Chit Chat Stocks - Investing Power Hour #49: Capital Gains Taxes, Altria Buys NJOY, & Sony’s Weak Dispute

Episode Date: March 12, 2023

The CCM Investing Power Hour is a live-streamed show every Thursday at 9:15 AM PST. On the show, Ryan, Brett, and a rotating list of guests have an unscripted discussion on a variety of investing topics. You can watch the show on our YouTube channel here: https://www.youtube.com/c/ChitChatMoney Follow the show on Twitter: https://twitter.com/chitchatmoney Subscribe to our newsletter: https://chitchatmoney.substack.com/ ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** 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

Welcome to Chit Chat Money. On this show, host 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 recommendation. Now, please enjoy this episode. Welcome in. This is the CCM Investing Power Hour, number 49. Ryan, I'm here as always with you. My name is Brett Schaefer, I should say. And yeah, this is the Power Hour. Ryan, how are you feeling

this week as we close out earnings season? A bit of a hectic morning, honestly. A little bit of context around our personal lives we're going on trips yeah right we're going on a trip so we've been i've been talking all morning so sorry if my voice is raspy we're trying to front load some of this work i'm going to be in new york this weekend meeting with a number of previous podcast guests actually uh friends of the show so that'll be fun excited for that um and then There's been some stuff, but nothing too newsy in the financial markets as of late. No, we get a lot of small topics. I think it'll be fun this week.

Yeah. And as a reference for the investing power hour, if this is your first time listening or watching, we go live every Thursday around lunchtime, Eastern time today, a little early, but that's because we're going on these trips and we wanted to get it out a little bit early before we have to leave. But regardless, in these shows, we bring in some investing topics. some business news topics, some finance topics. Sometimes we bring on guests, like last week,

we had Emmett Savage from My Wall Street, and we just kind of go with no script and see what happens. We bring some notes, but that's really it. But before we get into the Power Hour this week, today's episode is presented by Stratosphere, the best web-based research terminal that we use for company-specific metrics like KPIs and segment revenues. Ryan is showing it on the shared screen right now.

They have fantastic charting capabilities. They have fantastic historical financials, where if you use a premium plan, it can go all the way back to 35 plus years for hundreds of different companies, maybe even thousands. It saves us tons of time digging through SEC filings or saving time that would be going through SEC filings with highly accurate data that is triple checked for accuracy. And if you still want to look at SEC filings, they have an SEC file aggregation tool for all your companies, for your watch list, for all that good stuff that can really, really help you save time, which it does for us. So if you want to check them out, use Stratosphere as your investing

home screen, ditch Yahoo Finance and some of those old buggy legacy tools and try it for free by going to stratosphere.io. That is stratosphere.io. Okay, Ryan, what is your first topic today? That's a good question. Let me check. Oh, capital gains tax. A couple of comments about this last night. Apparently, President Biden's new proposed tax plan would take the long-term capital gains tax rate from 20% to 39.6%. 6%. This wasn't approved or passed, but that would be a steep change, no doubt. So honest question here, if it passed, how would you change your investing approach, if at all? Ooh, good question. Well, I think I would be a lot more...

So from the professional perspective, I think we would take it into account for sure. Because when we're, but I'm going to talk more personal because that's really the audience we're talking to here and the professionals don't need to hear me talk about it. But from a personal perspective, I think I would be much more, how do I say it, deliberate about what stocks go into my Roth IRA or any sort of tax deferred account. And if that's a position that I think would be more likely to be sold for a gain, or if it's that type of one compared to a never sell position, or maybe it's something that has high dividend income, I would put that in the Roth IRA as opposed to the non-taxable account. I think that would be the only thing that changes for me. But besides that, I don't think this can let – we try to invest with taxes being low anyway, so I don't think it would affect much for me. What do you think? No. Well, yeah.

It's kind of interesting because I guess you can take it one of two ways. One, it's a big one for the never-sell camp because maybe you just wait until they reduce the capital gains tax again to sell some of these positions that you own forever. But for me, and I worry about the incentive that this creates, it makes more sense to lock in short-term capital gains. oh yeah well i don't think we need any more incentives to lie in short-term games given how trade happy the market has been and market participants have been lately so i don't know if that's gonna like how much of an impact that will have i mean yes you're right it does incentivize comparatively to have more short-term than long-term um but which i think we i we already right we already we already see so much of that can it even get any worse

I guess I never say never I guess that's I just wish for my worst nightmare to double the day trader gurus out there yeah I mean it would incentivize me to do a lot of stuff that I think would like be shorter duration bets like which would

probably be stupid on my part but like merger harp stuff or stuff where I think it'll close like I could lock in short term gains although that's not something I'm good with, but my concern is it does incentivize gambling. It incentivizes shorter-term bets because if you can lock in shorter-term capital gains, theoretically, I would say most people are getting a lower rate, right? Yes. I think as an economist would agree

with you, but I think economists don't live in reality. And in reality, I don't think it would change much because most people do not invest off of these type of things um or you know some people do but i think most people don't and most people invest off of feelings so this tax stuff like they they don't even know so i don't think it's going to cause much but i think on an institutional side it could it could cause some rumblings for sure it's a win for the never sell camp for sure because you get now you want something where you can pick when to sell it not because you have to sell it because it's like a horrible business or something. I also love how many people are in shambles, like about this,

like, Oh my gosh, how stupid. We've been good. If we're in team capital, I guess technically we are, even though we're basically the most broke team in team capital or most broke people in team capital, the last 40 years have been very kind to us. So if they're going to raise them a little bit, it's not a giant, I mean, It's a big raise, but, you know. Well, I don't know. I don't love the policy, but I would rather just have, like, higher, like, income tax brackets where, like, you know, like, just extend it beyond the current – because what's the threshold right now?

