Chit Chat Stocks - How We Value Risk vs. Reward

Episode Date: July 13, 2021

This week we discuss how we like to weigh risk versus reward. How do we identify potential rewards? Where are the obvious and sometimes hidden risks? What happens when the business and corresponding stock do not reflect the same risks/rewards? Listen in as Brett and Ryan answer these questions and more. Let's go! 7investing is empowering members to invest in their future. Use our code “CCM” to get $10 off your first month or annual subscription, or use this link: https://7investing.com/subscribe/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps 1st Half | (2:54) 2nd Half | (36:46) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. Today is Tuesday, July 13th. No interview today, but we have a fun topic. So we're talking about how we weigh risk slash reward. I mean, it's a difficult concept. It's hard to quantify. So we're kind of going to go through some scenarios. And risk reward of a potential investment. So when you've looked at a company, you're going to try to understand what am I buying here. Downsides, downsides, all that. But we also have our topics on the second half. Anything interesting for you? Let's see. Oh, we have TikTok banning cryptocurrency promotions. Oh, yeah.

We'll talk about any fallout from that. And then let me check. I have, oh, the Jedi deal. The Defense Department changed up the Jedi deal. The cloud industry is going to be pitching their lives to the Department of Defense to see who's going to get the tens and tens of billions of spend that's going to come out of there. So it will be a fun discussion there. What do you got? I've got the Traeger Grills S1.

They're going public. Pretty interesting. really interesting read actually and i mean on the ticker alone yeah ticker is cook spoiler alert uh but then my second story i'll be talking about the uh space wars richard branson recently took his uh trip to space kind of funny and there was a follow-on incident that was funny as well but before we get to that we got to talk about our friends seven investing you want to go ahead and yeah i can talk about that i mean seven investing like they say their mission their motto is to empower your financial future. If you're a subscriber to the service, they're going to

give you seven different stock picks each month. They're going to go in a variety of different industries. They have experts on cloud computing. They have experts on biotechnology. They have experts on fintech. They have experts on healthcare. And then they have others too that I forget every time. But they have plenty of experts. You can use our code CCM to get $10 off your first month, try it out. Go ahead. And if you're already a member and you haven't done so, I really recommend you go check out Matt Cochran's video from this month. Very funny. Very funny. Yeah. Got to go. Got to go watch that. And that is to say too, that they're adding videos to the reports. It's pretty comprehensive. It really helps you understand these companies

and it's a great part of our research process. Definitely. Without further ado, let's get to the show. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. All right, welcome in. We're going to kick off. The first half will be our risk-reward segment.

So do you want to kind of start with how you evaluate? We'll do reward, then risk. Yeah. And I'll separate it that way. Yeah. So this was my idea for the topic. So I'll kind of explain it quickly. We're just going to go through different ways to identify what types of reward you would look at for a stock. And really what we're saying there is how do I evaluate how much potential upside there is here, how predictable that upside is. And then we're going to go through some examples of what we like to look at to try to maybe see if, you know, you can find something special or maybe something that a lot of people are underrating or overrating, stuff like that. First one up for me

is going to be a new subsidiary that's growing quickly so this one sounds a bit specific but in our experience you can it can provide a lot of opportunities for rewards and then again rewards here just means you know strong returns over the long term but it can provide opportunities for rewards if a segment is growing significantly faster than the overall business and the reason I think that is is because a lot of people and it's because they don't have infinite time during the day, they're just looking at the headline numbers. And a lot of people are just looking at stuff maybe in Bloomberg or Coifin or Capital IQ or whatever. They're looking at consolidated numbers. But if something is growing a lot quicker under that, I mean, and then it can really start

accelerating the consolidated financials within like one to three years, I think the chance for upside can be strong. And then for some reason, the market tends to undervalue these opportunities. Do you agree with that, I should ask? Yeah, any time that, I mean, sometimes the performance of the business at large can really mask the performance of a hidden asset. And I think we've witnessed that on several occasions, especially if they're not breaking them out into their segments. So you really kind of have to pay attention. I mean, match groups probably, sorry if I'm stealing any of your examples, but that's kind of the primary one that comes to mind. how they have this giant portfolio and any one of them could see like any one of those brands

could see explosive growth but you're only seeing the top line numbers uh across the portfolio that's kind of is that kind of what you're talking about with the hidden assets yes exactly i i do have match group as an example there i'll go through that maybe in a bit um and then you know it can be hard sometimes to evaluate something like this a subsidiary if management doesn't break out explicit financials on them which a lot of times they will do and sometimes they'll do that because they don't want to tell competitors how good this business is, stuff like that. A classic example, maybe the biggest of all time, is AWS in 2015 with Amazon. Stock went up like 20%, 15% maybe.

I could be exaggerating, but it went up a ton once they finally broke out AWS out of that other page. But when that, you know, like the pre-AWS stuff or when you're just looking at a subsidiary and thinking, okay, you know, this could be promising, but I don't know exactly sure how big of it is. you kind of have to go to third-party sources and you may have to make some vague assumptions. And sometimes you just got to ask how big or, you know, how reasonably big can the subsidiary be in X time period? And typically the way we like to do it is like three years, five years.

