Henry Ellenbogen - Man Versus Machine - [Invest Like the Best, EP.452]

Welcome, I’m Patrick O’Shaughnessy, and you’re listening to Invest Like the Best, where we explore ideas that make us better investors of time and capital.

My guest is Henry Ellenbogen, founder of Durable Capital Partners and former leader of T. Rowe Price’s New Horizons Fund, where he built a standout small‑cap growth track record; his philosophy centers on understanding people and change, and he loves backing “act two” teams who turn lessons from a first win into lasting compounding. Let’s start with the origin story of your approach and the core ingredients that shaped it.

I didn’t come up through finance; science and policy shaped how I think about systems in balance, which led me to companies that serve customers, employees, owners, and communities in a healthy way.

My mentor at T. Rowe, Jack Laporte, taught me to back owner‑operators in small companies with strong cultures and sharp capital allocation, and that lens stuck.

When I took over New Horizons, I read fifty years of letters and saw that only a handful of stocks drove most of the returns; one missed Walmart became a lesson in how a single sale can erase a decade of good decisions.

Studying history, I concluded that roughly one percent of companies compound at approximately twenty percent for a decade, and most begin as small caps, so I built a philosophy and an organization to maximize our odds of finding those.

Once you knew you wanted to live in that one percent, what signs tell you a company might belong there, especially around the IPO boundary?

Repeat builders are more likely to do it again, so we study prior winners deeply and build case studies to spot patterns.

The winners aren’t confined to tech; durable advantages can emerge in broad industries when incumbents use new tools to reset cost or convenience curves.

Domino’s is a favorite example: they upgraded the product, then used software to make ordering and targeting radically easier, which compounded into a brand and unit‑economics edge.

We look for “good to great” transitions where technology turns a solid physical‑world business into a structural advantaged one, and we anchor on people we’ve known and tested over years.

Meeting Luis von Ahn at Duolingo felt like meeting a technologist with rare clarity and communication, much like my early time with Tobi at Shopify, so we cleared our calendars to go deep.

Talk more about act two teams and why they can create especially durable compounders.

Act two is when founders take domain mastery and apply it with a clean sheet and a better platform, which lets them solve edge cases from day one.

Workday’s founders had built PeopleSoft and knew HR systems cold, then used cloud to rebuild the system of record correctly for scale.

Max Levchin is another archetype; we first backed him at Slide and later at Affirm, where his technical depth, recruiting gravity, and resilience stand out.

When you built Durable, what did you change in your own act two, and what did you leave behind?

We kept the core mission—back small companies that can become large—but rebuilt structure so the same investor can follow a company from late private through public and stay engaged across that arc.

Time allocation follows future compounding, not current position size, and our memos require that if the thesis works, we’d want to add at higher prices; we’re transparent with our investors that this approach brings nearer‑term volatility.

So you build positions by adding as the business proves itself, even if the stock is higher?

For early growth names, we underwrite a three‑year path to competitive advantage and add as risk falls and quality shows through; for established durable growers, market dislocations often let us buy more on drawdowns.

Our work on Colliers is a good example: the market labeled it a cyclical broker, while we saw a capital allocator building higher‑quality, less cyclical earnings streams.

How have changes in market structure and principal‑agent dynamics shaped your process?

We studied quants years ago and concluded machines win short‑term pattern games, so we doubled down on people and change, where human judgment still has edge.

With most institutional flow tied to one‑ to three‑month horizons, earnings seasons swing wildly; we choose to do fewer things and know them so well that we can lean in when the crowd is forced out.

In 2022, loss‑making small caps were thrown out broadly; we added to Duolingo because we believed it could adapt and earn real returns under higher rates.

You’ve lived through internet, mobile, and cloud; where does AI fit, and which patterns carry over or break?

AI is at least as consequential as the internet, and we approach it by asking how it changes our companies’ cost curves, product velocity, and defensibility rather than buying a theme.

Think of China’s role in product cost as an analogy; AI is that for white‑collar and IP‑heavy work, and leaders like Max at Affirm expect to grow without adding headcount by leaning out processes.

Danaher’s business system shows how disciplined process improvement compounds; AI lets you bring that Kaizen to knowledge work at scale.

Amazon’s playbook still applies: ride a structural cost curve, gain share, and reinvest the unit‑economics edge into moats that persist even if competitors wake up.

So you’re finding the teams who can catch those curves early and also making sure you don’t own the ones that get run over.

Exactly, and our favorite outcome is when already advantaged companies use AI to move from good to great.

