Chris Bloomstran – What Makes a Quality Company - [Invest Like the Best, EP.141]

Theme 1: The Core of a Quality Business—High Incremental Return on Capital and a Unique Business Model

Chris Bloomstran believes that the most important metric for assessing the quality of a business is the incremental return on capital—the rate of return a company can achieve by reinvesting its retained earnings. He elaborates on this view using the case of Costco.

• The Costco Case: Bloomstran bought Costco in 2004 at a price-to-earnings ratio of about 20x, when its overall return on capital was only 11%, which seemed unimpressive. However, he found that new stores took 6–7 years to mature, and mature stores generated returns on capital in the mid-to-high teens. As the proportion of new stores declined, the overall return naturally improved. Today, Costco’s return on capital stands at 21–22% (with 2–3 percentage points attributable to tax reform). More critically, Costco passes on the procurement advantages from economies of scale to customers, reducing gross margins from 14% to 11%, while net profit margins rose from 1.8% to 2.1%. Bloomstran argues, “My holding in Costco is my best teaching tool—it taught me how capital works, and the importance of reinvested capital and incremental returns.”

• The Dollar General Case: Bloomstran considers Dollar General one of the few retailers capable of withstanding Amazon’s impact. About 70% of its business is in rural markets, where Amazon’s economics for delivering small orders are poor. Dollar General plans to double its store count from 15,000 to 24,000–25,000 over the next 10–12 years, with an excellent unit economic model. Management continues to improve operational efficiency by increasing the number of freezers, optimizing store sizes, and reducing employee turnover.

• The Five Below Case: Bloomstran mentions an “interesting but too expensive” example—Five Below. He believes its unit economic model is the best he has ever seen among retail concepts, but with a price-to-earnings ratio of 60x, it was uninvestable.

---

Theme 2: Distribution Rights Reclamation — A Key Strategy for Strengthening the Moat

Bloomstran highlights a key investment theme: "bringing distribution back in house," where companies take direct control of customer touchpoints rather than relying on third parties. He illustrates this with Richemont, Disney, and Cummins.

• Richemont: This company, which owns luxury brands such as Cartier and Van Cleef & Arpels, boasts a gross margin of 65%, with high-end watches reaching margins as high as 90%. When demand in the Asian market declined due to China's anti-corruption policies, management chose not to resort to discounting. Instead, they repurchased inventory from third-party retailers and even publicly destroyed some Cartier watches (removing the movements and melting down the precious metals). Bloomstran quotes Chairman Johan Rupert: "The only way to kill the Vacheron Constantin brand (founded in 1855) is to make the product cheap." The company subsequently invested in its own retail and e-commerce operations (acquiring Net-a-Porter and Watchfinder), sacrificing short-term profit margins in exchange for long-term control over distribution.

• Disney: Bloomstran argues that Disney's decision to reclaim content rights from Netflix and launch its own streaming service (Disney+) is a classic case of "controlling distribution." Disney possesses a vast library of "tentpole" IP (such as Marvel and Star Wars), which can be monetized through theme parks, retail, films, and other channels. He asserts: "Once Netflix loses this content, I'm not sure they can do what Disney does. Disney's library is priceless, and its intangible assets are priceless."

• Cummins: This diesel engine manufacturer acquired independent service centers 6-7 years ago and consolidated them under the Cummins brand. Now, Cummins not only services its own engines but also those of competitors, creating a significant competitive advantage. Bloomstran believes that despite market concerns about electric trucks disrupting diesel engines, the battery weight (approximately 10,000 pounds) would directly reduce a truck's cargo capacity by 10%, and charging times are too long, making it "economically nonsensical."

---

Theme 3: Berkshire Hathaway — Strategic Transformation from Insurance to Real Assets and Future Protection

Bloomstran provides an in-depth analysis of Berkshire Hathaway, arguing that its most critical historical decision was the 1998 acquisition of General Re. This was not a bad deal but a successful strategic transformation. He elaborates on this judgment in detail.

• The 1998 Dilemma: At the time, Berkshire's stock portfolio was extremely expensive (e.g., Coca-Cola had a P/E ratio of 45x), accounting for 65% of the company's total assets. Bloomstran believes that if the status quo had been maintained, Berkshire's return on equity (ROE) might have been only 6%.
• The Nature of the General Re Deal: Bloomstran points out that this transaction was not a simple acquisition but rather "a shift in asset allocation from stocks to bonds." General Re's assets were 90% invested in bonds. After the acquisition, Berkshire's stock holdings as a percentage of book value dropped from 115% to 69%. This provided Berkshire with substantial cash and bonds, fueling subsequent acquisitions (e.g., utilities in 2000, railroads in 2009). He calculates that without this deal, Berkshire's book value might have only grown from $35 billion to $110 billion, whereas it actually increased to $350 billion. Therefore, "this is not a single-variable assessment."

