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Zorea Capital Equity 4Q 2024 letter
- Simon Bennaim
- Jan 7
- 12 min read
Updated: Mar 21
Fellow investors,
This marks the first annual investor letter from Zorea Capital (“Zorea”). Zorea commenced operations in 2024, launching our equity portfolio on May 1st. Consequently, our 2024 performance includes only eight months. As long-term investors, we emphasize that eight months is a very brief period. We advise against drawing any significant conclusions from the performance figures below.
Our performance for 2024 was 6.6% (gross) and 5.3% (net). Our net performance is calculated with our standard fee schedule ‘M’ which charges the highest management fee from our different alternatives but no performance fee. As will be elaborated on later, the share price of our companies underperformed the underlying company fundamentals. This, along with some portfolio changes, leads us to believe that our portfolio is more attractive today than on May 1st.
Our goal at Zorea is to achieve attractive absolute returns while taking on a low risk of capital impairment (over a market cycle). In our experience, most managers with strategies similar to ours aim for positive relative returns. The average equity manager would rather lose money but outperform their benchmark than make money but earn less than the benchmark. In other words, most funds would take Scenario A below over Scenario B.
Our perspective is different. We chose Scenario B. We care most about our investors’ growth in purchasing power. Otherwise, why invest! While we cannot guarantee future performance, our explicit goal is for our investors and their heirs to have substantially more purchasing power in the future because they invested alongside us.
We do expect to perform better than market indices over a market cycle. It is just not our goal, but the output of our goal.
Broader market behavior can impact our performance. Rising markets can be a tailwind to our portfolio, while falling markets can be a headwind. On the other hand, we own a portfolio of 12 stocks, whose businesses (and stocks) will behave in idiosyncratic ways. As long-term investors, it can take time to know whether we are right or wrong. This makes your job – evaluating our results – difficult. That is why it is important for us to provide you with the tools to track our underlying performance.
How we suggest you track our progress
In our presentation Investing in the Public Markets: Separating the signal from the noise, we argue that as long as an investor doesn’t overpay to buy a stock, and is willing to own it for years, the investor’s results will be at least as good as the underlying businesses’ results. Over a period of 10+ years (the longer the better), the stock’s returns will be primarily explained by earnings per share (EPS) growth and dividends[1]. Additionally, although there are exceptions to this, we believe revenue growth and returns on capital[2] tend to be two of the most important drivers of long-term EPS growth.
This same logic can be applied to a portfolio of stocks (such as Zorea’s). In essence, Zorea’s portfolio is an aggregated stream of earnings. Similar to a large company that owns several businesses that together determine the results of the parent company. As such, we plan to provide you with aggregated financial performance of our portfolio companies. That way, you can judge our progress in a way that is similar to how we judge the financial progress of our companies; by looking at the underlying results, not the short-term movement in share price.
The table below includes six metrics that are relevant for giving you a sense of the financial characteristics of the portfolio you own. To help provide context, we have added comparable metrics for the S&P 500. The idea of adding the S&P 500 is so you can contextualize our metrics with those of the largest, most successful companies in the United States. Please refer to the important disclosures about our methodology towards the end of this letter.
As you evaluate the table above, please keep in mind that its metrics are about the recent past, while investing is about the future. The good news for us, if we are right, is that we expect the earnings metrics of our companies in the future to be either consistent or better than they were last year. We would suggest that the opposite is likely the case for the S&P 500 but that’s a topic for another day. Taking the above metrics at face value; our portfolio is more profitable, grew EPS significantly faster, and trades at a material discount than the S&P 500. More importantly, we believe the underlying companies producing this output have strong, defensible businesses. This provides the right ingredients to allow us to compound our capital at an attractive rate with a low risk of impairment over the long term.
As time progresses, we plan to provide you with the historical progression of these and other metrics, which should make the data more informative. In future letters we plan to provide more context on the underlying companies driving these metrics and their respective results.
Be aware that the data in the table is not perfect and sometimes comparisons are not exact, but we believe they are close and lead to the right conclusions. We think our calculations of Zorea’s numbers are conservative and, in aggregate, likely understate economic reality. For example, one of our largest holdings, HCA, has negative equity, and is therefore excluded from our ROE calculation (even though its ROE is essentially infinite). Another example is BRK.B where our ROE calculation is 8.8% vs Factest’s ROE for BRK.B at 18%[3].
Notably, the above table excludes what we think will be one of the most important metrics to track our progress; the actual ‘look-through’ earnings growth of our portfolio. This metric, which we plan to call ‘ZCE Holdco EPS growth’, will reflect our actual estimated underlying EPS growth (inclusive of portfolio changes) and we expect it will be included in our next letter.