Like, 49% is the max or something like that if you make, like – or is it 40? It's, like, 40%. I have no idea. We don't have to worry about it. I don't worry about that stuff. But I'd rather extend it that way because then – I mean, the problem with this is if I'm getting taxed to invest – if I'm getting taxed at potentially 40% on capital gains for – and maybe I'm thinking about this wrong. But for big and long-dated investments, it doesn't really incentivize me to participate. There's less incentive to fund a lot of businesses.

I think you're overrating the impact of that. I don't think it would have much of an impact in reality if this happened. Remember how high capital gains was? It's been high before in US history. And was that any less innovative? Maybe. I guess we don't have the exact details and it's kind of hard to calculate. but uh she was gonna say i think i was gonna say that yeah they are overrating it but we'll see if it's probably not gonna get past either also oh one thing i was gonna say on the income stuff i think that works good in theory too but a lot i think they probably want to target fairly the a lot of the ultra wealthy people don't really have necessarily income you know so they want to target that and a lot of people can shield themselves from that so this might be better. Let's get those real estate loopholes out of here. Screw that. Those real estate loopholes are, I guess, hey, don't fight them. You should just join them.

Maybe the people that join real estate and are those investors are right because they know that it's so tax advantaged, but it's just, can we just get that loophole out of here? Who is that helping. It's helping very, very rich people. You've just pissed off all our potential real estate listeners. Our real estate cohort? No, I mean, hey, let me compliment them. You are smart for taking advantage of those tax loopholes, but I think the rule doesn't make much sense. Yeah. I feel like America's largely benefited from a smaller long-term capital gains tax rate over the years i'd agree we could target it somewhere else yeah target short-term hire target income at that whatever that you know the make it less uh target the ultra wealthy there

target that real estate stuff target some other things that uh the vat taxes that could be interesting as well this one seems weird it's more of a political game kind of like the buyback tax Why not do a progressive income taxes? If you've sold more than a million dollars or you've earned more than a million dollars in capital gains, anything above a million is a higher capital gains tax rate. It's progressive, just like income. I like that. I like that. As someone who is not going to have much for a long time, I like that. Because I think that's fair, too, because you're showing, or at least like if someone is selling, say, $10 million in a year of capital gains, you're showing that you're not going to be hurt by these taxes. um yeah i hope that i hope no one take this as political these are just ideas we have no affiliation we're basically pure independent so no affiliation any part of these are just our ideas so no no no listeners take that as anything political yeah i you know it becomes all this stuff does become political and uh when people discuss it it's i doubt it'll get passed

because I mean, at least not at this rate, not at 40%. Maybe they're throwing a high ball out there so they can negotiate down to 30 or something like that. Yeah. The interesting thing is like, all right, pretty much all politicians have people that financially back them. It's hard to be a financial backer if you're not wealthy. And if you're wealthy, you've probably been advantaged by this long-term capital gains tax rate. So do you want to hurt the primary financial backers of every politician? The idea is probably that they would vote against it.

Yeah, the lobbyists. That's my thinking. Who's going to influence them? Yeah, I mean, that's probably the key reason over the last 40 years why some of this has happened. But we don't need to go into the historical replications of any sort of politics and stuff like that. Why don't we move on to the next topic?

If you have nothing else to add there, Ryan, you have Sony. I didn't see this or maybe I did see it a new dispute with Microsoft over the proposed acquisition of Activision Blizzard I should have a note as of the time of this recording we do have a stake in Activision

Blizzard read our full disclosure at our Arch Capital Fund website although we do have the disclosure at the beginning and the start of these episodes yeah I guess in terms of like updating the situation here they I think on February 8th

UK regulators expressed they had an intermediate ruling, or maybe a temporary ruling, that said we're concerned about these two things, which was the exclusive games and the potential monopoly in cloud gaming. And then Microsoft said it licensed – it struck a deal with NVIDIA's GeForce Now, which is the cloud computing version of NVIDIA or what NVIDIA offers for cloud computing, mostly on PC. I think it's only on PC. But that kind of alleviates a couple of things. They've also struck deals with Steam and Nintendo that gave them 10-year licenses to Call of Duty, which basically says they're not interested in making their games exclusive. It's not going to be a monopoly in cloud gaming purely from this deal. And so the only people that are really disputing it at this point are Sony, which are the makers of PlayStation, who ironically are the leaders in console gaming. And they've also bought their own studios, and they also have exclusive games for PlayStation.

