Animal Spirits Podcast - Talk Your Book: Investing in Free Cash Flow

Starting point is 00:00:00 Today's Animal Spirits Talk Your book is brought to by Victory Capital. Go to victory shares.com to learn more about the Victory Shares free cash flow ETF and the Victory Shares small cap free cash flow ETF. That's VFLO and SFLO. Again, that's VictoryShares.com to learn more. Remember, all investing involves risk. Victory Shares ETFs are distributed by Fourside Fund Services LLC. And you can visit VictoryShareth.com for details and prospectuses. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ridholt's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spurs with Michael and Ben.

Starting point is 00:01:01 On today's show, we're talking about how to build a portfolio using free cash flow as the underlying metric. Then, a lot of the traditional value research in the academic world was focused on the price to book factor. Book value is essentially the net asset value of the company. The first time that I saw free cash flow, which is, I guess, like the modern day book value, The first time that I think I saw that was Michael Mobison, who spoke about how using free cash flow as a metric would have screened, or you would have using free cash flow to value Amazon would have showed you, yeah, this company on a gap basis is losing money for the last 37 quarters in a row or whatever it is. But if you make some adjustments and you look at free cash flow, because there's a lot of capbacks involved, which we get into in the show. If you look at the free cash flow, what is available for the company to put back into

Starting point is 00:02:04 the business, to distribute? If you look at that metric, Amazon looked like a pretty healthy, sustainable, growing business. Right. The traditional valuation metrics for Amazon were saying it's overvalued forever, which is why you tried to short it in like 2011, probably, right? Actually, that's exactly right. Yeah.

Starting point is 00:02:20 So you had to make some changes. I was getting some flashbacks from the CFA hearing about this stuff. So we talked to Michael Mack as an associate portfolio manager at Victory Capital. He helps run the victory shares, free cash flow ETFs. And yeah, I was getting, I had the three-ring binders of equations and stuff from the CFA. And I was thinking through, like, take this out, add this back in, subtract this. Yeah, bind us full of equations. Me too.

Starting point is 00:02:48 That's true. So anyway, this is, and to your point, like the whole VATTS, value thing. A lot of it, it's same thing with dividends. A lot of it depends on how you define this thing. There's not one group of this, and this is how you do value. Because I thought the most interesting thing about looking at Victory shares pre-cashly ETF is if you look at, compare it to the sectors in the Russell 1000 value index, and it's nothing like it. Right? It has way more energy, way more health care, way more consumer discretionary, and it's a totally different way of looking at it. So value is not just this one thing. It's kind of in the eye of the beholden.

Starting point is 00:03:22 Anyway, really interesting conversation. Here's our talk with Michael Mack from Victory Capital. Michael, welcome to the show. Thanks, Mike. All right, so today we're going to talk about the victory shares free cash for a strategy. And you guys have had a heck of a run I'm talking about in terms of investment appetite or investor appetite. So you started the year, the ticker is VFLO, the victory shares free cash. ETF. You started the year at just around $125 million in assets. And now you're up to

Starting point is 00:04:00 nearly $900 million. And the performance has been fine. It's, it's, you know, roughly in line with the index. Talk about typically flows follow performance, and that's not the case here. So I'm super interested to hear about what is it in the story that is resonating with investors? Yeah. We've had the advantage of having a, you know, I think, high experience. free cash flow strategy. So kind of know the market, know the client base. I think the real challenge for people is for years on the value side, you've had a lot of value investors just shouting into an echo chamber, right? Like you see that article, it's like values underperformed by 15 years. And, you know, some articles just stop there. But I think a lot of investors are tired of being told

Starting point is 00:04:42 the same things with value investing. They're looking for new answers. And I think the advantage of free cash flow yield is how it finds value, how it tends to be more resilient. in a growth market while still doing well in a value market, I think the concept of free cash flow is really timely, especially in a world where Mag 7 is dominating returns and people are trying to find sources of return outside of those names. So Michael and I both have our CFAs, not to brag, but some people in the audience might not be familiar. Why don't you just tell us how you define free cash flow? Yeah, it's a good question. It's the cash that's left over after a company's reinvested in its business. So if you think of, it includes a lot of things, right? All the

Starting point is 00:05:25 company expenses, your interest on your debt, your taxes, and most importantly, reinvesting in your business. And so when a company has free cash flow, that's cash that's left over to do what we think is a lot of shareholder-friendly things like buybacks, pay and grow a dividend, pay down debt. And then what's interesting about free cash flow is we think about it as a profitability or a quality metric, we turn this into a value metric by taking the free cash flow over the enterprise value and making it a yield. And when you do that, if you think of like for the everyday person, if you think of like a rental property, two questions you ask, right? How much will I pay and how much will I rent it out for? That's really what free cash flow yield is solving for.