You could go a longer time period or you could just say one year from now, something like that. Asking that question can show, okay, how much upside is there from the subsidiary? Yeah, this is also where Scuttlebutt plays a big role because there's times when companies intentionally mask the financials aws aws is a big one like you didn't know that it really how important it was how profitable it was until they broke it out so there you go if you can break down and you can go to let's say engineers or people that are using aws where you can figure out how influential how sticky how important it is and then kind of

take a guess i guess at the profits or the profitability of the business it's huge yeah And I think another current example, I'm not sure if it will work out or not. I know it's an interesting stock that a lot of people look at right now is Topgolf with Callaway. They break out some of the financials explicitly. I think they do revenue and adjusted EBITDA. So, you know, you're getting some numbers there. But once they acquired that, that's growing significantly faster than the underlying Callaway business, which is pretty mature. You know, that seems like one of those situations that could occur.

we use this a lot actually which is why you know i was inspired to use this as a topic so from our current portfolio some examples could be i want to make clear that these are not guaranteed to work out but say like for spotify one of it is podcast advertising and again we're saying that on a podcast right now but the sources and the scuttlebutt were ourselves there is pretty easy to figure out how lucrative they were another one that you mentioned is match group with hinge they gave out numbers that they're growing revenue triple digits and you kind of look at that and then you get some anecdotal evidence the scuttlebutt there pretty easy you just use the app and talk to your friends uh nelnet is another one that we own there's a sass hidden asset and then huddle

investment and then wix is a pretty interesting one too i know there's other subscription services that have this as well they have the e-commerce part that's a lot smaller than their overall business right now but is growing at like a hundred percent year over year while the underlying business is growing at about or sorry not the underlying business the overall business is growing at about 30 percent and then i think the king of this was iac over the last few years huge i mean match group was a part of that and then they have hidden assets within match group um they had that with vimeo which people put probably no value on for a few years and now it's worth eight billion dollars you had no idea how fast that was going within there well

i guess you kind of did they broke out some of the metrics but but yeah uh do you want to go to one of yours and then we can flip back to mine sure so for mine i kind of break up i break out Even on risk and reward, I break the upside or the risk into the business parts and then the stock parts because there is – we'll talk about one way to get a lot of reward on the stock side, which is separate from the business. But I had basically a lot of the same ones as you. I guess another one that wasn't talked about as much is just category growth, which – so I think having – When you say category, does that mean industry? Yeah, so a lot of people say industry tailwinds, but that can provide a lot of – if you have an industry that's growing, a category that's growing, you don't have to put in as much cost in order to gain customers. It's a lot of natural adoption.

And so I guess the example that comes to mind is gaming. There's been so much ancillary product growth. So you think about like the secondary, like the viewing market of sports, that that kind of has built a network effect to more people wanting to play. Just any kind of gaming proliferation of streaming, that kind of thing has really helped the incumbents a lot where they haven't had to up the cost. So FIFA hasn't even raised prices in I don't know how long, both on the actual game and then within the game. I can't remember a single time that they've raised prices. They might do more of those one-time purchases things, the in-app purchases that some people do complain about. But yeah, I understand.

But even that, there's a, okay, for anyone that's not familiar with FIFA, you can buy the bucks or whatever, like the in-game bucks, essentially, which we call it FIFA points. They haven't raised prices on those either, which is just to say they've grown revenue all that time. So that's purely from customer growth. Obviously, they are doing things to kind of proliferate that growth where it's like building better games and stuff like that and new in-app stuff. But a lot of it's just coming from the overall category growing at large. And then another one that kind of comes to mind is Wix. So Wix kind of has seen the tail end of low code, no code. A lot of people, a lot more developers, a lot more users are starting to build websites that way.

And sometimes it's – And that's the – sorry. That's the transition over from the WordPress open source model. Yeah, and coding it yourself, like engineers doing it as well. You're seeing a lot of engineers start to just become – like Fiverr, I guess, is building a lot of growth for the sector as a whole because you can just ask someone, hey, can you build out this low-code, no-code, whatever website for me? And it's become a lot easier. And so apps like that are helping Wix grow where it's not as costly for them to grow. It's less marketing expenses, stuff like that.

and so that's just that adds meaningful revenue growth uh for each of the companies and anytime when i'm looking at upside the main driver i believe i forget where i saw this is always revenue growth that's kind of been the driver of the best long-term returns uh yeah i've seen a lot of smart people push back at that the stat is right but i've seen a lot of people push back at that that is a correlation not a causation um i forget why uh because it sounds so right but yeah ideally you obviously want operating leverage where you want operating income to outpace revenue growth but ideally you want revenue growing also so that operating income even if it isn't growing as a percentage of revenue it's also growing in line let's say