So kind of- Much more historically than Xbox. So yeah. Yeah, a little ironic there. But the other part I wanted to show, the most recent complaint against this deal passing was Sony said basically that Microsoft could release a poor quality game for PlayStation, or they could intentionally put bugs into their software updates for any PlayStation gamers to ruin the experience of Call of Duty. why would they sabotage themselves

to maybe a max a million new players over a three year period to transition to Xbox yeah which is just it's so dumb and at this point there's like I think Sony showed that they don't have like any leg to stand

on the other part I wanted to find and I can't I gotta find it Basically, the CEO of Sony Interactive Entertainment said, we don't want – okay, I got it right. So the executive vice president of Activision Blizzard, or one of the executive vice presidents of Activision Blizzard said, kind of there was this question posed to the Sony Interactive Entertainment CEO that said literally like, you know, why do you keep refusing a long-term deal with Call of Duty? And apparently a direct quote is that he said, we don't want a new Call of Duty deal. We want to block this merger. Yeah, that's not going to help in court.

Yeah. It's going to be interesting what happens because there's could be you never know what the regulators are going to do because someone might make a move and say, OK, we're going to block it or, you know, however the process works and kind of take this thing to court. Or there could be kind of a domino effect where a lot of the regulators say, no, it's fine. And then all the ones that have been a little bit pesky about it Are just going to fall in line Especially if the US, Europe, and China are all in tandem Which China is kind of its own unique cookie, I guess You know, they're different But yeah

It's weird where there's so much How do I say this? it seems like at the start sony and probably their lobbyist and whoever else was on their side really tried to drive the narrative that xbox was trying to become a monopoly through this deal when you saw that constantly in the news right you probably saw i saw you probably saw it as well when in reality that's not xbox is actually not that successful of a division yeah i mean i think the concern for playstation is that game pass is going to be a huge success and kind of steal share as the migration to cloud gaming do you think they make a target for one of

the big um i think the only two big ones that would have a meaningful push like activision would be ea electronic arts or take two do you think sony well there were rumors do you think Yeah, do you think they try to throw a bag at Take-Two Interactive? What do you think that tells regulators? Like, we're going to buy Take-Two. Doesn't that tell if you're a regulator and that's their, like, we're going to go out and try to buy them? Like, doesn't that give Sony no legs to stand on for, like, this argument?

Yeah, I know. Like, they play themselves, if that's the case. Yeah, well, I think from a regulatory perspective, this would this will help solidify xbox and sony's sort of duopoly i know nintendo's slightly different it will solidify their duopoly even further but there was no and i guess maybe the steam deck could take on something but and pc is technically a competitor but there's there wasn't going to be a third entrant into the console wars with the same strategy as sony and as xbox because again nintendo has a different strategy even before these mergers so i don't know how this

harms the consumer either way because there's less um it's just one of those industries that's gonna have a few players as the distribution platforms that just works better for the publishers the players everything and you're just gonna have some rules in place to make sure people aren't acting anti-competitively and you know some industries do that yeah i mean my gut tells me this deal is going through my we own stock in Activision so yeah so we're biased here

I mean there is downside for sure but yeah they uh I was gonna say the other part is from Sony's perspective it honestly does kind of make sense to buy a competitor here like buy take two because then you can at least keep it

keep every game ubiquitous across consoles um so like because if if microsoft after the 10-year deal expires says we're taking call of duty in-house if you have grand theft auto you can just copy them and say the same so it's kind of like a if you do that we'll do the same and it makes your subscription offering that much better yeah but then on the flip side like what's the advantage of having activision in-house for xbox yeah it's honestly not that big of a deal and i remember kind of laughing when they said they

wanted the mobile stuff but when we look through activision blizzard again they do have half their revenue from mobile so i think that could be interesting where they're really trying to expand xbox game pass to be a much more valuable subscription if you can add on mobile games although mobile is different because a lot of the stuff is free to play so i don't necessarily know how they would work with that. But one of the reasonings, and I don't know if this was a lot of fluff to just appease the regulators, is that they said that if they have Activision, they can really go after the mobile market more and try to impede Google and Apple's duopoly as mobile distribution platforms. But I don't necessarily know why having a few popular mobile games is

going to allow you to do that, but we'll see. It doesn't seem like it's going to be that different like this deal is way overhyped the Activision Blizzard's business is not going to change much the only thing that really mattered was getting the licensing deals for Call of Duty and then the subscription business for Microsoft might improve a bit but is it going to improve that much not really because the monetization within a lot of these games are the add-on content which doesn't really jive with subscription yeah I agree all right you want to talk about altria yes uh the potentially worst capital allocators in we'll talk about maybe we'll debate this i have a nice stratosphere chart to show um what so how the narrative can change here

but let me go through there's a few um just a few notes on what they did here so altria is buying another vaping company it is called well njoy let me enjoy enjoy uh 2.6 billion dollars i believe this comes right after they exited their stake in Juul, which they remember acquired for $12.8 billion. Here's the quote. Altria, which makes Marlboro cigarettes, will have global ownership of Enjoy's e-vapor product portfolio, including Enjoy Ace, the only pod-based e-vapor product with market authorizations from the FDA. So I think a lot of this was this company already had stuff approved. They think they're going to put it on a global distribution platform, especially the u.s and now with how restrictive the fda has been with vaping they're going to

have an advantage here and this is extremely valuable to have these licenses um i guess yeah i have one question here about the uh the current state of the reduced risk product market but we can have that second i think what are your thoughts on this deal what are your thoughts and we followed altria for a long uh not a long time but for a few years now thoughts on the deal just first glance at it well i don't like any investments in the vaping market at this point i i really just don't think like i hate that market because everything is so displaceable there's no real competitive advantages um like how many iterations No one so far has proven they can separate themselves from the pack for an extended period of time.