Starting point is 00:06:11 So it's not just the companies that have the most free cash flow. Quite frankly, that would mostly be the Mag 7 because they are the beachfront properties, if you will. It's the companies that have the most cash flow relative to their enterprise value. So maybe if I bought a property Bayside, I could only rent it out for half as much, but if it cost me a fourth of what the beachfront property is, that's a better deal. It's always about trying to find the most value for your dollar invested. And that's what free cash yields solves for. Ben, it's funny. You mentioned the CFA because my mind went to the same place. I remember back in the day and my in my bed and I had like a whiteboard. And I had all of these free cash flow formulas. And there

Starting point is 00:06:49 was free cash to equity and free cash flow to firm. And you could start with notepad or EB or all these sort of things. So, yeah, fun times. What's a difference between net income and free cash flow? Yeah, it comes down to, there's a couple things. One, it's net of the investments, right? CapEx has taken out of free cash flow. I think where it really becomes meaningful today. if you read a good article on why value investing struggled, they've talked about accounting earnings not being as relevant and biasing gross stocks in particular tech. And the reason for that is the way earnings count for R&D, they expense it 100% immediately. So if a business is investing in R&D, it's hitting their bottom line. Whereas if a business is investing in CAPX, right,

Starting point is 00:07:37 they're only depreciating a small part of it. So where in earnings, you look better if you're spending more on CAP-X and you're kind of punished if you spend more in R&D. In this case, it just deducts them both. So it's a level playing field. It looks at all the cash expenses, and that's amount, and it's the cash that's left over. You mentioned something interesting about how free cash flow has been like a value-ish metric that has held up better in a growth, in a growth environment. I'm wondering if value really traditional value metric, valuation metrics really make a comeback. Do you think that free cash flow might go out of favor? Oh, we don't because I think of at the end of the day, it's the value of a business.

Starting point is 00:08:13 It's kind of going back to the source. The value of if I could dust off your textbook again, the value of a business, it's the present value of the future free cash flow. Yeah, sure. So you're aligning with what drives it. It should be, right? So I'm curious if this whole strategy is quantitative or if there's any qualitative measures that you put on top of the free cash flow yield that you're looking at.

Starting point is 00:08:34 Yeah, it is all rules-based. So that's a key part of it. funny. A little background, that was at a hedge fund. That's where I first started kind of focusing on free cash flow right out of college was, you know, everything was through the lens of free cash flow. But we had a quant model where the number one factor was free cash flow. And it was interesting. The PM there, he would pick, we had two sleeves he ran. The first he ran was his own free picks, right? He was allowed to pick whatever he wanted, unconstrained kind of alpha. That did well. But when he picked from the model, that did poorly. And I think one of those things

Starting point is 00:09:09 you realized is, right, part of the alpha and free cash flow is keeping it unemotional. You're buying into weakness. It's hard for someone to apply a fundamental overlay. It's almost one of those things of don't outthink it. If the price dips, the free cash flow goes up, systematically add to it, vice versa, lighten up when the yields drop, and you'll create better returns through those rebalances over time. It is funny how the best ideas portfolios, like, never work out. It always sounds great in theory, right? Like, we have this screen that gives us 500 stocks, but we're going to pick the best 50 or 100. And you're right. The test always show that rarely ever works. I don't know, maybe because of the emotions or it's just hard to pick the winners.

Starting point is 00:09:46 Remember Joel Greenblatt's book, the little book that beat the market? Yeah. And he told the story about this, that they screened for these stocks quantitatively. And then the PMs picked the stocks and like almost inevitably, they underperformed. Exactly. And unemotionally. And I mean, if you look at the best name this, one of the best names in terms of high free cash flow stocks, it was a utility that became an AI, Like, I don't know who had that one on their bingo card going into the year. Well, you've got another one in here that I want to mention a little bit.