So in addition to finding operating leverage, yeah, trying to find companies that you think will grow sustainably, revenue, double digits, at least that's what I look for. Yeah, and then you also don't want – okay, no, you don't. Something that can be better is not having to steal market share from someone else. If it's a zero-sum pie, I'm trying to think of an example of a market like this. Possibly grocery. Web development might be one. No, but that's a really fat – that's growing. that's a definitely that's a growing market there's new there's new stuff coming out all the

time i think something like grocery in a you know in a country that has a very stable population that is a zero-sum market where you're competing for market share with people and when there's a tailwind in the industry that's pretty strong say whatever it's been growing at 10 a year for a long long time you don't have to come in to competitors you can all just acquire new customers like you said before without having to compete on advertising costs that can really commoditize no it doesn't come it's a different topic there that's why i'm saying web development fits the non-zero sum where even if let's say wick sustains one percent of the market share of new websites that are developed that one percent is going to be nominally much

higher uh let's say five years from now yeah that's what that's what i think we're in agreement you heard me i said zero sum not non-zero sum okay yeah what's your uh second one all right it's going to be operating leverage and or a change in unit economics so this is one there's a lot of examples people are probably thinking of right now but it's an interesting one because it also adds risk so when there's operating leverage or and it's not just i'm talking not i'm not just talking 10 basis points i'm talking a whole change in unit economics say going from 10 you know, profit margins to 20% or getting gross profit from 40, 50% up to 70, 80% over a long time period. There is risk in that because it changes how the company interacts with customers,

typically, at least I'd say most of the time. But if executed can be greatly beneficial to shareholders. So some questions I like to ask are, if this business model change or unit economics change is successful, can it accelerate sales growth? And then how much faster can income and cash flow grow than sales, which is the operating leverage? I think that's a very easy question to ask, but can be underrated by the market. You know, there could be some uncertainty in that sometimes. Netflix is a great example here. When it transitioned from licensing video to making it on its own. That changed the profitability or potential, I guess, for profitability and the market rewarded it accordingly. Now, you know, the jury's still out if they can make a decent movie,

but it, okay, it changed it from just, you know, we have this fixed cost structure and then we add any additional subscriber on top of this fixed cost structure is pure profit. That really changed the unit economics of that business, and it helped them get potential for operating leverage. The market rewarded it. It could have priced in some stuff into the future, but if you look at that time period, 2014, 2015, 2016, that was a great opportunity to own Netflix shares there. Another example would be software companies that have successfully transitioned to SaaS. So software as a service, they transitioned from just licensing stuff or selling stuff on a one time basis and then trying to convince people sell the new product each year to just selling

it on that subscription service, typically through the cloud. I guess AWS Azure really helped define that. Another one would be video games going digital. Yeah, video games going digital. That is a great example as well. I forgot about that one, but that is good too. That raised the operating margins by I think six percentage points on average. And then also the free to play games was another one in video games as well. That changed it up. But big examples here, Adobe Autodesk Microsoft plenty of others did it too but if you look at their stock charts and their financial performance over the long the past decade those companies have done phenomenally you know business model or unit economics they if they change or they have the potential for change

I really think it provides an opportunity for strong rewards if you have to come down to two things though can you map out what the financials could look like after the transition and then do You have the conviction or the knowledge that the company can make it happen. Like how confident are you that they'll be able to make this happen with their customers? Because if they fail, that is a risk and it adds some uncertainty to it. Any thoughts on that? Yeah, it just makes me think. Like the risk – when we talk about risk-reward, the reward side is so much harder to quantify because you're taking –

I mean obviously you can look at like TAM estimates, stuff like that, but you're taking – But those are – Yeah, obviously those take them with a grain of salt. But then you have to say if it's successful, if whatever this business model transition or business model is trying to do is successful, what could the cash flow be in the future and then disconnect it back to the current day. But then you also have to say what's the likelihood that it's successful, and that's really hard to quantify. I guess another thing that probably provides some of the best rewards for stocks is multiple expansion. I put three things down here, multiple expansion, dividends, or growth in earnings through buybacks. And so I categorize that as stock upside.

Like dividend payout growth and earnings per share growth through buybacks. But I would almost categorize those more on the risk side because they kind of create that margin of safety. But I'll talk about multiple expansion because it really alleviates a ton of required business growth if you're able to buy stuff cheap. And so I guess to illustrate this idea, if you buy a company at 20 times earnings and it trades in the end at 20 times earnings, whatever that terminal date is, in order to get a 10-bagger, you have to 10x earnings, right? And so I guess to just go along with this illustration, if you buy something at five times earning, I know that's rare, and eventually it trades at 20 times earnings, it only has to 2.5x or whatever those are in order to get a 10-bagger. and so often the problem with that is finding stuff that's super cheap is oftentimes it comes from a point when the business isn't performing that well in your most people are just extrapolating out extrapolating out 12 trailing 12 month numbers into the future so you kind of have to find

if you can find companies where you think the future is going to be very different and their worst years are kind of behind them that's probably where you're going to find the cheapest businesses. And so I guess one example that comes to mind, obviously we're talking our book, is Sprouts Farmers Market. So they had bad comp sales, management came in. I feel like a management pivot is where a lot of returns come from. A lot of that opportunity. I think we'll look at stuff that we don't own, Bed Bath & Beyond, Target, two great examples there. Yeah, perfect examples where if you look on a trailing basis, yeah, it's not that cheap. But if you think the earnings can revert and they can start to perform a lot better operationally,