What have the best CEOs you’ve backed done to adapt themselves and their organizations to fast change?

They start from operational strength, are already winning in a core market, and show resilience and humility while moving decisively.

At Duolingo, Luis is shipping new products like chess far faster with tiny teams, which raises both the opportunity and the required discount rate; we size risk and reward accordingly.

If Kaizen for physical product and Kaizen for digital work had a child, it would be robotics; how are you thinking about that wave?

Our views are early, but in several use cases robots already beat analog processes on cost, and improvement will be geometric as general models feed machine iteration.

If costs fall by mid‑teens annually for years, companies on the right curve could pull away in power‑law fashion, especially in distribution‑heavy and other physical networks.

Do you have a favorite kind of moat you return to?

I love hard‑to‑replicate physical networks—fulfillment centers, reconditioning hubs, service footprints—because you can’t spin them up quickly or place them perfectly after the fact.

I also admire cultures like Danaher’s and leaders like Jay Hennick at Colliers and FirstService, who compound through decentralized incentives and sharp capital allocation even without a single obvious network effect.

What makes for a great investment memo in your shop?

It forces clarity on competitive advantage, culture, and owner‑mindset, and it lays out the few things we’ll track so we can add when it’s working or sell when it’s not.

We do quarterly operating reviews across the entire book and simple three‑year lookbacks that compare what we underwrote to what happened, which keeps us honest and learning.

You did a CEO tour in 2022; what was the message then, and how would it differ now?

Back then, we helped leaders recalibrate for positive real rates, where progress toward profitability matters again and free money patterns no longer apply.

We advised companies like Duolingo, Toast, and Affirm to show credible margin paths and communicate with discipline; today we’re back to listening and learning as the environment normalizes.

You once distilled decades of media history into a few pages; what did you learn that still matters?

Cable networks were incredible compounders inside a closed system, but broadband broke the gatekeeping and let new standards like YouTube and Netflix win.

The dangerous move was owning yesterday’s durable asset while the distribution paradigm shifted; the safer move was backing the next platform.

How do you find and develop investing talent at Durable?

We hire for curiosity, resilience, and team competitiveness, often from nontraditional backgrounds, and we expect junior voices to influence decisions.

People learn to analyze early private and scaled public businesses, because our edge is following great people across stages and contexts.

“Make your colleagues better” is a core value; how do you actually enforce it?

We run 360s that demand specific examples tied to investments, and we create forums—idea meetings, Friday lunches, KPI reviews—where shared insights are the currency.

Offsites are learning sprints, not trust falls; we review, study, and teach each other so the whole team compounds.

Those reviews must sharpen the upfront projections.

They do, but the tone matters; we’re clinical, not punitive, because honest self‑assessment is what improves judgment over time.

From your tour of great and not‑so‑great investing franchises, what did you take away about enduring beyond the founders?

You have to design the system for long‑run success from day one, hire only people who can be future stewards, and keep growth subordinate to investment excellence.

We’d rather do a few new privates each year and support them deeply than scale for its own sake, while proving the next generation can lead investments.

Why should great private companies still consider going public?

Staying private longer can work for some, but the public markets are a proven path to build generational compounders if you use the feedback and discipline well.

Netflix’s messy transition from DVDs to streaming showed how public signals can force scenario planning, realign incentives, and fund the next act without losing the plot.

So the value is the daily mark as a signal and the depth of capital to act on it.

Yes, and the discipline that comes from balancing growth, innovation, and profitability, with a CFO who sets standards that sharpen choices instead of just policing costs.

Any final ingredient we should know about you and Durable?

We want to win while rooting for others to win, too; we’re fiduciaries first, but we keep supporting founders we believe in, even when we’re not shareholders, because the relationship and the craft matter most.

So you’re contrasting a peak Warriors, Steph-led style with the Jordan model?

Yes. Like John Wooden, who prized character while letting very different stars be themselves, the best teams blend joy with excellence—from Magic’s Lakers to the early Warriors, whose energy and threes changed the game; Steve Kerr mixes competitiveness with mindfulness and fun, even visiting players at home to truly know them, and that’s my blueprint for building something durable.

Let me end on my usual question: what’s the kindest thing anyone has done for you?

I’ve thought about this because I listen to your show: my mom. After my parents split, she raised me; when I left Harvard at nineteen to run a House campaign and then wanted to drop out to be the new congressman’s chief of staff, she loved and supported me but made it my responsibility to fund school if I ever returned, which taught me to choose carefully and own the consequences.

Beautiful story, a different flavor than most. I loved it, and thank you, Henry.