over a fixed cost of the land, and that leads to attractive unit economics that increase over time as the business grows. And it also has a network effect of buyers and sellers. Insurance companies go there because it has the most buyers, and buyers go there because there are the most sellers.

And most importantly, I think, with Copart is the barrier to entry. And that’s because no one wants another junkyard in their backyard, right? So it’s sort of a NIMBY (not in my backyard) concept there. And it’s very difficult for a competitor to develop the relationships. It’s not just the fact that no one wants it in their backyard, it’s very difficult to get the zoning permits to set up, even if you wanted to set this up. And so Copart has, I think, some natural advantages there. And it’s a business that enjoys relatively low competition. There’s one other main competitor, but it’s not a business that gets a lot of attention from VCs. You know, there aren’t a lot of people that want to go into the junkyard business. And so there are just some natural advantages that I think a business like Copart enjoys. And those are three things that I spend a lot of time thinking about.

As John Huber mentioned, Copart provides online auction services to sell and remarket used wholesale and salvage titled vehicles, and they operate in a number of different countries, including the US, Canada, UK, Brazil, Ireland, Germany, Finland, among others.

[00:29:00] Clay Finck: On their site, they also offer a number of different services, including salvage estimation, end-of-life vehicle processing, vehicle inspections, dealer services, as well as membership services that give you access to their network.

Now, this is anything but a sexy business, but when I look at the numbers and the advantages this company has, it really gets me excited. So on their site, I see that they have a free tier, a basic tier that they offer members, which is $99 per year, and then a premium tier for $249 per year. Copart started back in 1982 with a single salvage yard, and it has grown to become a global leader in the online auction space for vehicles.

The company IPO’d back in 1994, and it has been a strong performer as the stock has risen from a split-adjusted price of 30 cents in 1994 to $77 today. The business has two main revenue streams, which include their service revenue and their purchased vehicles revenue. Service revenue is essentially when someone lists a car on their site, and they collect a fee on the sale for being the intermediary. Purchased vehicles refer to vehicle sales where Copart has taken ownership of the vehicle, sells it at a higher price, and then pockets the difference.

Service revenue was up 24% in 2022 at $2.8 billion, while purchased vehicles revenue was up 61% at $648 million. Quite impressive. So service revenue accounts for over 80% of total revenue for fiscal year 2022. When thinking about this business, the point that John Huber made on their network effects really resonated with me. You want to go to the largest network with the largest number of buyers so that you can get the best price you can.

When I look at the financials for Copart, I see a ton of good things. Over the past decade, revenues have grown by 14% annually, and free cash flows have grown by 17% annually. So the company has operating leverage, meaning that their earnings are outpacing their revenues, and this is because they’re buying the land, which has relatively fixed costs. While their revenue and market share increases year after year, their debt-to-equity ratio is only 0.3, so they have a really strong balance sheet. They’ve been profitable each of the last 20 years, and their return on invested capital tended to be in the mid-teens, but it really jumped back in 2017, and ever since it’s been in the mid-20% range.

[00:32:00] Clay Finck: Their strong return on capital is a testament to the quality of the management team. Chris Mayer shared this data on Twitter that compared Copart to their primary competitor, Insurance Auto Auctions, which I’ll refer to here as IAA. Copart invested four times more back into their business since 2016, despite during that time period, they paid down $700 million in debt, and their competitor issued $1.3 billion in debt.

On top of all of this, Copart produced $1.4 billion in free cash flow over that period since 2016, and their competitor produced no cash flow, and they paid out these substantial dividends to their shareholders of $1.8 billion. Copart very clearly is all about reinvesting back into the business. Copart actually doesn’t pay a dividend because they have so many investment opportunities that they’re capitalizing on. And I think this is a really important piece that I picked up from Chris Mayer. You’ve referenced that quote from Thomas Phelps in my interview with him, that dividends are an expensive luxury, meaning that it might be nice to see a company paying out a dividend, but if the dividend could have been used to reinvest back into the business at say 20%, then you’re missing out on that substantial compounding over the years ahead.

Chris had another quote from our conversation: “Copart seems to get better with age since they’re continually reinvesting back into the business. And the lead over their competitors just gets larger and larger. And at this point, they’ve reinvested so much back into the business that their advantage is insurmountable because it’s costed them billions and billions of dollars.”

Then, you can compare the market share between Copart and IAA. Copart’s market share has marched upward year after year, while IAA is losing market share. Chris shared this data that was pulled from a presentation by Leer Capital that I’ll be sure to link in the show notes for those interested.

Leer Capital was an advisory firm that highly recommended that Ritchie Bros not acquire IAA because Copart was such a better business, and you don’t want to be competing with them. Essentially, when IAA’s business is already deteriorating, there’s a headline from March 20th, 2023, that Ritchie Bros acquired IAA for $7 billion weeks after two proxy advisory firms urged shareholders to reject the deal.