Jewel was kind of the first to really be popular. It's since died down. I've seen so many different iterations. There's Puff Bars. There's Elf Bars. There's so many of these different things. There's disposables. There's now pod-based ones.

At least in my experience, there's no preference. People don't care which one it is. So I just don't see the competitive advantages. I don't see the moat. I don't see the sticking power of any of these things. Maybe you could be the low-cost provider, but I mean- It's not that meaningful. They're not that expensive. Yeah. It doesn't feel to me like any money allocated here is really, it feels like very speculative if you invest in any of these things as one of the premier tobacco companies. So I don't like it. Do you? No, no, I don't like it either. But I think this brought up a good point. There's been a lot of discussions around the investment community of, you know, Altra is a good business, clearly, obviously the right price, but the capital allocation over the last five to seven years have been quite poor, pretty objectively. probably Kronos. I mean, that was a joke. Juul, that was a joke. Some of the other ones were not great either. They had to sell off that Chateau Saint-Michel wine business, which I guess was kind of small. But farther back, they made some good acquisition moves and they also made that cigar one, I believe in like 2010. But regardless, what are your thoughts? And I guess this is one

in general of their capital allocation, how you look at capital allocation versus a really good business like Altria that might be trading at a dirt cheap price with a dividend yield that typically is above 8%, which can be just fantastic for a tax-advantaged account. I'd also... Let me show that chart here before you go and start on here. Let me share the screen. Now, if you look at Stratosphere here, which again, go to stratosphere.io as our sponsor, support them. You'll really save yourself some time and money. If we look at it, it's loaded up here. We have Altria's long-term chart. I went back to 2009 because they split up from Philip Morris International. So some of that stuff gets... The chart doesn't... You have to

do some pro forma stuff that'll make the chart look weird. But if you look at their free cash flow per share, it grew from 2009 to about 2018. And then it's been very flat since then, which for a business that has huge volume declines is not the worst outcome, especially if you can buy them at a sub 10, you know, at an earnings yield above 10%. But when they take that money and spend $13 billion on jewel, you get a little bit concerned. And then they do this about $3 billion potentially with enjoy with that

context. What are your, what are your thoughts on buying a good business with a bad capital allocator? it's so funny because people are like please just repurchase shares like just or invest in buy back invest in more yeah yeah and they're like how about some more enjoy or can i can i interest you in more vape like no one wants this um i think it's really i mean it's a bummer but at the same time i find it interesting because what would you do if you're the ceo here And you feel – obviously, the number of people that smoke cigarettes is continuing to decline and decline and decline. Now, maybe if there's a push towards greater employment in the labor markets over the next 10 years, that decline might stabilize somewhat.

But the – or if we hit a recession, maybe more people smoke cigs. But the – I mean, what would you invest in? What are you going to do with that capital? Are you just going to keep paying it back and kind of risk the long-term part of your business? If you know you're in secular decline, where do you allocate it? Because you could do it in nicotine pouches, but it seems like Zin is largely winning. I wouldn't know where to invest. Yeah, don't invest then.

Just buy back. Just die slowly. No, buyback. You're dying slowly. You're returning cash to shareholders while you're doing it, and you'll probably return more cash than your current market cap over the next 10 years. Well, actually, if they buy back, they can – and this is kind of an interesting thing for someone who has a dividend payout strategy that they want to grow their dividend every year. Their overall dividend payouts in future years can decrease if they buy back their stock, and their dividend per share can increase. So I think the combination of them for buybacks and dividends can be quite magical, especially for people looking for dividend income over the long term.

Yeah, but at the end of the day, you're still fighting the secular decline. Yeah, fighting it quite well, though. I mean, they have, but I think that management's gotten to the point where they're like… Well, they feel forced. Yeah. They feel like they're backed into a corner where we got to do something to extend our earnings power. Yeah. And you can't wish anything unless you're an activist investor. You cannot wish anything to happen. You can't be like, well, stop it. Stop it. Don't buy back. Or start with this. Just make some maybe small purchases and invest in nicotine pouches and

then buy back stock and return cash to shareholder through a fat dividend. But the reality is they're not doing that so you have to take that into account and yeah yeah i mean yeah that's why the that's why the stock trades at um and i guess sometimes the pe the p is probably elevated here trades at an ev to ebitda of 12 so i mean that's cheap and i think some of that might be a bit understated actually um but whatever i haven't looked at the company deeply lately yeah we used to own it made money but sold it on the few one of the few oh that was the other thing i was going to say was this is actually brilliant on biden's part because they raise capital gains taxes no one has capital gains

at least in the last two years no one's no one's got capital gains so can't tax what you don't have uh oh i don't know it's a bummer that to see this like But Altria, if I were to get interested in the tobacco markets again, which is certainly possible, it wouldn't be domestically here in the U.S. And it would have to be someone who has clear runway to grow in other categories, and you're already seeing that with some of the brands. So preferably a nicotine pouch. Philip Morris has that now in Swedish Match. Yeah, it's the other ones, not Altria. Yeah. In the US, I mean, the decline in cigarettes is just so much quicker, it feels like.