Starting point is 00:10:15 But before we get to some of the individual names, let's talk more about the process. So what is your investable universe? How do you screen it down and how do you ultimately select stocks? We start from a large-cap universe. We define it as the top 400 profitable companies. You can essentially think of it as it's going to pull from the VETI-1000 universe, but it's going to be similar in exposure to like the S&P 500. We originally kind of did our studies on the S&P.

Starting point is 00:10:39 We get the question a lot. Should we do large and mid or just large? What we found is you can get similar returns with large cap without the risk that comes with mid-cap. So that's the first part. We're going to exclude real estate and financials just because, you know, in the case of real estate, sometimes one-off acquisitions or disposals can skew it. And then if you think of like banks, they're really not conductive to one measuring free

Starting point is 00:11:06 cash flow. And then on the enterprise value side, we don't think you can probably systematically kind of capture their derivative exposure or whatnot. So it's hard to get a free cash flow yield in those spaces. So we exclude them knowing that when those sectors tend to do well, value will do well during those periods as well. From there, we screen for free cash flow yield. We do it a little uniquely, we think, and that we don't just look at their trailing. We'll also look at their forward estimates. So we average the two together. to come up with our free cash flow yield. And then from there, we apply a growth filter. So we go from 75 down to 50 based on a company's growth score. And then from there, that 50 stock

Starting point is 00:11:50 universe, we weighted by their size and their yield, their free cash flow yield, and we rebalance it quarterly. So I'm curious how cheap you're finding some of these areas. Because you see all the, you see these charts that show the S&P 500 is overvalue or the large cap. Universe is overvalued. If you take out some of the big tech names or just the Meg 7, whatever it is, the market looks more reasonably price. So I'm curious how cheap you're finding your current universe to be these days. You really do need, you can't just be in a broad value fund. You're probably leaving a little on the table right now where like you think of like the Russell 1,000 value. It owns 850 stocks.

Starting point is 00:12:25 So it's going to trade at 17 times earnings where if you really screen down and get a focused value exposure, the valuations are some of the widest we've seen, probably closer to 2,000 levels. they were before. Michael, let me give you some numbers and then you could talk about this. So I'm looking at from from your website, I'm looking at some fundamental data. So your EPS growth of the last three years is 20% compared to the benchmark that I'm seeing as a Russell 1,000, 14%. So 20% EPS growth the last three years versus 14%. Price to book is roughly in line. Price to earnings. You guys are 15 and changed. The index is 21. And then the return on equity is 23 versus 16. So higher ROA, lower price to earnings, and a higher EPS growth. That's a pretty nice recipe for stock selection, at least in theory. I mean, we think free cash flow

Starting point is 00:13:17 does a really good job at multifactor investing. If you think about like the FOMA French stuff, right, it was at first it was booked the price, right? That was value. And then it's interesting. The two elements they've expanded on is they've added profitability, one, and then they've added low investment. Well, when you think about that, they're basically trying to get to free cash flow through a multi-factor lens, right? We think free cash flow kind of being the source is the ideal place to go. And as a byproduct, you'll get those favorable factor exposures. You mentioned that there was a utility stock that was kind of surprising you. What sectors are showing up as cheapest on your screens now? And I'm curious if you have any sector constraints

Starting point is 00:13:54 that you put a ceiling on these things if it gets too high. Utilities did see. There was a couple names. Most, you're typically not going to see a lot of value in utilities because they're regulated. The companies that have done well happen to be the ones that aren't regulated. In terms of where we're seeing, you know, and I'll take a step back to historically, free cash flow has found value in technology, health care, and consumer. So we talked earlier like, why is it do well in some of those growthier markets? Well, it's able to find value in some of those growthier sectors. But today, where it's finding value is, again, health care as usual, what is different? is energy. And energy is something where there was a horrible free cash flow generation for about 20

Starting point is 00:14:35 years. Then 2020, they kind of got religion. They're now comped on being profitable. And the mantra at a lot of these energy companies has went from profitability in any price, or sorry, growth in any cost to now profitability at any price. So we've seen energy screened in a level. It's never in the past in terms of free cash flow generation and some of the quality metrics we look at. One of the stocks in the ETF that I'm looking at that I wouldn't think of as synonymous with high free cash flow is Zoom. Zoom has been a horrific stock for the, I don't know, a couple of years. I don't know what the drawdown was. I'm guessing it was 70% plus, at least probably a lot more.