then it's obviously really cheap and that's where you're going to find a lot of that multiple expansion people might say oh yeah duh but you that's i mean it's that's where like it's just a leap you have to take yeah look at the greatest performing i guess other than maybe like roll-ups or brochure yeah look at the greatest performing stocks um a lot of those come from not only good returns on invested capital but uh big multiple expansion netflix is really the one that comes of mind there yeah what's uh what i mean i think they went from sub one-time sales to eight-time sales yeah they were 1.6 times sales back in the dvd days i mean there's so many examples on they had a whole table of that um that was floating around twitter i can't remember some of the other

ones another autodesk adobe those are part of it too because when they got the reliable subscription revenues people really re-rated that and they're like all right no one turns off of these things so yeah we can have signed a higher multiple on this revenue another way you can find companies that trade at really cheap multiples is typically if there's like a dominant narrative in the market of let's i guess game stops the one that comes to mind all right this is blockbuster but and i don't know if operationally or fundamentally it is that much better of a business but uh that can really start to dominate the stock price uh and reflect in the multiple so So if you can kind of like distinguish what narrative is actually right, even if it's really kind of what the crowd thinks, that's another area where you can find multiple expansion.

I think another example of that would be Roku back in 2017, 2018. I forget when they came public. If they weren't public in 2017, I think they were. But that's one of some people's favorite stock now. And that's because the narrative has shifted into the direction of, okay, Roku is going to be the dominant player in this space. but before then people were like what is this just kind of tv partnerships yeah they no one understood tvs right narrative was that amazon and apple were going to crush them because they had the ecosystem and turns out roku executed well if you could see that i mean the opportunity was

there we'll say with all these and we're going to get to risk so any pessimistic value type people kind of you know like us we'll get to the risk and the downside of this type of stuff but it is hindsight bias here yeah just know yeah all right let's talk about the risk side what do you kind of look for yeah one that you know people might not like hearing this I think it's very relevant right now is multiple compression the opposite of the multiple expansion that you were talking about this is an easy one the higher price you pay for the same business if the business is the exact same every incremental say percentage point you pay a higher price the more risk you were taking. Here are some questions that we like to ask and consider. So first one, how many years

of growth, and this could be either sales, gross profit, cash flow, whatever stuff you like to use to measure the business, how many years of growth will it conservatively take to get to where you think this business will be valued at, at maturity? If it is over three years, and you're kind of, you know maybe even two multiple compression is a serious risk to consider i think because unless okay unless the narrative continues and banking on the narrative continuing that this company is going to what do whatever it's you know going to do uh and people are projecting and you can say all right it's valued highly right now but if it grows at blank for 20 years or whatever i mean that's a bit audacious but you have to be worried about multiple

compression because not only can it go back to where you think it's going to trade at maturity it can get cut in half from that there's no reason you know a stock can fall forever um that's something you have to take into consideration another one i think it's fun to ask is how many years it will take to get to a 10 cash flow yield at your cost basis or if they're really reinvesting a lot of their operating cash flow you could do operating cash flow too if you know what their returns on invested capital are if on this number it's going to take like seven to ten years or longer and that might be a bit i would say maybe even five years the possibility for multiple compression i think is very high yeah and i'll kind of step in here and say that after 13 years

of a bull market or whatever we've had it gets easier and easier to rationalize higher and higher prices um but looking back and i hate to use this as a reference because everyone does look at the dot-com bubble not the not necessarily the bad companies but look at the good companies what's the example you had are you going to do microsoft yeah think about that it was still a great business it it had a great decade ahead of it uh and the stock basically went nowhere for 10 years so and it was a quote quotes here air quotes only trading at 60 times earnings right or what was the number you gave me one time 60 or 70 something like that not it wasn't like 200 yeah and so that's just the risk you run with uh buying something at a high multiple um yeah i guess

it changes business by business we'll wrap this one up some examples that from our recent research which kind of goes to any deep dive shows we've done where you look at the business you're like man this is good but wow is the multiple compression risk huge for my portfolio i mean Shopify comes to mind, Adyen, Evolution Gaming, Vimeo, Coupang, Olo. But I'd also say size matters in that regard as well. So Olo trades optically at a higher sales multiple than probably some companies, but they are sub, I think they're sub $5 billion market cap. So that's just to say if their opportunity is big enough,

their growth rate could probably be higher for a longer time. Yeah, and that's a great thing that Motley Fool called. Brian Feroldi's talked about. Yeah, I was going to mention that. I don't know whether to call them colleagues, but we'll call them colleagues, Motley Fool colleagues. Brian Feroldi, he mentioned that if a company is $100 billion, that's such a big difference when evaluating gross stock than it's at $5 billion, like you just said. I think what he said is if there's a company that's sub a billion dollars and I think it's going to be worth $10 billion in the future, I don't care what I pay for it. That's kind of another way to look at it.

But I'll get into one of mine. So risk, I kind of segment risk into two things. So, well, when I say risk, I also – basically, I'm just trying to assess the margin of safety. And there's two margins of safety for me. There's operational margin of safety and margin of safety on the stock or financial margin of safety. And so operationally, what I'm looking for is durability of the actual operations of the product. So the thing that comes to mind is Autodesk. What are the odds that people are going to be using Autodesk five to ten years from now?