Yeah. It's one of the worst markets out there for the tobacco industry. All right. Speaking, I guess, of tobacco investors, our friend Lawrence Hantel, who's been on the show before, who hasn't been on in a while, but good follow on Twitter. He had this tweet that spurred a lot of conversation. And this is, I guess, my second topic. He said, I often think that one of the worst bits of luck one can have early on is a windfall on a lottery type stock. When I've seen it happen, the usual result has been a learning of all the wrong lessons, namely that process and risk management are secondary concern. And then there was a response from someone that said better to pay tuition early and often. Thoughts on this? Thoughts on how the first few years can

be very formative? Do you think it was good that we kind of went through the bubble and popping of the bubble as we're still in our 20s for this type of stuff? I mean, don't get me wrong. I'd take a big wham, but I'd hopefully learn the same lesson. I don't think I would have learned the same lessons that I've learned over the last three or four years. Yeah, I think the environment that we kind of started into where we've now seen – we've seen the top of a cycle and what can happen when things actually do get irrationally exuberant where – Know how it feels, know the signs, know what it looks like. Even though you read about it in history, it's a lot easier to go through it. I, excuse me, it's still easier to see it after you've experienced it the first time. Cause I think clear, like we are able to see now bubbles forming, um, much easier than in 2020, 2021, when we got caught up in it a bit. Yeah, and those little things, those little microcosms where you see – okay, so for example, there was a lot of times where people were like, okay, Beyond Meat has a $20 billion valuation.

There was a bunch of companies that were pre-revenue that had crazy valuations. Do these little microcosms make you bearish on the overall market? And my answer was, well, does this have any bearings on the earnings multiples that comprise the majority of the S&P 500? So like Google, Apple, does it affect them? No, but it's indicative of the excess liquidity of how much money is being allocated to stuff that doesn't matter. And I think that once that kind of cycles through and once that gets washed away, affects the top line of a lot of these businesses and it affects the overall economic environment. So I do think those little indicators aren't just like a brush under the side. It is an indication of excess.

Yeah, when Google was growing, what did they grow revenue like 60% at one point in 2021 when you're an advertising based business and the largest in the world? Yeah, there might have been some excess getting funneled into their advertising slots. It also, having this last two years where we've seen companies that were growing 30%, 40% and now are seeing declines in revenue, has helped me realize how difficult growth really is. Like, I overestimated so many businesses in terms of quality. Like I said, like, oh, this is a really quality business. Look at, you know, look how much they're growing, that kind of thing. Like to grow durably at more than 10% a year is like, it's really difficult. So it's certainly, I think, rationalized my estimates of growth for businesses, which hopefully will allow me to find better investments and preserve more capital. My concern is I don't want to take away the wrong lessons. Yeah, that's true. Like, don't take any risk.

Oh, okay, I would never buy something above a PE of 15, stuff like that. You don't want to really constrict yourself and just go with the flow of what is, you know. Well, you can, I think, change your overall philosophy, but it needs to make sense. And you have to really be cognizant that you're not just going with what's popular among the crowd at the moment. Because it could have been a mistake, and it was a mistake to buy growth stocks without regard to the price in 2020 and 2021. But that doesn't mean you should avoid growth stocks forever. It doesn't mean that you should not be buying any sort of growth stocks right now. it might be a mistake to learn or excuse me a mistake to see that but back on that revenue

growth thing yes and i agree i mean that's you know you don't have to agree with you it's kind of just it's just a fact the most dangerous thing and you get caught up in this when you're a novice or starting out and you kind of you're learning how to read financials and stuff like that you go oh, this company's growing revenue 50% and it's trading at blank, it's a buy. That is the most really, really dangerous. It's so easy to extrapolate out what's currently happening instead of looking at base rates. And also on the flip side, on the flip side, this is why when you can get someone who's accelerating revenue growth, that can be quite promising because a lot of the times there's a lot of companies out there maybe right now,

