Akre’s Three-legged Stool Theory to spot good businesses to invest in

Eminent value investorsays the rate of return should be the bottom line of all, as it is the only standard by which investment opportunities across different asset classes can be measured.

Akre says great investors know how to best exploit rate of return opportunities in an investment and that helps them amass wealth over time.

Akre is Founder Chairman and CIO of the Virginia, US-based, and is a renowned investor, financier and businessman.

  • How it all started

Sharing his investment journey, Chuck Akre says when he started as a stockbroker in July, 1968, he had no idea about investment or stocks as he was just a BA in English literature and had not taken even a single business course of any variety.

“I had, in effect, a clean canvas, as to where I should go and what I should do. Since I knew nothing, my goal was to figure this out, and the investment puzzle I dealt with was what makes a good investor and what makes a good investment,” he said in a presentation at Talks at Google, whose video is now available on.

Talking about his early days in the stock market, Akre said in order to figure out the investment puzzle, he started reading voraciously books like The Money Masters, 100 to 1 in the stock market and Intelligent Investor, which influenced his investment journey considerably.

  • What makes a good investor

According to Akre, in order to become a good investor it is important to read about the businesses which look attractive for investment. He advises investors to read business biographies of their target companies, because they can say a great deal about human behaviour.

These biographies also reveal how great minds behave in their business life and business world, and how that affects what they are able to do.

Akre believes great investors have the ability to define the risks associated with an investment and know the amount of risk they are prepared to take. If things do not turn out in their favour, they always know the reason for losing a significant amount of money in an investment and rectify their actions.

  • How to measure a successful investment

Although a great investment might be simply described as something that has met an investor’s goal, but Akre says the only real way to measure the success of an investment is by identifying the real growth in economic value per unit of ownership.

  • How to find high quality businesses

In order to identify investments that can lead to an above-average rate of return, Akre offers a Three-legged Stool Theory:

1. Quality of business: Akre suggests investors to ‘fish in the pond’ of high return businesses as the return a stock can deliver in the long run is dependent on what a business earns. He says focusing on the right category of businesses goes a long way in spotting high quality firms.

Akre advises investors to ponder over the essence of a business and the reasons behind the unbelievable rate of return it is getting. According to Akre, businesses with below-average risk and the ones that are trading at attractive valuations are the right ones to investment in.

2. Quality of management: An important factor that can lead to the success of a business is its management team. Akre says a management that treats investors as partners and hires skilled resources of high integrity go a long way in creating value for shareholders.

“People who run the business, we want them to have both skill and integrity. What we say is that they have got a demonstrated record of being just killers at operating their business. In addition to that, they also treat us as partners even though they do not know us. It’s a really important idea, because there are people out there who do whatever they can to make sure that public shareholders do not get their fair share. And we do not want that. We want what happens at the company level to happen at the per-share level also,” he says.

3. Reinvestment of free cash flow: Akre says companies that put cash back into the business if there’s great opportunity are more likely to be successful in the long run.

Akre advises investors to look for businesses that have the ability to reinvest earned capital back into businesses as they will most likely earn a higher rate of return.

“If a business has a high return on owner’s capital, we would like them to be able to take all the free cash they generate and put it back into that business to continue to earn those high rates of return. It’s way more efficient than paying us a dividend,” he says.

  • Look for ‘compounding machines’

Akre is of the view that the three components of the Three-legged Stool Theory have the ability to create the compounding effect and businesses that meet these requirements can be called ‘compounding machines’.

So Akre believes investors who can find companies that compound capital at above-average rate on a below-average level of risk can amass great returns in the long run.

To identify businesses with below-average risk levels, Akre suggests investors to look for companies with more growth, higher returns on capital, stronger balance sheets and lower valuations than the market. There may be some risk due to volatility in the short run, but it will have minimal impact on a business in the long run, he says.

Akre says companies that can be called compounding machines are rare and, hence, suggests investors to always hold shares in only a small number of companies.

International Speedway Corporation,, Master Card, Moody’s andare some of the companies that have given Akre phenomenal returns over the years.

  • Trust your judgement

Akre says while making an investment decision, it is important for investors to apply their judgement based on what they have learnt and found valuable. There will be situations when they will make judgement errors, but with bad judgment they will gain experience. It is better to make bad judgements and learn from them as opposed to listening to others who may distract us from what we do well.

“Good judgements come from experience, and experience comes from bad judgement. We are surrounded by hundreds of people who are bright and very interesting and their stuff would be intellectually appealing to us, but they would distract us from what we do well. Create a situation for yourself where you have the ability to apply what is it that you have learnt and found valuable, as opposed to listening to what, or your next door neighbour, or your suite mate says,’ he says.

  • No magic formula to become successful investor

Finally, Akre advises investors to keep things as simple as possible, have faith in their abilities and follow whatever investment strategy suits them as there is no correct or sure-shot secret recipe to become a successful investor.

“Imagination is more important than knowledge, you know? So I say, simply use your own observations. It is very important. Just because you have a big brain doesn’t mean you could be good at investing. And finally, there is no correct answer. There is no correct way. This is just the way it works for us,’ he says.

(Disclaimer: This article is based on Chuck Akre’s presentation at Talks @ Google, whose video is available on YouTube)

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