Is it susceptible to go – is there any chance it goes away? I would bet with high probability that it's going to be a staple of the AEC industry in five years. It's going to be very important. It's going to be integral to the day-to-day operations of its customers. I would say, and again, we're using examples from our own portfolio just because those are always on top of mind. But something that we don't own is Google. I think that one comes to mind as well where the margin of safety isn't necessarily in the earnings multiple. Or I think, you know, Google, I believe, trades at a free cash flow multiple of 30.

But, you know, you're like, okay, is search going to be around for a decade? I mean, like, yeah, most likely. Yeah, and the thing with this I like to think about, so how the company generates revenue is also important. So let's say a company has generated a billion dollars in revenue, but we have Autodesk versus Yeti, for example. One of those companies only has to sell once. the other one has to sell multiple items or sell continually times right yeah so and that isn't to say yet he's a bad business but let's take yeti last year for example had 40 sales growth in order to do that again they have to sell more and more items obviously um and or pricing power whatever

and they had a good year so it's like is that probable i don't know i like the business but obviously it's a little harder than generating the same amount of revenue for a company like Autodesk who assume if we assume they have no churn in order for them to decline in revenue they would have to add no new customers and decrease prices or obviously lose a bunch of customers but that's just they're in so much more control of their operations and of their success so that's where I consider the operational margin of safety and then I'll get into financial but why don't you hit your second yeah and I say another example right in the Autodesk playbook are the ones I mentioned before Adobe and Microsoft that's why those companies traded

at such high multiples, and it's why AWS, Google Cloud, and Azure, and even Oracle, and well, IBM's kind of a joke, but it's why those cloud businesses get valued so much even by random estimates is because of the reliability. Let's see. We'll go through this one quick since it's kind of going long here. So one big risk I look at is short-term trend or gimmickiness. So the worst scenario when this happens is when trailing sales growth is really strong, And I think an example you just had there was Yeti.

And you're at a high valuation multiple, but it's not a sustainable business, and it's only kind of a one-time thing. I think an easy example here is Blue Apron. This isn't to dunk on Yeti either because it's a business they both like. It's just like they did see a huge benefit, so there's a little more risk in the future growth. Yeah. There's more uncertainty than a subscription business. Something like that. Okay. So an example I have of her here is Blue Apron. The idea was interesting. It was novel. It provided value to customers, right? I don't know whether they're called dinner boxes or whatever, but the unit economics didn't work and it ended up being kind of a fad. And now the stock is down 97% since

IPO. That's a stark comparison. But another easy example for this that I think can hit home for any listeners is movie pass so these ones can be extremely dangerous for investors because you know it's usually something like this a consumer product is all over the media news social networks friends are talking about it that can warp your perception and make you think the stock can justify its valuation and then something that doesn't actually have an underlying business or no unit economics whatever it's only a trend people try it once it's kind of a gimmick you know movie pass ended up being a zero or yeah something that needs to reach a certain level of scale to be viable and it's priced like it's going to that tends to be one of those scenarios

i imagine as well yeah and then some present uh some potential investments we've looked at where you know quote unquote fad was a risk concern which provided some uncertainty where we're like i don't know if we pay this high of a multiple for it uh thread up comes to mind poshmark comes to mind beyond meat comes to mind although i don't know how much we seriously considered that for an investment yeti like you just mentioned peloton duolingo which we just covered on the sunday show wish yes corsera and we know we probably just pissed off a lot of listeners so i'm not saying these are bad businesses i'm just saying that's a risk associated with them it never feels trends never feel like they're just trends at the time like like i don't know p90x might have

seemed like a viable business at the time great example um or i don't know is rosetta stone still a thing rosetta stone actually yeah it ended up being a value play it got bought out by a private equity firm but it it underperformed because i looked at them up when we were doing duolingo it underperformed pretty starkly versus maybe our maybe our takes on these companies are naive but you like as the investor you have to distinguish is is this a trend or is this durable is that uncertainty that we have and a lot of other investors probably have is that warranted or is it not um and then to finish the offer here i think a good inverting of this topic what businesses do you know for sure that aren't fads i believe that is a great hunting ground for potential investments

i mean consumer staples kind of come to mind there stuff like that where you know all right the customers unless something totally changes unless they go on a um what uh i mean everyone talks about the Buffett and the Buffett with Coca-Cola unless they go with a new Coke thing and totally screw up you know their brand yeah that is something where there's a less and less uncertainty and in that situation it was a huge opportunity because you could see through the new Coke phase I guess an example here would be Starbucks you know why people pay such a high multiple for that stock and now it's kind of a consensus you know that you're going to get a high multiple for that. Costco as well. Home Depot, stuff like that, where you know that's