I would think that we own some of them, but who knows? We'll probably be wrong on some of them. But when you can accelerate revenue growth, when someone's extrapolating that near-term stagnation to the downside, that can be a good buying opportunity. What is your general – this is like the most boring question in the world, but we talked about it a lot yesterday, so I want to throw it out there. What's your general outlook on the markets for the next two to three years? that well i have no clue because it's not how we think but for the podcast it can be fun to discuss i well we said it yesterday i don't think in optimism because that usually takes care of itself but the only thing i'm worried about from a market perspective is that the pe's look cheaper or the earnings multiple looks cheaper than it actually is because

we're seeing margin compression. And I'm also worried that the affordability issues across housing, cars, student loans get turned back on and credit card debt is soaring at a really rapid rate. I actually have a chart that we can talk about later that looks into that. I'm worried about that something is breaking and that there's lagging effects on this stuff with the Fed raising rates and that things are going to be pretty bad at some point and we can't really see it until it happens um so that's what i'm worried about but that just means by by businesses that are have conservative balance sheets that are utilities not discretionary items that have recurring revenue blah blah blah can insulate themselves from inflation

which are few and far between the ones that can truly insulate themselves from inflation i don't know i used to think like oh this business immediately yeah i used to think like oh this business is inflation protected they're not going to be like they could just raise prices and it's like raising prices without true customer attrition is very rare yes or the companies very few companies can do it almost immediately and it's really just cpg companies i think when you look at someone where I kind of like- Or the card networks. Or the card. Well, when you're a take rate company. Yeah. Yeah. As well. Yeah. Because we like a lot of targeting or researching what we would describe as digital utilities. This could

be software. This could be consumer internet. We like the music space. We like the dating app space. We like software companies within certain markets. Those, I think, are inflation protected over the long-term, but in the near term, they can have effects on their business. They do have lots of employees that are going to have raising wages. So if inflation is high consistently, they're going to see margin compression just because the wages are going to go up faster than they can raise subscription prices. And they can't be like Hershey and just go, yeah, we're going to raise prices by five cents a pack. Yeah, agreed. We do have a comment from Favre. Yo, yo, yo. What's up, fellas? Long time no see, Favre. Nice to have you back in the comment

section feel free to drop any questions um i know the i think the general like the area that i'm probably the most and we we sound like broken records on this is housing areas yeah the area that i like concerns me the most is housing because let me share a screen but you keep going i'll share a screen that's interesting but there's no way well there's if housing prices stay where they're at and rates stay where they're at it's going to hurt the rest of the economy. I agree. To me, it's just like, that's my big, big worry.

And then on the flip side, the wealth effect of thinking your house is worth something when it could be worth less. If you start to see your house price collapse or come down, I feel like spending might contract us as well. Yeah, I agree. And here's a chart. If you're on Twitter, Lance Lambert is a writer at Fortune and covers the real estate market. He's pretty good at throwing out a lot of facts here. This is from August, but I think it still applies now. And I think one of the big things that just housing bulls talk about or people that say the housing market's going to be fine talk about is they say, well, there's a shortage of homes and they state some number. But when you look at these four different sites, which are four different, why don't we have Freddie Mac, Moody's, Realtor.com, people within the space, people with good knowledge, people with good data, Realtor.com estimates there's 5.24 million homes short in the US, Freddie Mac, 3.8. This company, their handle, I don't know what it is, says 1.7 million, Moody's says 1.6 million. My thought when seeing this is that this is such a wide variance that no one actually knows what the home shortage is.

Yeah. Well, I mean, there's always a shortage until there's not. It's not necessarily going to be fixed by new house supply. It's going to be a lot of people. Well, I guess in some sense, there's so many homes that are being owned right now. A long enough timeline, all the boomers die. I mean, the mortgage- What was it? I saw some crazy stat that most mortgages are like- were all based on 2020, 2021 rates. There was like a ton of refis.

It's not necessarily that like those people are going to default because they're not variable rate mostly. I assume almost like 99% of mortgages are fixed rate on some low rate base. But like new people just can't, like new wannabe homeowners just can't afford them at these rates.

Like the average, I'd say – I mean, we see it with mortgage applications down 40% or 50% year over year. Like it's just – I think the answer is going to be more renters, unfortunately, which means rent prices would probably go up. Or yeah, I guess maybe there will have to be – just build your way out. Are we really short that many houses? Yeah, exactly. Okay, here's the thing. But if we build our way out now, over the next five years, then eventually there was a huge glut. Huge. Unless the population, granted, there's other variables, unless the population goes up by a significant amount. Which really, all the indicators are that it's going to stagnate. yeah i don't i'm not sure the the big concern for me that like gets me hung up on like could home prices stay elevated is like people just unwilling to sell they own so much of their home they're old so many big boomers are homeowners or percentage the homeowner pie like they

they're just going to hold on to these things it's just going to be less movement Yeah, and I think on a real basis, that means they're going to be down, even though nominally they'll be up. Because inflation in that scenario will be high still. Prices, like home prices? Yeah, if home prices stay high, inflation will likely stay high because it'll flow through to rental prices with these interest rates. And then, sorry, I'm trying to do a lot of mental connections in my head here. And then the prices, you know, won't, they won't go down, but on a real basis, they're going to be down quite a bit.