They have this slide in their long and in-depth presentation that is titled “Copart versus IAA is Not a Fair Fight,” and it says, “Copart has more buyers, more sellers, a stronger network effect, a stronger balance sheet, far more EBITDA to invest out of, an advantaged cross-structure from owning their land, and an experienced management team.”

[00:35:00] Clay Finck: And just looking at Copart here, at the time of the presentation, it had a market cap of $33 billion, almost $1.5 billion in EBITDA, 9,500 employees, 17,000 acres of land, $1.5 billion in net cash, $425 million in CapEx in the trailing 12 months, and their co-CEO is the founder. All of these statistics I just listed trump their competitors.

Another slide shows that Copart has three times the number of unique visitors globally. A big issue with IAA, according to this presentation, is that they lease their land and have largely neglected reinvestment, while Copart has heavily reinvested in CapEx since 2016. So IAA has just fallen further and further behind on all fronts, and they need to invest billions of dollars just to try to compete and regain that market share.

The situation IAA is in with them paying these big dividends to their parent company puts Copart in such an advantageous position where they just continue to get further and further ahead with their continued competitive advantage. There’s one slide here that I feel is such a good business lesson.

It’s titled “RBA Management is in denial on why IAA will not be the exception to the laws of nature.” It states, “The history of marketplace businesses contains numerous examples of number two players burning enormous amounts of cash to catch up with no sustainable share gains to show for it.” Then it shows brands such as Amazon versus Walmart, Uber versus Lyft, Spotify versus Pandora, and then Airbnb versus Vrbo. And of course, we have Copart versus IAA with Copart having a market cap 5.6 times the size of IAA. The point they’re making here is that the first mover gets a sizable head start.

Over all of their competitors, and it becomes exponentially harder for the other players to catch up, meaning that you just can’t simply invest the same amount of money that the first mover did. You’re going to have to invest much more than the first mover just to even have a shot, because there are many different aspects that are difficult, if not impossible to capture, such as the customer mindshare that the first mover got.

Once someone is so used to shopping on Amazon, and it works really well for them, why would they all of a sudden want to switch over to shop on Walmart online for all of their online shopping? The same concept applies to co-part with their online platform. It’s also really nice as shareholders to really only have one real competitor.

[00:38:00] Clay Finck:  80% of the market they’re in is split between Copart and IAA. In the US, Copart has a 40% market share, so there’s still room for them to grow and continue to capture share from their competitors as well as just the overall industry growing and expanding itself. So they’re growing in terms of stealing market share, and then they’re also growing from the overall industry growing as well.

The competitive landscape is not really a situation where there’s dozens of players and you don’t really know who the clear winner is going to be. I listened to another podcast that Chris Mayer was on, and he was talking about his research and how he had spoken with someone who worked at IAA, and he asked this person that worked there how difficult it is to compete with Copart.

And the guy evidently told him that it would be crazy to compete with Copart. You’d have to get all these physical yards all over the country in places that are, you know, really tough to get land. And then from a physical perspective, it’s just not the type of business that people really get attracted to.

And then there’s the regulatory aspect and the zoning laws as well, where only certain pieces of land can become a lot for salvage cars. So essentially in order to get the land you need to be buying a lot of these lots from Copart themselves that were able to get these back in the 1990s when the laws were different.

You know, the zoning and regulatory aspect in that landscape was totally different. Copart’s advantage seems to be especially shining in the past couple of years as their revenue in 2021 increased by 22%, and then 2022 increased by 30%. It’s just really amazing. One piece I really like about Copart’s business is that there’s both the physical and the online presence.

So they’re benefiting from both. The online piece enables the network effects where anyone can go online and purchase the vehicle. And then the physical piece is all the land they’ve purchased to support that online network and make it incredibly expensive for a competitor to work its way into their business and industry.

[00:40:00] Clay Finck:  And it took a ton of time and a ton of effort for them to build this out. It’s not like they’re just a pure technology company that might be disrupted by a new technology. So I definitely think that sort of industry dynamic and that dynamic with Copart is definitely worth considering. Taking a look at insider ownership, I found some data on this site called SEC Form four.

Willis Johnson, the founder, owns almost 25 million shares, which today is worth roughly 1.9 billion. So he has substantial alignment of interest with shareholders. The CEO Jay Adair owns 5 million shares, and the co-CEO Jeff Liaw owns 325,000 shares. The CEO, Jay Adair is Willis Johnson, the founder’s son-in-law. Jay started with Copart all the way back in 1989 at the age of 19, and he became the CEO in 2010. Willis Johnson is no longer with the company, the founder, but he still has significant ownership in Copart. So the insider ownership seems to look really, really good.