Starting point is 00:15:18 But then I put my white trots and I look at Zoom's free cash flow. And yeah, sure enough, it's at an all-time high. So I think this goes to the unemotional aspect. of using the rules-based screens as opposed to Zoom is probably not a stock that most people want to own, hence value. I think most companies don't want to be value stocks, and that's probably why it ends up working. It's because there's like a human bias that makes people want to avoid these names.

Starting point is 00:15:43 That's it. People tend to focus too much on price and lose track of the fundamentals of the business or the earnings or the cash flows, and so that can lead them to confusion. Oftentimes, you can see a life cycle. And we saw this with like Microsoft and, you know, some of those in the past where the price goes up a lot, then it sells off, goes out of favor for a long time, then it becomes really cheap and growth does recover. There's a belief that if your price down, your growth can't recover, but that's not the case, right? So Zoom is the case of that where they have, they're actually

Starting point is 00:16:14 their fundamentals are strong. It's just the momentum's been negative on the stock from a price momentum standpoint, which is what you're looking for, a lot of free cash flow relative to enterprise value. I'm curious what kind of quant you are because some quons say, I don't care what stocks are in our portfolio. I follow the rules and they are what they are and some people don't even really pay attention. They care more about the risk factors or the characteristics of the portfolio. Do you actually follow the individual companies that are in your portfolio or you just kind of say I'm going to let the model do what the model is going to do? We do let the model do. It is unconstrained. I think it's like the way we think about it. This is the second free cash flow

Starting point is 00:16:49 fund I've had the chance to develop. So you do get opportunities to improve things. You know, when the over maybe a 10 year period. But in general, I do think it's important to look at it like an active investor. I think the advantage of a strategy like this is, is it's coming from the lens of kind of, I mean, our team does a lot of active quantitative strategies. So I think if you look at a lot of the index providers, I think one of the challenges, they're Quants and engineers. So like, if you look at all the traditional value, I think any active person, if you pulled all your guests, I bet they would all say cash flow is a consideration. But I think what people are surprised to know is almost every traditional value index does not include free cash flow.

Starting point is 00:17:28 Everyone includes price to book. None of them include free cash flow. And I think that's because the data. If you look at where the data is, you got 150 years academic research on price to book. You got nothing on free cash flow yield. But an active manager who knows the fundamentals would know to look for that. So I think it's important to understand these companies and how they work. Even if you are, it's just stripping out that emotional element in terms of the day-to-day decision making

Starting point is 00:17:53 that you want the passive element to this. So free cash flow on top, enterprise value on the bottom. Why enterprise value? It comes down to debt, right? I mean, and I'll get an extreme example, by the way, is Nvidia. People don't, if we have an example on our deck where Nvidia was in 2013, they were, their free cash fuel was 15%. Right.

Starting point is 00:18:19 And what was interesting about that example is at that time, they had a $7, $8 billion dollar market cap, half of their market cap was cash. They had no debt, or at least they, they had a net cash position of $3.5 billion on an enterprise value of $7 billion. So hopefully I've made you all sick knowing that Nvidia was a $7 billion company. It makes me sick talking about it, right? Well, I'm sure Apple, Apple probably too. Apple probably 2013 is the same exact thing. Yes. You had a lot of Mag 7 that screened well in the early part of the decade. But yeah, in that case, they had a ton of cash where then if you looked at energy companies, right, They're loaded with debt.

Starting point is 00:18:54 So enterprise value looks at their whole balance sheet, tilts you towards stronger balance sheets, and it keeps you from buying those leverage names that appear cheap until you play devil's advocate. So enterprise value makes a lot of sense if you're thinking about, all right, what is it business worth if you acquire the whole thing, right? Like if a private equity comes in there, it takes the whole thing or there's M&A and somebody, you know, competitor buys it, they, you know, debt is certainly a part of the equation for sure.

