Pat Dorsey Returns - The Moat Portfolio

**Patrick O'Shaughnessy** (0:00)
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Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com.

**SPEAKER_2** (0:59)
Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.
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**Patrick O'Shaughnessy** (1:23)
My guest this week back for a second conversation is Pat Dorsey. Pat ran equity research at Morningstar before leaving to start his own asset management company, Dorsey Asset Management. His areas of deep interest are competitive advantage and capital allocation. He believes that capital allocation should be in service of a competitive advantage and invests in a concentrated portfolio that he and his team feel embody these ideas. If you have not already, I strongly recommend listening to our first conversation first, which is a sort of crash course on moats. In this conversation, we cover different ground. We spend much more time on individual stocks like Facebook, Google and Chegg, using them as examples to explore Pat's investment philosophy and strategy.
Across a few conversations with Pat, I can tell he is in love with this stuff and I always enjoy talking to investors like him who so passionately pursue an edge. Please enjoy round two with Pat Dorsey.
At the first time that we spoke, we did sort of a 45-minute crash course on all things moats and capital allocation. We'll touch on some of those ideas as we talk about some businesses today, but we'll explore a couple of other different topics first and I think a fun place to start would be your framework for valuation. So obviously you're looking for companies that have moats, hopefully run by people that are good capital allocators, but at the end of the day even if you had those two things there could be a price at which it didn't make any sense to buy the business. So in your third quarter letter this past year you did sort of a deep write up on how you think about valuing a business and so I would just open it up to you there to talk a little bit about the methods that you've used and found to be successful.

**Pat Dorsey** (2:54)
So from a holistic perspective we do not buy $0.60 and I think that if you view a business as a dynamic collection of projects, which is what any business is, you cannot look at it as a $0.60. I think that makes sense if you're looking at more static enterprises, if you're looking at businesses that perhaps have a lot of hard assets to them, real estate, oil and gas, but if you're looking at a business that is growing and producing cash via different projects, I think you have to take a more dynamic view. And so what we do from a technical tool perspective is we use both a DCF full three-statement model as well as an IRR framework and those two do two very different things. The DCF helps us unpack the cash economics of the business.
DCFs are, as you know, very blunt tools. I mean, one change can swing it one way or the other. So we actually place very little confidence in our point estimate.
What it helps us do, however, is frame what are the value drivers here? What are the things that move the needle? And you can also run some scenario analysis with it. We marry that with a more less academic, more market-based framework, looking at our free cash flow and EBIT forecasts three and five years out and then applying a multiple to those what we think is reasonable, either higher or lower than today based on kind of where we think the business should be. Again, it's subjective, but the idea is that's kind of a more market-based approach and it should triangulate with the DCF model. And we use a minimum 15% IRR hurdle for the EBIT free cash flow.