Copart’s managers really are best in class as they always think really long term, and they’re always looking to allocate capital effectively. Their return on invested capital has increased in recent years, like I mentioned earlier and year after year. It’s just been really strong and consistent. Here’s a line from their CO CEO, Jeff Leo during their Q4 earnings call that I wanted to read here. The priority certainly is always to invest in, and this is what any good steward of capital would, I think, is the framework they would approach the question with, which is, how do we maximize those returns over 30, 40, 50 year time horizons? And if that is your framework, we would always elect to invest productively in the business long term. There is power in the network, there’s power in physical capacity, there’s power, as you heard me say in owning it. And controlling it into perpetuity. We generate cash, of course, net of those investments as well.

As you know, from our history, we buy shares back. We do so aggressively in real volume. We also do so periodically as opposed to a predictable routine buyback program. But at some point we will be buying back more shares. As Jeff stated, management is very opportunistic about performing share repurchases. Buffett taught us that you only want to perform share buybacks when the intrinsic value of the shares is more than the share price. If buybacks are performed when the stock is overpriced, then shareholder value is being destroyed. As a result, very few management teams truly act in shareholders’ best interest in this way.

[00:43:00] Clay Finck: Since Copart has a really strong balance sheet, they’re also well prepared to serve their largest customers, such as insurance companies, during these times when they need Copart the most. This could be during something like a natural disaster, such as a hurricane. Insurance companies want to partner with a business they can trust, which management really understands and really wants to take care of their customers.

Back in 2019, Copart partnered with Geico to take on more of their business over time. A big reason they did this was because after Hurricane Harvey, I, as a supplier, wasn’t able to meet Geico’s immense needs during that time. Sometimes it literally takes a disaster for a business to make a change, and insurance definitely isn’t an industry where players are moving really quickly. They’re really slow to change, and while Copart focuses on having these long-term relationships with their customers, they continue to attract business from their competitors. Because they’ve built that trust and that reputation relative to their competitors.

In fact, since I mentioned Geico, when I, as a supplier, would report the results, they would exclude one of their large customers when they would present these pieces of the results to their shareholders, and that company that they excluded was Geico. Geico was transitioning away from IaaS to Copart, and rather than presenting the facts to shareholders, they would try to cover up that information and say, “Hey, if you ignore this one customer, then we’re actually growing,” which alone is a tell of managers I personally don’t want to be partnering with. I want managers that are being honest, they’re being transparent, and they’re being straight up with their results and taking ownership of their results rather than trying to hide or manipulate them.

[00:45:00] Clay Finck: The other reason Copart holds so much cash is that they want to be in a position to opportunistically buy back their shares. It’s no wonder that management thinks and acts like owners and acts in the best interest of long-term shareholders. If you were to own hundreds of thousands of shares, you wouldn’t want to be destroying shareholder value by overpaying on buybacks or incurring unnecessary taxes by paying out large dividends to their investors. Copart doesn’t even pay a dividend, and that’s because Copart’s managers have skin in the game, while IaaS’s managers do not.

Transitioning to cover the risks, one risk with Copart is the eventual transition to autonomous driving. Hypothetically, if autonomous driving is really good and many people are using it, then in theory, there will be fewer accidents and less inventory for Copart. Autonomous driving is not here yet, as we all know, and we don’t know when that will really be widespread. The kicker with Copart is that since there is so much technology involved with cars nowadays, this has actually been a tailwind for their business because a lot of times when you have these minor accidents, it essentially totals the car because it’s so expensive to fix. So for now, it seems that the rise of technology in vehicles is more of a tailwind rather than a headwind for Copart, which is another interesting dynamic in my mind.

Another piece to consider here is that Copart is continuing to expand internationally. So while there may be autonomous vehicles rolling out in the US and Europe, there won’t be in a lot of other places.

They’re expanding over the near term, say five to 10 years. Autonomous driving shouldn’t be a big risk for Copart, in my opinion. 

 [00:47:00] Clay Finck: And management also discussed electric vehicles in their Q4 earnings call. The EV market is still very small, but as it grows, it will actually benefit Copart as well because they’re easier to total due to the more advanced technology in them.

And then there’s just an absence of repair networks for these vehicles. Given the sheer change that can happen in society over the long run, it’s really hard to tell what Copart’s business will look like way down the line. So turning to valuation here, Copart is definitely not a cheap company.

When looking at the multiples, I’m looking at the EV to EBIT, for example, it’s currently around 26, and over the past five years, this multiple has trended from 17 to around 35 in late 2020. So today’s EV to EBIT is roughly in the middle of where it’s been historically over the past five years. And then the PE tells a similar story, which sits around 31 today for fiscal year 2022.