Starting point is 00:19:19 But what about, what about like, if. a company has no chance of being taken out. And the debt is, I don't know, like normal, where it's it's healthy debt. It's not an overly levered company. In that case, would it make sense to really include the debt? I think it still makes sense to use it. One of the cool things about free cash flow versus other value strategies is you have a built-in catalyst. So if you're stock cheap, right, you can take advantage of that and buy back stock. Right. And so having a big cash pile is going to allow you to buy back more stock. If you have debt, you may not be able to buy as much stock back. But if you think about a free cash flow yield, it tells you how much you

Starting point is 00:19:56 can buy it back. So in a case of a stock that's like Zoom, right, they don't need a catalyst. As long as their free cash flow generation remains intact, they don't need someone to buy them. They don't need something to happen. They can just organically grow the business by buying shares, kind of the Apple way, if you will. You talked about Nvidia being cheap back in the day. Your team sent us some really cool stats that said in 2010, I guess when this bull market kind of took off. The Russell 1,000 growth and the Russell 1,000 value were trading at like equal P ratios, basically. And the idea being that one of the reasons that maybe growth is at such a good run is that it was actually pretty cheap on a relative basis, right? You would expect a value

Starting point is 00:20:36 index to be much cheaper than a growth index. And I think a lot of people are trying to figure out, is this just a really long cycle or is something completely changed, right? And this time is totally different. And tech stocks are going to eat the world and growth is going to work forever. and I'm just curious how you think about that push and pull between valuation and maybe thinking about how how this cycle plays out and where we stand now versus 2010. No, that's a great point. That's exactly how we think about it. I mean, if you're trying to figure out, I mean, let's separate value investing from do valuations

Starting point is 00:21:06 matter? They certainly do, right? And they, um, if, so to your point, right, if, if growth straight and say multiple is value, you buy growth all day. So we think the first part of this move was just growth valuations normalizing, right? where there's a healthy premium in terms of the price to earnings. And then, of course, we think it has gotten excessive, right? But I think if you understand that the first 10 years were rational and it's probably

Starting point is 00:21:30 post-COVID where things have became a little frothy, I think it does give you more patience. And, you know, if you didn't understand the beginning, you might wonder, is this ever going to happen? But we think valuations remain intact. In fact, we think it helped support growth for a long time. Do you guys have any opinion on buybacks or dividends? Does that enter into your equations at all? No, we prefer to go to the source.

Starting point is 00:21:52 So regardless of how you grow your dividend, pay a buyback or do a buyback, either works, right? It's really who can have the most? Because the other thing with buybacks is not all buybacks are great. The buybacks that are best for shareholders are when the company's cheap. So we know if we solve for free cash flow yield, we know the companies, if they do buybacks, we know it's going to be beneficial to shareholders because, again, we think of free cash flow yield is the amount of company could buy back every year. So you could have a company where the earnings are flat and dollar amount. But if they have a 10% free cash flow yield, they can buy back 10% of

Starting point is 00:22:27 their shares sustainably every year and basically manufacture their own growth. It's a part that people often miss on the value side is you can get growth through that company returning capital to shareholders. What about margins? I would assume that just flows through to what you're already looking at. It does. There's a link between free cash flow and earnings and its returns on capital, the quality metrics you will, which is tied to margins. But we're not, this isn't going to be specifically tied to margins. You can have like a health care stock where the, they have really low margins, like the health insurers. We own some of those, right, Cigna. They, they have a very low margin, but they do a lot of volume. So it's a profitable business.

Starting point is 00:23:08 All right. Well, here's one more. What if? What if the company has a high free cash flow yield, but the free cash flow has declined for four consecutive quarters. Is that something that you look at? That's an interesting. So the way we do our growth filter is, it's designed to look at not like the short-term growth. It's designed. We call it the growth trajectory. It's a seven-year number, five years historical, two years forward. And we're basically trying to rank companies one, two, and three and eliminate the threes.

