INVESTOR COMPASS

December, 2022

Concentrated value investing

 Eldred Rock Investor Compass December 2022

THE POWER OF OWNING GREAT BRANDS

“Products are made in a factory, but brands are created in the mind.”
~ Walter Landor, consumer branding pioneer

B
rands can be fantastic investments. Well-known brands attract and retain loyal customers, earn
stronger pricing power, enjoy margins double that of other manufacturing businesses, and report faster
earnings growth. They generate superior cash flow, and each dollar reinvested back into the brand
through marketing or new product development earns high returns on capital. Strong brands are an
effective barrier to competition with the Financial Times referring to modern consumer brands as the
ultimate source of enduring competitive advantages. Brands compound investor capital and produce
significant excess cash flow – creating long-term value for shareholders.

At Eldred Rock, we love owning companies with strong consumer brands because the parent company is
more resilient to economic downturns, reducing downside risk for our clients. Branded companies have
historically outperformed broader indices (Exhibit 1).

Exhibit 1: Companies with the best global brands vs. benchmarks.

Source: Interbrand analysis with data sourced from Thomson Reuters, 2019.

A brand is a promise to the consumer that builds trust over time. It may begin as a differentiated product
with tangible qualities, but eventually an effective brand will earn intangible appeal. In the late 1800’s,
bath soap was one of the first trusted consumer brands in the U.S. Colgate Palmolive, Proctor & Gamble
and others initially promised consistent ingredients and product safety (restrained use of lye). Trust
developed in these early brands – reducing consumer risk, spurring repeat purchases and the beginnings of
brand loyalty. Consistent packaging and recognizable logos reduced search costs for the consumer.

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 Eldred Rock Investor Compass December 2022

Effective marketing transitioned the brand message from the importance of regular bathing to eventually
more value-added health and beauty benefits.

Brands require clarity. A clear marketing message helps to build trust and recognition with the target
audience, and ensures that brand communication is consistent. By maintaining clarity of brand, a
company effectively differentiates itself from its competitors and builds a loyal customer base.

The best brands possess legacy and heritage through effective marketing. If your mechanical watch was
worn by the first men on the moon – flight qualified by NASA and able to survive the hostile conditions of
space, you have an iconic brand and an enduring story to sell your customers.

Source: The Omega Speedmaster chronograph in 1969. The first watch worn on the Moon.

Luxury brands are aspirational and communicate social status. As Charlie Munger has often observed,
luxury goods are the only consumer product that can both raise prices and report higher volumes.
Because of the higher prices, the conspicuous products are more exclusive, providing social proof and
raising the status for the owner.

At Eldred Rock, we own several exceptional brands in the U.S. Value and International Value portfolios. For
over the past 120 years, Pepsi became a strong national brand by differentiating itself from its competitors
and building a loyal customer base. Yet, Frito Lay is really the crown jewel of the company’s portfolio, and
dominates snack aisles around the world. Strong brands benefit from impulse buys, and Lay’s recognizable
and consistent packaging drives spontaneous purchases. Management has shown exceptional skill
evolving their snack portfolio to changing consumer tastes. We have owned PepsiCo shares in the U.S.
Value strategy for 17 years.

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 Eldred Rock Investor Compass December 2022

Source: The New York Times, 2012.

Brands must convey trust, but do not have to be consumer products. For over 100 years, the Kone Oyj
brand has meant safety and reliability. Company reputation and trust drives customers to elevator
manufacturers with a long history of successful projects in the world's most iconic buildings. Kone provides
customer value through customized product design and decades of reliable service. Kone was the newest
addition to the International Value portfolio during 3Q 22.

Name recognition does not denote a strong brand. The Chiquita name is synonymous with bananas in the
U.S. But, Chiquita fails the brand test because consumers are not willing to pay more for a Chiquita
banana than a private label alternative. Chiquita’s tangible and intangible qualities are negligible to the
consumer. It is difficult to build a brand in a commodity category where the consumer is focused on price.

Fads are not brands. Product categories where the consumer seeks to experiment are difficult for
marketers to build long term brands. Fast fashion, children’s toys, and some alcoholic beverages are
examples of brand categories that rise in popularity but disappear just as quickly. Zima, a beverage
marketed by Coors, is a recent example. Zima popularized the “low alcohol, beer alternative” category;
however, low barriers to entry, an increasingly crowded category, and poor brand management drove the
brand off store shelves within a decade. Often referred to as the Lindy Effect, the best test of a brand’s
future life expectancy is proportional to their current age – with each year the brand survives, their life
expectancy increases. It is difficult to kill brands with legacy and heritage.

Effective brands must build customer loyalty or possess strong pricing power. The best global brands deliver
both. At Eldred Rock, we seek proven businesses run by competent management teams with a long
history of brand building and creating long-term shareholder value. During most market environments,
these high-quality companies sell at a premium. Occasionally, transitory issues arise, disappointing
investors, but creating compelling long-term opportunities for our clients.