Avoiding biases
As the great late Charlie Munger said “if you make a public disclosure of your conclusion, you’re pounding it into your own head.” Writing these letters subjects us to anchoring bias, escalation of commitment bias, and confirmation bias. Please note that no investment operation has had a perfect success rate. We will not be the first. As such, we reserve the right to change our minds and hope to do so quickly and swiftly when appropriate. We take on no obligation to communicate changes of opinion.
Watering the flowers – a case study
We believe that holding on to ‘winners’ in a portfolio of equities is one of the highest wealth creation tools available to investors. Using it can be a more important determinant of success than being a really good stock picker[4].
Here is a story to help illustrate the point. We simplify the story to make it easy to read[5]. In December 2018, I had a conversation with a relative. In our conversation we discussed a couple of companies I liked and owned. That relative went ahead and bought shares in a few of them. One of those companies was KKR, which he sized at about 10% of his portfolio. He bought shares at just under $20 a share[6].
As the years went by, this relative did not touch this (or any other) position. Since December 2018 KKR has done extremely well (both the company and the stock). The company’s shares closed in 2024 at $148 per share. Including dividend reinvestment, the investment has generated 6.9x what he paid for them, translating to an annualized total return (“CAGR”) of 40.8%!
After just six years, KKR has grown to represent 79% of my relative’s initial portfolio value. That means that everything else he owned could have had a mediocre performance, and he would have still done quite well. If the rest of his portfolio, the other 90%, would have hypothetically had a mediocre 5% annual return, his total capital would have doubled in the six years ending in 2024. That is a 12% CAGR at the portfolio level. Considering that the average 20+ year CAGR for an index such as the S&P 500 hovers around 10% and that only a very small number of managers beat the market, those are some good results. It only took one moderately sized successful investment and six years to achieve this hypothetical result.
There is no denying that KKR has been a positive outlier in my relative’s portfolio (40.1% CAGR over six years!), but the beauty is that because he kept KKR, everything else became marginal.
Our example highlights another classical trait of compounding. In 2019 and 2020 KKR’s cumulative performance was 114%[7]. That performance added ‘only’ 11% of value to the portfolio based on the starting portfolio amount. In 2024, KKR shares were up 80%, and despite the significantly lower relative performance (vs 114% in 2019 and 2020 together), that year KKR added 35% of value to the portfolio based on the starting portfolio amount. Stated another way, a 2024 return that is 30% lower than that of 2019 and 2020 combined added 3.2x the amount of dollar value. After only four years.
That is compounded growth, you don’t notice it until it is the only thing that matters. This fact pattern has implications for how we think our performance may evolve over time, with potentially bigger movements as our winners potentially start becoming a larger share of our portfolio. This is a trait that is normally associated with Private Equity and Venture Capital portfolios. We believe we are likely to display it, but with a very different risk profile than that of Private Equity and Venture Capital.
A 6.9x in KKR over six years might not mean much for some in early 2025. We realize we are writing this when many part-time investors have enjoyed a 12x return on Bitcoin, a 13x return on TSLA, and a 22x return on NVDIA over five years and while doing little work. The compelling part of the KKR example is that, for us, at the time, the probability of losing money by investing in KKR below $20 a share was extremely low. In fact, the reason we liked it then was because of the downside protection. We didn’t have a view that the company would execute as well as it did or that the valuation would reach current levels. But as it was executing, an investor could track its progress and understand that the company could do tremendously well.
At Zorea, our goal is to try to find potential KKRs (though 40.1% a year for six years is not something we will find with any regularity). We won’t know which ones will end up being the ‘next one,’ but we believe we have the tools and know-how to have a reasonable chance at finding a few over the years. And of course, always keeping a close eye on our companies, because the best company in the next 10 years can become a mediocre company in the following 10.
This is not an endorsement to buy shares of KKR.
Alignment
A cornerstone of our portfolio management philosophy is to manage client portfolios in the same way we invest our own capital. At Zorea, we cannot guarantee results, but we can guarantee that we are in the same boat as our investors.
Thank you for your trust.
Yours truly,
Simon Bennaim
Footnotes
[1] We use earnings per share as a catch all phrase to represent a company’s earnings power. Sometimes a metric such as free cash flow per share, amongst others, might be more appropriate than GAAP EPS.
[2] Because we own some financial companies, we use ROE instead of ROIC.
[3] Our method for calculating earnings for BRK.B is using operating earnings for the wholly owned subsidiaries and look through earnings for their securities portfolio. We believe this is a more accurate depiction of earnings power than GAAP Net Income.
[4] In this context a good stock picker is someone with a high hit-rate.
[5] Taxes are also excluded.
[6] For the purpose of this letter we assume shares were purchased in the middle of the month.