We're already seeing that really right now. It's also, okay. I see this all the time too, which is people are like, no, I'm getting bids. Like there's a lot of bids on, on my house. Or like I have a friend that has a house for sale and he said he got a lot of offers. Like, that's great. Like everyone's got their own anecdotal evidence with this stuff, but mortgage applications are down 40 or 50% year over year. How do prices go up in that environment?

there's half the bidders there are half the bidders there were last year or two years ago i think you're gonna get the same price quoted to you that seems very unlikely yeah there was how home purchases in 2007 that's pretty meaningless if one person buys a home here's another topic though and i'll share the screen again so you can kind of see it and read it a bit ryan uh for the youtube and i can't remember if we put these in spotify as well all right loading the share screen here's a tweet from and i'll have this in our sunday newsletter as well for anyone who wants to take a look i thought it was very interesting it's from this i think it's anonymous colorado travis account um starts out the thread and i'm not

going to go through the whole thing it says we are now at the beginning of the window for when we might start to feel the effect of the first rate hike which again were about a year ago and he quotes long and variable legs, and he explains why the legs on interest rate changes long and variable and why we're not going to see it here. Now, there's two things. There's structural things that affect the economy, and then psychological when you raise interest rate. The structural one, we all know, it changes the price of collateral, it changes the price of capital, it changes the price of money. The psychological one, though, and the structural one, excuse me, is going to happen when they raise rates, right? But the psychological one, we don't know when it's going

to impact decisioning. And he lays out this very interesting chart, which I'll load up the screenshot here. I'll describe it for the listeners, where you have a chart, one of the lines in the chart, and it goes from 1995 to now, is revolving debt outstanding of consumer credit, and generally goes up into a straight line. It goes up much faster right before the great financial crisis, and then it goes down, and then it goes up again, then it goes down during COVID, and now it's gone up again. But during that time, the GFC, we saw the second line on this chart here,

which would be credit card interest rates. The interest rates went up, and then consumer debt went down, which makes sense, right? They're trying to tighten the economy. And this is, I think, before the housing crash, which then they lowered rates to zero. But what's interesting here is we're seeing consumer debt levels rise, but the interest rate is also rising at the same time. So right now, the interest rates are not stopping consumers from spending, but they will eventually. It's kind of what his threat is saying.

We just haven't seen that yet from a psychological level. They will eventually because people will be able to spend. he is saying over and over he wants it to happen i mean if i do think there's maybe to some extent um with like consumer spending an addiction where it's like it's just what you know or like it's habitual like um you know you spent this much on on your food bill for the week you're like well i can continue to spend it that's not that big of a problem but then you know your debt levels begin to go up and it slowly slowly tightens and you're still spending that because you're kind of addicted to spending that and it's it's your habit but you don't really have the

money to do so obviously that doesn't end well and it ends in tightening um yeah but i think it'll take some time to trickle through the other part that i'm seeing kind of anecdotally around like my peer group and we've talked about this is like the unemployment stuff so many of so many people i knew just weren't working in 2020 2021 because they were like well i i have enough liquidity or i have enough cash i'm getting stimulus checks that kind of thing too like young people you're at you can be with your parents especially with covid it didn't really matter like i don't need the money so i'm not going to work like some labor job that like hurts my hurts my ego in a way like i'm not going to work at chipotle like that's kind of like it almost feels degrading now it's

There are too many people, and I guess we're one of them. There are way too many people with that Chipotle is above, which it shouldn't be. Yeah, I mean, it's like a – I don't know. I think it hurts a lot of people's egos to work labor jobs. I'm jealous of Chipotle, honestly. $25 an hour now? It's pretty good. Sorry, go ahead.

$25 an hour? Well, at least in Seattle. Yeah, some of them. It's pretty good. But I think now People don't have a choice They have to work or they're not going to get paid And so I think that's why you're seeing

Unemployment continue to fill Despite layoffs at big tech companies Everyone's talking about layoffs And they're like well why is unemployment going up There's all those open labor jobs too Open vacancies Immigration's been Zero for a while

That helps We're not zero but really low yeah we sound like a bear porn podcast this week but it's fun it's it's it's uh there's been a lot of well this week frankly there was a lot of data around that so i don't think we can be bland here but it's also fun let's talk about something else for the last 10 minutes though did you have any miscellaneous things let me see what i had linked here oh i linked my own tweet what other what was the topic i've seen some i found something funny because we just kind of wrapped up earning season, and I've seen this so much now, where you've got unprofitable or marginally profitable

software tech businesses that have been just pouring money through stock-based compensation and just diluting the crap out of shareholders. And then the stock comes down and it's the only lever that the CFO knows how to pull because they don't want to... If you don't want to do layoffs or you don't want to decrease compensation, they just slap a repurchase authorization on it. Where they're like, we got approved for $5 billion in buybacks, which, so that's going to offset any dilution.

Don't worry about that. But it's like, first of all- I love how they think that's going to make the investment community happy. First of all, an authorization, it's not a buyback. A buyback is a buyback. So I'll believe it when I see it.