Starting point is 00:23:32 And if you think about it, I joke that this is like the IBM filter. For years, I used to run a free cash flow strategy before this. And for years, IBM sat in the portfolio at like $120, right? And I know it's rallied, but, you know, once you hate a stock, you hate it. And so what's interesting about IBM is that they have a high free cash flow yield. But if you think about why they have a high free cash flow yield, it's not always because the company's cheap. In this case, if you look at IBM, they've seen their revenues decline over the last five to

Starting point is 00:24:02 10 years. So in those cases, it's less about the market thinking that company's cheap as it is the market expecting lower cash flows in the future. And so what our research has found is you don't need to bet on those. want to avoid those potential value traps where the free cash flow yields high based on their cash flows today, but where they're not expected to be as high going forward. So you can simply eliminate those. And so it's not about maximizing growth. It's just from your value high free cash flow universe, just eliminating some of those, you know, stagnating, declining businesses over

Starting point is 00:24:34 time. When you go on to a lot of financial data sites or applications or software, whatever, a lot of them, or even just the company itself, I should say, if you go to the company's financial statements, most of them don't break out free cash flow, right? So there's all sorts of adjustments that you have to make as the PM on the back end. Is that, is that a complicated process? What the general convention is, is to take the cash from operations. That's probably in that top section. And then you subtract the CAPX. That is the generally kind of defined definition of free cash flow. See, this is the difference between real world and textbooks.

Starting point is 00:25:12 That's all it is, is cash flow and you take out cap X? Yep, that's it. On the test, there was like a, oh, come on. They wanted to make it tough. All right. So you also have the Victory Share small cap free cash flow ETF. And Michael and I have been talking for a while. If you look at any of the valuation metrics, price to book, price earnings, price

Starting point is 00:25:30 to sales, small caps are cheaper. Do you see a wide divergence there between small cap and large cap, even in a free cash flow segment of the market? The one caveat is you have to make sure in the, small cap that it's quality. So if it's profitable, because like what's interesting is we get this question a lot of like, how do you think the Russell 2000's cheap? And that depends on how you measure it because if you look at, I think in the 90s, roughly 20% of the index was unprofitable. Today, it's closer to 40. A lot of calculations we see out there just exclude the unprofitable,

Starting point is 00:26:01 right? And so it's challenging to say, so really when you see some of these stats to say small cap cheap. It's really, well, ignoring the unprofitable ones, it's cheap. So it's hard to know unless you, so that all goes away if you're using like a quality. So if you're looking at an S&P 600 or, you know, one of our strategies or some things that focus on profitability specifically, then you really do have an apples to apples comparison against history. And yes, I think if you look, when we look at these valuations, they're towards the widest end of the range we've seen in a while. So we spoke about the screen and getting companies into the portfolio. What knocks them out? it's one it's two things either the cash flow deteriorates or the price rallies too much so be one or the

Starting point is 00:26:43 other so is there like a hard line where the yield needs to be five percent or above or something like that it's it's ranked so it's the top 75 out of that large universe so i'd say the cutoff tends to be five and a half six percent um depending on market conditions getting back to the the large cap version of this there's not a single mag seven name in the basket um How close are those, or I guess, how far away are those from meeting it and once in the last time that they were in one of them? Yeah, you would have had Apple, Nvidia, and Microsoft would have screened well, probably up to about 2019. So free cash flow deal probably cut the first five innings. Those are all examples of names that were sold because the enterprise value went up and the yields declined because of that.

Starting point is 00:27:30 today it's interesting the one that it's closest to making it in that that probably you would have never have thought in the past is Salesforce. Salesforce is not too far away. Google would be next in line. That's on Michael's watch list too. Stocking that, baby. I'm curious how much rebalancing there is done in a fund like this because I assume there has to be, like you said, companies go up in price or they go down in price or the free cash flow rises or falls.

Starting point is 00:27:58 us how much turnover isn't a fun like this? There's a lot. And it's by, it's a feature, not a bug, right? And if you think about the key of how we're applying this is inside a tax-sufficient ETF wrapper. So we talk to advisors all the time that, you know, we hear this like direct indexing trend come up. You know, we have some to think about doing their own.

Starting point is 00:28:17 We actually have a decent amount of clients that they could do this themselves. They come to us because they want that turnover inside an ETF wrapper where you can take advantage of it. So higher turnover. And there's value, right? to buying. So every quarter, you're going to increase your weightings on the highest yielders. You're going to lighten up on the lowest yielders. And you can have circumstances. Like, we have a company in the fund that we benefited from where first quarter, like it came in as an