[7] Source data on this paragraph is Factset.
Disclaimer and disclosures
The information in this presentation was prepared by Zorea Capital LP (“Zorea”). It has been obtained from public sources believed to be reliable. Zorea makes no representation as to the accuracy or completeness of such information. Opinions, estimates, and projections in this presentation constitute the current judgment of Zorea and are subject to change without notice.
Any investment in any strategy, including the strategy described herein, involves a high degree of risk. The description of the approach of Zorea Capital LP (“Zorea”) and the targeted characteristics of our strategies and investments is based on current expectations and opinions and should not be considered definitive or a guarantee that the approaches, strategies, and your investment portfolio will, in fact, possess these characteristics. In addition, the description of our risk management strategies is based on current expectations and should not be considered definitive or a guarantee that such strategies will reduce all risk. These descriptions are based on information available as of the date of preparation of this presentation, and the description may change over time. Past performance of any strategy we employ is not necessarily indicative of future results. There is the possibility of loss, including loss of principal.
Any projections, forecasts, or estimates contained in this presentation are necessarily speculative in nature and are based upon certain assumptions. It can be expected that some or all of such assumptions will not materialize or will vary significantly from actual results. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections or estimates shown. This presentation is not intended as a recommendation to purchase or sell any commodity or security.
Performance information in this document reflects the actual performance of the account established by Zorea’s Chief Investment Officer as of May 1, 2024. Reported net performance is net of all actual trading and other account expenses, reinvestment of all income, as well as Zorea’s fees. Zorea’s fees, as presented here, are composed of our standard fee schedule for non-Qualified Clients, consisting of a 1.8% management fee. Our Qualified Clients may elect from other fee schedules we offer. Qualified Clients who elect a different fee schedule may pay higher (or lower) fees and therefore realize lower (or higher) net returns depending on the portfolio’s performance. The specific fee charged to a client will be identified in the client’s advisory agreement.
Because this account was established prior to Zorea becoming a registered investment advisor, this means the performance results are ‘hypothetical’. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio.
Index information is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators. Index performance does not include the deduction of fees or transaction costs which otherwise reduce performance of an actual portfolio.
Broader market events will generally have some corresponding impact on our results and the client portfolios managed in accordance with our strategy. For example, if US equity markets rise overall, that will frequently help the performance of portfolios with exposure to US equities, while declines in the overall US equity markets will frequently hurt the performance of portfolios with exposure to US equities. Similarly, increases or decreases in interest rates will have an inverse relationship on bond market prices (higher interest rates generally result in lower bond prices, and vice versa) and also some corresponding impact on the returns of fixed income investments. No investment approach can guarantee a positive return or prevent loss.
Performance results shown are not a guarantee of future results and are not a guarantee or prediction of how any client portfolio will perform.
The information contained in this presentation is provided for informational purposes only, is not complete, and does not contain certain material information about our strategy, including important disclosures relating to the risks, fees, and expenses. The information in this presentation does not take into account the particular investment objective or financial or other circumstances of any individual investor.
This presentation is strictly confidential and may not be reproduced or redistributed in whole or in part nor may its contents be disclosed to any other person without the express consent of Zorea and/or its managing partner.
Zorea Capital LP is a registered investment adviser in the state of New Jersey. We may not transact business in states where we are not appropriately registered, excluded, or exempt from registration. Individual responses to persons that involve either the effecting of transactions in securities or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.
Portfolio Metrics – notes on methodology:
For all companies we use latest reportable information as of the date of the quarter. The numbers are our best estimates and what we use internally. However, coming up with the different numbers requires assumptions and some subjectivity. We try to be consistent with our methodology through time but there is no guarantee of accuracy. We use source documents for our calculations. The growth calculations under this table are a weighted average of the underlying growth of our investments. Some important callouts below.
Revenue per share growth (LTM): only includes our single names (indexes are excluded). For CACC, SYF, and AER, we substitute Revenue growth for Book value growth as we see that metric as more relevant to underlying business growth.
# of Positions: excludes T-Bills.
ROE, PE, and EPS growth: all three of these metrics use ‘earnings’ either in the numerator or the denominator. For the companies that we see GAAP or IFRS Net Income as a good proxy of earnings power, we use that. For the companies where it isn’t, we use the metric we deem most appropriate, which is usually Free Cash Flow or company adjusted earnings, but can be something else. We believe we are conservative when publishing these numbers, but we cannot guarantee that such is the case. Both ROE and EPS growth calculations excludes our exposure to indexes and cash. HCA is excluded from our ROE calculation because the company has negative equity.
PE (LTM, ex-cash & index): This metric represents out calculation of PE of our individual company investments. It excludes cash as well as any index exposure we may have.