Like anyone can authorize money. to do something but also none of this stuff is truly offsetting dilution in in a lot of cases yeah yeah it's just really not working i or it's unsustainable like it's a short-term stop like maybe your share count declines two percent year over year but you can't do this on a continuing basis and then it's up five percent next year yeah be wary of that i think uh we fall into that trap uh we're trying to watch out for it is when they have the free cash flow targets the only loophole they have is sbc or they change their definition of free cash flow so my recommendation when someone has a free cash flow

target watch the sbc line watch if they change the definition of free cash flow this is better than adjusted ebitda but they can make it adjusted ebitda at some point if they want yeah did you have any takeaways from the spotify stream on event i thought it was a mixed bag like we're looking from a podcast from our own perspective and i guess it kind of ties into the investor perspective because if they do better for podcasters then it's better for the their business um oh there are some good tools they're consolidating everything into their spotify for podcasters thing which makes sense. They have signed some good deals with more people that are big in the space that should attract a lot more MAUs to the platform. They signed NPR, which is a

huge podcasting studio or publisher, I guess, for their automated advertising. They showed some decent numbers on the automated advertising. But the two things we're watching that they really didn't announce yet is opening um the advertising marketplace to everyone and opening the advertising marketplace internationally those are the two most important things maybe uh to the whole the streaming ads to everyone yeah their advertising marketplace automated advertising marketplace would you agree those are the two most important things you're watching for for this entire business outside of the core obviously users and stuff like that yeah i mean there's like small stuff that they like just need to do um the international rollouts one

um and the difficulty is if i don't see the international rollout or i don't see them open up more inventory which means like letting all podcasts access the streaming um or the automated ad network it tells me there isn't enough advertiser demand right now and then on And on the flip side, it's not going to happen overnight, but you want to see it happen on a relatively quick pace. And they showed some progress here. You know, signing up NPR, that's a lot of inventory. They should have a YouTube like a pro. I mean, if I were them, I would just copy YouTube as much as they can in terms of the platform side.

But for audio. Yeah. I thought just the discovery would be sweet. I'm hoping that this, at this point, uh, this video we're having right now shows up on somebody's discover feed because yeah, that'd be great. It, you know, it spurs so much new demand. That's what's so great about YouTube. Um, even though we don't, the, the value of an ad isn't as high or we don't collect that much, um, from YouTube as we would from Spotify. Um, their recommendation algorithm is so good that it's, it's new eyeballs, it's new ears. Um,

and it helps us with organic yeah uh organic ads um but yeah spotify has been talking a big game about podcast discovery since maybe what last two years or so yeah about getting something to market and it's still been tbd they are launching stuff with this new thing and i'm gonna choose to be optimistic because i hope they nail it because the podcast market could use some discovery um stuff really yeah i do worry sometimes too that they are prioritizing their own podcasts over yes like the open ecosystem they talk yeah yeah they they yeah the hand that feeds you is the one that beats you or whatever yeah or they get like maybe they're only gonna start with npr and joe rogan and caller daddy on the discover feed and not open it up to everyone to like get more

listeners that way that just i don't like that um and the streaming ad insertion is only available to spotify podcast like spotify's podcast as opposed to the dynamic it's not a huge difference but and maybe they just don't have the advertiser demand yet but like i don't know that would that kind of concerns me is that they're gonna like you know they can't do it on apple they can't do streaming on apple because apple that's that's apple's fault that's not their fault couldn't they make it functional though for just your spotify track oh yeah yeah but they they i'm saying streaming streaming ad insertion is only available right now i believe to spotify owned or spotify exclusive podcast maybe but they do pay us more for ads on spotify versus off spotify

So I'm not exactly sure, but I guess that is, it's unclear to me. Yeah. I don't know. That's my concern is like with YouTube, you've just got such an open platform that like, there's no risk that they're going to prioritize. I mean, they tried to do like their own content for a while. Hey, maybe that means Spotify is on the same path, right? The difficulty is like the eyeballs started on YouTube. They didn't, YouTube didn't have to compete for those.

I mean, they're at the point where it's such a monopoly that they don't have to get the eyeballs over to youtube the eyeballs are just there spotify has to attract the eyeballs first before it can really create this like open platform which is a much harder task and it means that they're going to have to give probably preferential treatment to their own shows first yeah they're doing a lot of good things to attract people on the consumer side especially with some of those popular shows shows doing video um where the only way you can watch the video for people that want to is on spotify so they get users to switch you also have the q and

polls that have been popular on a couple of shows they're only available on spotify you know if someone says hey look at the poll you're listening on apple you're listening on overcast and you go hey there's no poll here and they say oh the polls are only available if you listen on spotify and it's free that's a great customer acquisition tool um along with other things that i'm forgetting at this moment but i think that's good but yes they're not in as advantaged of a position as youtube although i think and we can dunk on ourselves that this is wrong i think spotify's moat will be wider three to four years from now doesn't mean the stock is going to work but i think their moat will be wider three to four years from now yeah but i think it's probably from a low

base like users will certainly be up i imagine they'll have more users on the platform i didn't say it wasn't a low base didn't say it wasn't but like i don't know it just to me it's not it it is it isn't gonna i don't know if it'll translate to cash flow that's the issue yeah well that is the big thing all right well that's gonna do it for this episode it is uh We're coming up on an hour. Thank you all for listening. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation.

Make sure to check out our dating app themes starting next week. Watch these live on YouTube every Thursday around lunchtime Eastern, usually 1230 p.m. Eastern. Did I say the other disclosure that something might be owned by some stocks in the show? Yeah, we're not financial advisors. Anything we say on the show is not formal advice or recommendation. We're general partners at Arch Capital

and clients may hold securities discussed in this podcast. Thank you all again. We'll see you next time.