Again, they grew revenues by 30% year over year, which is partly due to the tailwind of rising used car prices during the year. Copart shouldn’t be too dependent on high used car prices, I don’t think. On the one hand, their average selling price on their services or revenues increases as the price of cars increases.

But on the other hand, as the price of cars increased, more people would be willing to repair their cars rather than sell them to Copart. So it’s kind of a give and take. Either way, it’s clear that Copart has seen really strong growth internationally, and it’s been continuing to steal market share from their competitors, such as IAA.

[00:49:00] Clay Finck:  Copart’s units in Q4 were up 5% year over year, while IAA’s units were down 3%, and they operate in a really large and growing market.

 As the US has roughly 285 million cars in operation, which is growing at around 2 million cars per year after considering what’s added and what ends up getting totaled, Copart’s market cap is around $37 billion.

They have a rock-solid balance sheet with $1.4 billion in cash, and then running a bit of math on the valuation here, just based on their net income numbers, which I will take at face value as their owner’s earnings before making any of their internal investments. Net income has grown by 21% annualized over the past five years, which is really high because we’ve seen a big boost in their business since Covid with a market cap of $37 billion and a net income for the trailing 12 months of $1.1 billion.

That puts their multiple at 34. When I project that out over the next five years, for example, and then assume a multiple of 25 at the end of five years, right now, the market is currently pricing in earnings growth of around 13 to 14% over that five-year period. So essentially, if Copart grows their earnings at around 13% over the next five years, and you see some multiple compression down to a multiple of 25, then I would expect this stock to return around 10%.

If you’re a long-term buy-and-hold investor, then today’s price is probably a fair price. It’s not super overheated, and it’s definitely not a screaming bargain. If you’re more opportunistic about your purchases and being selective when you buy, like my co-host, Stig Brodersen is, then you’d probably want to put Copart on your watchlist and keep

[00:51:00] Clay Finck: It seems that the more I read about Copart, the more I really like their business. I don’t believe I’m one to say whether it’s far overvalued or undervalued at today’s price, but I do believe that over the long run, this business will continue to do really well. One of the things I almost always look for in a company as well is to see how it did during the great financial crisis to see how resilient it is to weather through big economic storms.

Copart’s revenue was up 40% in 2008, just before the crisis, and then it was down 5% in 2009, so it definitely didn’t do too bad considering it had such a boost in 2008. Then during the crisis, they still remained profitable, so there was really no real detrimental threat to the underlying business. Remember that Copart is ultimately tied to the automobile market.

It might not be a surprise to you, but during a recession people still drive their cars and they do what they need to do, and inevitably accidents still happen. I saw one write-up on the company mention that this is very much like a Peter Lynch type stock. Since they’re in the junkyard industry, it’s just not a sexy business.

It’s not like Tesla with its cool cars and outspoken CEO and fun things always happening. It’s really the complete opposite, so simply because of that, it probably won’t get a lot of attention from everyday retail investors. If you’d like to learn more about Copart, Chris Mayer recommended reading the book “Junk to Gold.”

I haven’t gotten the chance to read this, but if he recommends it, I’m sure it’s a really great story talking about the rise of Copart. As always, nothing stated on this podcast is intended to be investment advice. Please consult a professional before making financial decisions. 

[00:53:00] Clay Finck: If you’re like me and enjoy learning about individual stocks and maybe what types of companies other people are researching, then you may consider joining our TIP Mastermind community here. Soon, I’m going to be chatting with Stig Brodersen and doing a Q&A session with him. Stig is meeting with the management team of a small company that’s only around $300 million in size, so I’m really interested to hear Stig’s thoughts around why he’s so interested in learning more about such a small company.

I have another call booked with Lance, who is a member of our community and he has aspirations of starting his own fund, and I have another call booked at the end of May to chat with a gentleman who specializes in researching potential multibaggers, which I absolutely love chatting about. I really enjoy being a part of this community because I think it’s just a great way to source ideas from others as well as stress test your own ideas.

I’m well aware that I have blind spots, so I’m always interested to hear the opinions of others who are like-minded value investors. Community members also get access to a community forum to collaborate and share ideas, as well as our paid tier of our TIP finance tool. Anyways, if you’d like access to these exclusive conversations, then you can check out the community by visiting theinvestorspodcast.com/mastermind.

That is theinvestorspodcast.com/mastermind to check it out today. That wraps up today’s episode. I really hope you enjoyed this one. I really enjoyed putting it together. I always love researching high-quality compounders. If you’re on Twitter and enjoyed this episode, I’d really appreciate it if you shared it and tagged me @Clay_Finck.

That would be very much appreciated. Thanks again for tuning in and I hope to see you again next week. 

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