• Future Protection Mechanism: Bloomstran believes that Berkshire's future does not entirely depend on Warren Buffett. Its subsidiaries (e.g., railroads, utilities) possess "permanent" and "oligopolistic" characteristics. Railroad networks are difficult to replace, and utilities can generate stable returns under regulation. Additionally, management has cultivated a deep succession bench (e.g., Ajit Jain overseeing insurance, Greg Abel handling operations). His only concern is that if Ajit Jain lacks sufficient backup, some specialized insurance businesses may need to be discontinued.

---

Theme 4: Accounting Adjustments — A Tool for Uncovering True Economic Profitability

Bloomstran emphasizes that he adjusts GAAP (Generally Accepted Accounting Principles) data to uncover a company's true economic profitability, which constitutes a core differentiating advantage in his investment process. He focuses primarily on two types of adjustments:

• Write-offs & Write-downs: He calculates that since the 1980s, S&P 500 companies have written off approximately 15% of their operating net income annually (higher during economic recessions, around 10% during booms). This means that if a company has a return on equity of 13%, write-offs reduce its actual return by about 2 percentage points. Therefore, he insists on adjusting for these "one-time" but recurring expenses.
• Defined Benefit Plans: Bloomstran has long assumed an annualized return of 4% on pension assets (far below the 6.5%-9% typically assumed by companies). He incorporates this difference into the income statement and assumes pension shortfalls are made up over 10 years. This approach has allowed him to avoid companies with heavy pension burdens (such as automakers), which appear profitable on the surface but actually allocate substantial capital to filling pension gaps.

---

Position Moves

Ticker	Guest Stance	Key Data
Costco	Bullish (Long-term Hold)	Return on capital rose from 11% to 21-22%; gross margin fell from 14% to 11%; net margin rose from 1.8% to 2.1%
Dollar General	Bullish (Hold)	Plans to double store count from 15,000 to 24,000-25,000; 70% of business in rural markets
Richemont	Bullish (Hold)	Gross margin 65%; high-end watch gross margin up to 90%; acquired Net-a-Porter and Watchfinder
Disney	Bullish (Hold)	Recovered content from Netflix; acquired full stake in Hulu; holds a large portfolio of "tentpole" IP
Cummins	Bullish (Hold)	Acquired independent service centers; diesel engines hard to replace by batteries in the Class 8 truck market
Berkshire Hathaway	Bullish (Heavy Position)	Book value $350 billion; railroad business valued at ~$100 billion; cash reserves $110 billion
Subsea 7	Bullish (Hold)	Norwegian oil & gas engineering firm; Bloomstran sees deepwater drilling investment opportunities
Five Below	Neutral (Too expensive, not held)	P/E ratio 60x; unit economics described as "best"
MasterCard / Visa	Neutral (Not held, due to price and regulatory risk)	Not disclosed
Ross Stores	Not disclosed (Sold, then surged 20x)	Bought at 10x P/E; became a 20-bagger after sale
Microsoft	Neutral (Previously held, fully liquidated)	Market cap $620 billion in 2000, sales $20 billion; share price later fell 75%
General Mills	Risk Warning	Incentive compensation threshold lowered from 3% organic growth to -1.4%; growth driven by $8 billion acquisition of Blue Buffalo
Mylan Labs	Risk Warning	Suspicious management accounting, frequent CFO turnover, bribery issues
Coca-Cola	Risk Warning	P/E ratio 45x in 1998; total return over the next 20 years only 4.5%/year, underperforming the S&P 500

---

Judgments Worth Remembering

1. “Incremental return on capital is the most important metric for evaluating management.” (Chris Bloomstran) — Costco’s case proves that even if the initial return rate is not high, as the proportion of mature stores increases, the overall return rate will continue to improve.

2. “The only way to kill the Vacheron Constantin brand is to make the product cheaper.” (Johan Rupert, as relayed by Bloomstran) — Richemont maintains brand value by repurchasing and destroying inventory, sacrificing short-term profits for a long-term moat.

3. “Once Netflix loses Disney’s content, I’m not sure they can do what Disney does.” (Chris Bloomstran) — Disney maximizes the value of its IP library (Marvel, Star Wars, etc.) by reclaiming distribution rights.

4. “The General Re deal was not a bad deal, but a shift in asset allocation from stocks to bonds.” (Chris Bloomstran) — Bloomstran argues that without this deal, Berkshire’s book value might have only grown to $110 billion, rather than the actual $350 billion.

5. “15% of the annual net profit of S&P 500 companies is written off.” (Chris Bloomstran) — This adjustment reveals that corporate real profitability is far lower than GAAP data, and is one reason why long-term market returns lag behind return on equity.

6. “Dollar General’s rural market is a natural moat against Amazon.” (Chris Bloomstran) — The economics of Amazon delivering small orders to rural areas are very poor, and Dollar General’s 7,500-square-foot small-store model is hard to replicate.

7. “Growth is an extremely important component of the value equation.” (Chris Bloomstran) — He admits that early on, he focused too much on low P/E ratios and missed many high-growth companies (e.g., Five Below), and is now willing to pay a higher price for high-quality growth.

8. “Berkshire’s future protection lies in the ‘permanence’ of its subsidiaries.” (Chris Bloomstran) — Railroad networks and utilities are hard to replace, and management has cultivated a deep succession bench.