definitely not a fad. People are going to be shopping there unless they totally ruin this business consistently. They get away with the price at that point. But you want to wrap things up with your last margin of safety thing? Yeah. So margin of safety on the stock or financial margin of safety, I guess an element of this could be considered liquidation value, but i try to let that no nothing's like that anymore not quite what i mean but uh i'm trying to assess the floor on the company so like what's the worst case scenario and i usually ask myself if the multiple got cut in half from where it is right now what would i think and so if i it's different for different businesses because they're in different parts of their life cycle

but it usually comes down to financial position so cash they have versus debt obviously and then free cash flow yield. So for some companies, I can immediately say, if this got cut in half, it'd be a home run, I'd want to buy it. Whereas for some others, and even some that I've owned before, if it got cut in half, like, I don't know if I'd be screaming, like screaming for it to be a buy. And so something that kind of comes to mind, I guess, is Dropbox. So Dropbox in 2018 went from seven and a half times sales to four and a half times sales, what happened? then you had people they were in a financial position where they could access credit markets they could buy back shares they were able to take advantage of that opportunity and instead of it

being a detriment to the business that the stock was down they're able to kind of take advantage of it and so obviously one thing that probably comes to mind is if it drops 50 percent would someone acquire them that's usually something that you think about it's hard to guess but that's kind of helped set the floor. And if you say, yes, this would be a home run minus 50%, whatever, or if the multiple was cut in half, then you can kind of start to inch your way up and build a floor. Whereas if you're saying, I don't know, so Wix is one that comes to mind. It trades at above 10 times sales. And remember, we're doing this in relation to reward, obviously. So if it got cut in half, I don't know if I'd be screaming for it to be a buy. I would

like it probably more than it is now but this also plays into how much do people use their stock and how do they use it so what come like if a company is using it using it to finance growth that presents some risk on the downside yeah because momentum can go both ways if you're paying your employees in stock a lot of employees take stock retrospectively so uh the stock's done really well sure i'll go there uh and i'll take stock and i'll become rich like the people before me but adversely if it's doing poorly suddenly people don't want to take stock uh as a means for finance or as a means for salary so that's just to say kind of yeah how's how fragile is the business in relation to its stock price and then you have to weigh that risk it's the

toughest thing i guess a quote growth investor does is weighing that risk with the potential reward and i would also add with that buyback program or a dividend yield or just cash generation in general that helps when a stock goes down 50 if you have a good capital allocator at the helm when we interviewed jake taylor he mentioned this that strong capital allocators can be anti-fragile in a and we use 50 drawdown it could be 40 could be 60 whatever in a big drawdown 50 if you have a good capital allocator at the helm that can help a ton on your future returns and to be honest it can make your long-term returns even better right which it's tough to stomach but i think it's true if you're able to buy back your stock at a 10 free cash flow yield instead

of a five percent and you're doing it in a reasonable manner you're actually reducing share account the business is still healthy which is a rare occurrence if a stock falls 50 that can be helpful but with some gross stocks that might not be profitable like the example you just gave what really changes you know it could be um it's not a bigger opportunity if anything it could potentially hurt the business yeah so just kind of trying to look at like how much are they relying on the stock versus uh what kind of opportunities it presents and something that trades at a lower sales or earnings multiple doesn't mean it's a better investment. We all know that by now. Yeah. But, you know, the risk is there. All right. Is that going to do it? Kind

of risk reward? Yeah. We're going to have a quick break and then we'll get to our second half topics. This episode is brought to you by KPMG. As a business leader, how can you innovate, build trust, and move forward in a digital era. KPMG can help by bringing together the right talent and technologies, generating insights that spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high-speed Wi-Fi to stream all your favorite movies and in the morning get fresh waffles with their free bright side breakfast

or squeeze in a workout at their fitness center either way you're ready to conquer the day tonight la quinta tomorrow you triumph book your stay at lq.com all right welcome back in i'm going to kick things off this week traeger grills filed their s1 they're going public it's actually under the name like tgx holdings number one or something like that some weird is it a spec or no no i don't think it's spec um but anyway some weird holding company name i guess um but i just want to kind of go through the thumbnails of the s1 it wasn't a super deep dive or i i didn't read through the whole thing but the company will trade under the ticker cook lovely i good for them that checks things off right there yeah and actually one of its mission statements slash goal whatever

objective things on like the first page was we make everyone feel like a backyard hero love that good one again that's honestly the s1 was pretty funny they they knew what they were doing um between 2016 and 2020 they sold more than 2 million grills thought that was interesting uh and i have a quote here it says our flagship wood pellet grills are internet of things devices didn't know this that allow owners to program monitor and control their grill through their trigger app which is used more on more than 1.6 million mobile devices per month are they paying for this is it a subscription on here i think that part's free well that's disappointing but there is a recurring revenue element which i'll get to um so other notes since 2017 traeger has

compounded revenue at 28 annually they did almost 550 million in revenue in 2020 here's another quote they have a very avid fan base if you can't tell by the dads that post the dads on twitter that posted pictures of their traeger grills yeah it says one our group of foodies pit masters and backyard heroes proudly wear our branded apparel sometimes sport traeger tattoos and occasionally name a child after us last one i don't know about that tattoo is interesting that could be fun it's uh i guess traeger's the new child name uh they have 43 gross margins they did more than 10 in operating margins for 2020 so 58 million in operating profits i think around 50 million in operating cash flow however 437 million dollars in long-term debt with only 17 million in cash

