Bill Ackman Just Made a $1 Billion Bet on This Stock...

Billionaire investor Bill Ackman runs one of the most closely filed portfolios in all finance. The Preferral he runs, named Pershing Square, has assets under management of more than 10 billion and sizable holdings in well-known companies. These companies include Chipotle, Hilton, Lowe's, and Restaurant Brands, which owns Burger King, Tim Hortons, and Popeyes.

Ackman recently announced two sizeable changes to his portfolio just this past week. It is important to note that Ackman is best known for being an activist investor, meaning an investor who takes an ownership stake in a struggling company and then attempts to make changes to improve the company and, as a result, increase the stock price. However, Ackman is such a big believer in this one stock that this is not an activist stake; it is traditional buy and hold investment.

"Take a listen to see what he had to say," he mentioned. "Starbucks, which is really an amazing business largely because he got to a price it was hard to earn the kind of excess returns we like to earn over time. You know, Kevin Johnson's done an amazing job; the team's done an amazing job. It's really a great, great business. But the stock just recovered too quickly, too fast, to—and I think investors will do well with Starbucks—but for a very brief moment, another restaurant company that we fought very closely over a long period of time dropped dramatically in price for reasons we didn't understand, and we were able to swap Starbucks for Domino's Pizza."

"Oh okay, well that's being nice," he continued. "We didn't get as much as we would like, but we own a little under six percent of the company. Okay? And that's been a standout in the pandemic, right? I mean, can you talk a little bit about what else you've liked about Domino's?"

"So one, obviously we like the restaurant industry. You know, interestingly we've never lost money in investing in a restaurant company. I think we've never not made a lot of money. And just to remind people, you own Burger King's holding company and also Chipotle. Yeah, so it's a space in history we know we like. Domino's is a pure franchising company, and interestingly, you know, they were really first and best in sort of technology and delivery, and they own their own dealer infrastructure, so they don't need to rely on the Door Dashes and Uber Eats in the world. And that is actually an important competitive advantage in a world where you want to deliver. You can deliver pizza for 7.99; it's hard to do that with a delivery service taking a massive, massive cut of the proceeds. So, it's an extremely well-run company. They've done an incredible job on everything about the way they run their business, to the way they grow their business, and to the way they, you know, allocate capital in their business. So it's a real standout; we admired it for years, and it was always never cheap enough, and then for about five minutes it got cheap. I don't know who sold or why, but we started buying around 330 a share and then it very quickly moved up a lot."

Before we get into the rationale behind Domino's investment, let's address Ackman's decision to sell out of his Starbucks stake. He is clear in the interview that he doesn't think that Starbucks is significantly overvalued, but rather he liked the opportunity that Domino's stock provided—a need to sell a position to fund the Domino's purchase. Starbucks stock has had quite a run over the past year, more than doubling from the market lows of March and April 2020. Given the quick rebound in the stock price, it is reasonable to assume that the stock price may have gotten a little ahead of the underlying fundamentals of the company.

When you look at Bill Ackman's portfolio, it is clear that he is a fan of the restaurant industry. This raises an important question: why would Ackman, one of the premier hedge fund managers with access to tons of investment information and opportunities, concentrate such a large part of his portfolio on this one industry, which is considered by many to be highly competitive? And even better yet, how does Domino's line up against his strict investment criteria?

"Take a listen to Ackman explain what he looks for in an investment, and then we'll examine the Domino's decision to invest," he remarked. "We look for very high-quality businesses, what we describe as simple, predictable, free cash flow generative, dominant businesses—a business that Warren Buffett would describe as having a moat around it, right? If you believe that the value of anything financial is the present value of the cash you can take out of it over its life, well, you need to know how much cash it's going to generate over its life. So, the business quality to us is the single most important criterion for determining what's interesting because if we can't predict the cash flows, we don't know what it's worth, we can't invest. So we figure out what it's worth, figure out how good the business is, how predictable will its cash flows be from a railroad or a spirits company or a real estate company, shopping mall business."

"And then we say, okay, well where's the trading? If there's a wide gap between price and value—you can buy for 50 cents, it's worth a dollar twenty—and then we're going to take a hard look and try to understand why it trades at a deep discount. And once we understand the reasons, we decide if these things that we can solve—you know, can we, in light of the situation, the circumstances, can we be influential in changing these levers that can cause this valuation discrepancy to narrow? And is this a business that, while we're causing the valuation discrepancy to narrow, we can also perhaps contribute to the valuation growing? And if those things are true, we found something that looks quite interesting for us."

The first point Bill Ackman makes is that he looks for a business that is dominant or, to use a Warren Buffett term, has a strong moat around it. It is clear that Domino's has been able to develop a strong moat over time. After gaining a reputation during the early 2000s as one of the world's worst pizza chains, Domino's went through a major shift in late 2009. The company started airing self-deprecating commercials that openly acknowledged their pizza wasn't good, and they were committed to upgrading their product. This turnaround was successful and helped Domino's establish a strong brand and loyal customer base. This strategy helped Domino's become the largest pizza chain in America based on sales, higher even than competitors such as Pizza Hut and Papa John's. The company has been around for more than 60 years, and it wouldn't be surprising for Domino's to be a leading restaurant brand 60 years from now.

The second criterion Ackman has is that a business needs to produce steady and predictable cash flow. This helps Ackman determine a value for a stock and ensure that he is buying for less than the true value of the company. Domino's easily checks the box on his criteria; the company has produced positive cash flow since it became a publicly traded company in 2004. Even during the Great Financial Crisis, Domino's has also been able to grow its cash flows substantially over time, from 42 million dollars in 2007 to over 500 million dollars in 2020. This is a 12 times growth in free cash flow in just a 13-year period. This is impressive for any company but especially for a company like Domino's that operates in the highly competitive restaurant industry.

Something else that Ackman mentioned is that a company needs to be simple, with little technological change impacting the industry it operates in. This helps Ackman more accurately predict the future operating results of the company, or to put it in another way, the ability of that company to produce cash flow over time. While some of the best-performing stocks of the past decade have been technology-focused—think Netflix, Zoom, Nvidia, and Tesla—Ackman avoids these types of stocks because of the uncertainty around the impact technology can have on the business.

"Bottom line is every company today is a technology company," he stated. "Whether you're Lowe's, Home Improvements, Starbucks, or, you know, a pure technology company. We've never really invested in what I would call a pure technology company—think Waymo or his bluff-driving business. You know, with respect to Pershing Square taunting holdings, we want to buy a business that we can predict what it's going to look like over a long period of time, and therefore we can predict what it's worth. I think it's very difficult to value what I so-called pure technology company compared to high-growth tech companies."

Domino's core product offering—pizza—likely doesn't have to worry about becoming obsolete due to a new technological breakthrough. Pizza has been a staple of the American diet for generations, and that trend is not likely going to change anytime soon. Because of this, Ackman is better able to project the cash flows that Domino's will produce better than a high-tech software company, for example.

Ackman needs to buy the stock for less than the true value of the business. Ackman was able to do this when he bought Domino's stock after a pretty substantial pullback in the company's stock price. While Ackman admits he doesn't know exactly what caused the pullback in Domino's stock price, he sure took advantage of it—buying a six percent ownership stake in the company for an average price of around 330 dollars per share.

So there you have it. It seems like this investment decision fits pretty well within Ackman's portfolio. It'll be interesting to see just how long he plans to hold on to this investment. Thank you for watching. Make sure to like and subscribe if you found this analysis helpful and interesting. Talk to you soon.