Starting point is 00:28:42 average weighting. What happens? Stock sells off. earnings disappoint. The yield goes up. So now you increase your waiting, effectively buying low. They announce a big buyback. Stock goes up like 75, 80%. At the end of that quarter, right, your yield's now half of what it was. You lighten up. Next quarter, it disappoints, but you've already taken half the position off the table, right? That buy, low, sell high, compounded over 50 stocks every quarter adds up. Now, the caveat would be that sometimes you'll leave stocks too early, but in general, we think that unemotional by the higher yielders, lighten up on the lower yielders, will add value over time. I'm curious to see consumer discretion I show up as a large sector, a large sector waiting,

Starting point is 00:29:25 just because of some of the pockets of weakness there, not just on the stock price side, but on the business side, although maybe not on the business. Like, you talk to some of the trends that you're seeing in that space? Yeah, this is painful as a millennial who still rents and never bought a home. The home builders are in very good shape. Right now, they're really the only game in town, right? If everyone has a 2% mortgage, right, no one's selling their home. So the only source of homes for, you know, a lot of these millennials is the new homebuilders.

Starting point is 00:29:53 So they're seeing record amounts of profitability. And it's an interesting sector industry and that it kind of reminds you of a little bit of semiconductors probably 15 years ago where semiconductors in 2011 was incredibly cyclical. I think it was I think it was Einhorn who came out and was saying that maybe semiconductors are going to be less cyclical going forward. And they're kind of experiencing a secular growth trend. You're certainly not going to have a different, like the competitive advantage. Like you're not going to see any of Vydeas emerge out of home builders because it's

Starting point is 00:30:23 pretty commoditized business. But I think you can expect to see a longer runway of growth than you would normally in a cyclical sector like that. I never realized so many homebuilders were in the top 25 of the consumer discretionary ETF. Yeah, I thought they would be like industrials. Yeah. So these, so I mean, these companies essentially got stronger in the past in the pandemic period, right? Because they kind of consolidated market share. There's fewer homebuilders than there were in the past. Their margins probably all went up because, because lumber prices rose and fell and they've been able to, you know, increased costs as home prices have gone up.

Starting point is 00:30:59 So those companies are still in pretty good shape, aren't they? They are, exactly. And that's what we're seeing from both a growth and a free cash-fueled standpoint. Most of the home builders in that universe right now are qualifying, just because everything. So this is your hedge against not owning a home then. Yeah. I had a personal level. I'd rather see, yeah, rather see their free cash-ful yields decline.

Starting point is 00:31:20 Michael, anything that you were hoping to get to that we did with? I feel like this was pretty thorough and meaty, but anything that we missed? I think the one thought of just like people shouldn't consider value in growth and isolation, right? So on the value side, a lot of value strategies just want to look at multiples, right? And that's great. But if two companies are at 10 times multiple, it doesn't tell you which one you want to buy necessarily unless you know their growth.

Starting point is 00:31:43 So if you're doing value, you should always consider growth. And Buffett has a quote where he's like people think the two are in opposition, but in his mind, growth is always a component in the calculation. of value. So I think you need growth to determine how attractive a valuation is. And then I think people just need to consider on the growth side that valuation also affects it. But like I think an interesting example of today is Apple. If you look at Apple over the last 11 years, their earnings has been around, let's call it 15%. Right. Nine of that has come from the underlying business. Six percent of that has coming from buying back stock. Well, the reason they were able to

Starting point is 00:32:19 buy back so much is people forget. Ten years ago, Apple was trading at 10 times earnings. I think in 2012 or 2013, it actually dipped below 10. So that allowed them to buyback a lot more stock. Today, their long-term earnings growth potential is going to be less on a per share basis, right? Because every dollar of buyback is getting about one third is what it did 10 years ago. So I think you also need to consider it on the growth is a big tail into these mag seven stocks was the fact that they were growing really fast and they're really cheap. Today, they're still growing fast, right? But they're no longer cheap. So there's less of a tailwind, not only from a multiple expansion standpoint, but also from the ability to grow earnings

Starting point is 00:33:00 through buybacks. For audience wants to learn more, where can we send them to learn more about your free cash flow, speed of products? Yeah, victory shares.com. You can get additional information and link to prospectus. Perfect. Thanks a lot. Thank you. Okay. Thank you to Michael. Member, check out victory shares.com to learn more about Drifty Capital. cashful ETF. Send us an email Animal Spirits at the compound news.com and we'll see you next time.

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Animal Spirits Podcast - Talk Your Book: Investing in Free Cash Flow

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