hope they raise hope they can raise here good amount three four hundred million maybe yeah i mean by now they're sort of cash flow generative so i think they can refi if they need to but i mean they're gonna it's an ipo they're gonna raise money and they can pay it off with the cash there but uh they do generate recurring revenue through their sale of wood pellets so apparently these are wood pellet grills so if this is sort of the uh that's huge yeah uh so as the installed base grows apparently they're selling more and more wood pellets um the bulk of the revenue still comes from the sale of grills but it used to be 18 percent of revenue comes from wood pellets now it's 22 i think that might have been year over year maybe it was 2017

to 2020 any interest in this business yeah i think it's going to go in the same category as yeti corsair gaming peloton stuff where i'm like this brand's pretty solid but it's the stuff we talked about the first half okay you're you make one purchase of this how many people are going to be reliable customers how much do they have to re you know acquire customers and without that and they may have the wood pellets oh okay they said 80 of their customers referred more than six people to use a striker i guess but you don't you just get one you underestimate the the dads here the spending i mean if they defer if they diversify into more backyard items maybe but gosh i don't know i just got merch they've got covers great merch sweet they've got ancillary

products two grills so like you know what i mean like the the scrapers and the patty flippers i I forget what they're called, spatulas, that kind of thing. Yeah, it's in the same category of these consumer brands that are discretionary items, one-time purchases. I am very uncomfortable investing in those. You're just not a backyard hero. I am not. I don't have a backyard. I don't even have a deck.

I'm in an apartment. So, yeah, maybe I'm just mad. I can't utilize these. All right, Defense Department is changing up the Jedi deal. So last week, the DoD announced the cancellation of its $10 billion 10-year Jedi Cloud deal that it awarded to Microsoft in 2018 or 2019. And then Amazon alleged and they basically proved now that Amazon was purposely left out, even though they were the largest cloud provider at the time, because of ex-President Trump's animosity towards Jeff Bezos. which makes me think that and we may have had this take on the show before that jassy at the helm from this next decade is way better for amazon than bezos um yeah that's a whole another

topic i think it helps with the image yeah for sure um in a press release the dod said that the old jedi contract no longer meets its needs that's a quote and this implies lots more spending on the cloud by the military the dod wants to make these an open-ended contract which means no spend limit with these cloud companies when they when whoever's running azure aws google cloud or oracle when they were reading this press release i feel like they had to sit down and like get some water because they say open-ended contract with the government i mean how valuable is getting this lock-in with the u.s military in my book it feels like overall this cloud business over the next few decades could be worth, just from the U.S. military, $250 billion.

Whoa. The Jedi deal was like $10 billion over 10 years. That's what I'm saying. It's going to be significantly larger. They're underestimating how much spend they're going to have here. I don't think it's going to be 25 times what they expected. I'm saying over a few decades, say until like 2050. It's impossible to predict, but I think it's going to be extremely lucrative.

You know, when they first announced the Jedi deal, I kind of thought, like, why are they stressing so much about it? Like one person, one provider? Yeah, because, I mean, $10 billion over 10 years, that's not that much of AWS's business. Exactly, that's what I'm saying. It's going to be way larger. But apparently other companies see it as a vote of confidence as the most secure cloud provider if the military uses it, if the U.S. does, or U.S. Department of Defense. yeah i don't know i think it's like a prestige thing honestly yeah i mean obviously 10 billion over 10 years or however much north of that this new deal is it's great but are they going to start calling this the sequel to the jedi yeah exactly exactly no and it's going to be multiple vendors

which these companies that are in this um like the snowflake type companies that are trying to utilize being the most like we can help you use all of the cloud providers you don't get locked in with aws or azure i have no idea if that will benefit them but possibly um talk to talk to the other the the sas and it experts uh that we are not of but yeah i don't know i think this is going to be incredibly lucrative these are almost like the these are the mod these can be the modern like lockheed martin boeing raytheon type deals i think which i i mean we know those have been some of the i don't know it seems it just seems incredibly lucrative all right i'm going to get into my story this is my last one i believe but richard branson went to space so the founder of virgin

galactic successfully reached well it was suborbital flight air quotes space yeah i guess i mean it's basically apparently it's like a rocket rocket powered plane right yeah it i mean well blue origins twitter tried to dunk on him which was it was a great tweet that was fun anyway he returned back down to earth this weekend so he one-upped jeff bezos uh if you haven't kept track of this little war that's going on. Bezos said he was going to go July 19th or something like that and Richard Branson decided to go

a week before him. I don't think Jeff will ever recover from this. But he's, okay, Branson didn't go to space. Well, I don't know. When he returned here, Branson proclaimed, welcome to the dawn of the new space age.

And then quickly proceeded to raise $500 million worth of stock as soon as the market opened this morning. So smart i'd say that's smart though that's smart yeah i don't know smart by them shares are down 20 percent uh 500 million is a lot yeah i guess publicity stunts followed by equity raises is just the modern day business model that's how these oh yeah these companies are going to operate okay here's the thing then someone someone was going on cnbc and talking about like hyping up the stock i think they were whatever proponent for virgin galactic or

they like the business and he said when when he was asked about the viability of the business model he came up and said thousands of people paying five hundred thousand dollars you do the math which typically means that they haven't done the math i'm gonna do the math right now keep going no they did and so jim chenos went ahead and did it and uh at three thousand paying customers which seems like a lot that's one and a half billion in revenue at the most revenue not earnings and how it's currently valued at a market cap of ten billion dollars roughly down 20 today so and by the way capital intensive manufacturing businesses do not trade at five times sales i think boeing is sub sub one time sales you're forgetting the tam i i don't know

yeah they gave us the tam i know it's small it is pretty small you have to do the math and that's 500 000 probably over their lifetime not a year yeah because you have to do the math on who has 500 000 to okay first off who has 500 000 that's like kind of the one percent and then who has five thousand dollars in liquid assets five hundred very very five hundred thousand dollars excuse me in liquid assets very very few people and within those who has five hundred thousand dollars they can just burn on a flight now if costs come down whatever but uh yeah this business is um we talk about risk in the first half i think it hits all of them um i guess gosh i don't know i can't get over how they talked about the dawn of the new space age when he suborbital suborbital

i mean i i don't want to be that guy but we went to the moon in the 60s i don't think this stuff's really that cool but this is an airplane all right apollo 13 whatever that's a movie let's talk tiktok yeah yeah uh okay wrap things up this one should be fun and i have a good new metric that i think might top community adjusted ebitda so keep people uh in the i'll uh use that as a what's the word nah i'm forgetting the word i don't know yeah you have no idea what i'm thinking okay tiktok bans cryptocurrency promoters so tiktok has updated its terms of service for branded content and has now banned the promotion of financial services including cryptocurrencies fintalk investors apologies you were out of a job

um apparently cryptocurrency promoters are now banned from the platform too and historically popular accounts would get paid a flat fee to promote a coin and most of these coins ended up being frauds whether the promoters knew that or not so probably a good fintalk investor what if i didn't know if mark cuban was a fintalk influencer i guess he is i guess he is um well there's plenty of others uh the top in crypto may have been either one when the barstool sports guy poor knowing did that like national signing day thing with that fraud and all those frauds and then when that porn star that jason swag talked about with that picture of the intelligent investor do you remember that photo yeah well it's a little distracting but the

picture of the intelligent investor held upside down and then promoting just the shittiest of shit coins in it to the 20 million followers yeah well i mean okay so is this the is this the end of crypto it's the i mean uh bitcoin whatever it's fine but the uh i forget what a bitcoin 2 gen do you remember that that that steven seagal that old actor that's like in russia he did bitcoin 2 gen look it up it has the greatest promo picture of all time it's him animated he has eyes this is from 2017 so he's early on the laser eyes he has like laser eyes pointing out his hands are making a diamond and then he's glowing and it's like bitcoin 2 gen it was a complete fraud and people went to jail but this has got to be the right move right any downsides from this except for

less comedy on our ends well yeah i kind of understand the chinese government's perspective here not sorry this isn't bashing on crypto but it's not technically providing any true value to society and it's exerting a lot of energy consumption or it's using a lot of energy consumption so i would be probably a little bothered if i were the chinese government that's true it seems like a bit of a waste wow you're just an authoritarian no just just joking That makes sense. What's this metric you're talking about? Yeah, okay, okay.

So I was looking at Circle SPAC presentation. We can wrap things up with a fun one here. What do you think about this? So they do peer valuation benchmarking, and they do Circle's growth-adjusted enterprise value divided by 2023 estimated revenues. They're trading at 0.03. I couldn't track all that.

Growth-adjusted enterprise value. What does that mean? just adjusted for your future hopeful growth yes growth adjusted enterprise value divided by 2023 estimated revenues it's i think this top making a face if you can't see that i think it tops this tops community adjusted even to i it might move it to my number one ranking of financial metrics yeah i mean i i still don't know what all it means i don't know what they're well what they're using to quantify that yeah i mean i said the the that i said that picture you know the it seems like you could kind of make that multiple whatever you want it to be exactly and they're

turning at 0.03 times it they're cheap huge i mean it's huge have you looked at the circle circle it's that uh stable coin um that it's tam was the entirety of the world's money supply so So their TAM, in the presentation, is projected to be $285 trillion. And it only trades at 0.3 times? No, no, no. That's not. We didn't do EV to TAM, which that could be very cheap. We're going to have to get out some scientific notation.

All right. That's going to do it. Thank you all for listening. Feel free to reach out to us. We've been drying up on the emails because I don't think I've mentioned it in a while. But it's chitchatmoneypodcast at gmail.com. I don't know casual conversation or if you want us to look at a company anything like that just go ahead and reach out you can also reach us on twitter just look up chit chat money you'll find

it dms are open I believe thank you guys for listening we want to remind you we are not financial advisors anything we say or discuss here on chit chat money is not formal advice or recommendation we are however general partners at arch capital and clients may have securities or positions in the securities discussed in this podcast thank you all for listening we'll see you next time We'll be right back.