Chit Chat Stocks - John Rotonti - Rethinking Value

Episode Date: April 6, 2021

John Rotonti joins us for this week's episode where we cover current valuations as well as interesting innovations in the market. The group discusses semi-conductors and potential moats in the industry. Listen in after the interview for news from the week, Archegos blow-up, and even Spotify's most recent acquisition. Let's go! Follow John Rotonti on Twitter: https://twitter.com/JRogrow?s=20 Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Subscribe to our YouTube channel: https://www.youtube.com/c/ChitChatMoney Follow us on Twitter: https://twitter.com/chitchatmoney Visit our website to see more from your hosts Ryan and Brett: https://www.chitchatmoney.com Email us: [e-mail] Timestamps Interview 1st Half | (4:05) Interview 2nd Half | (36:40) Archegos blow up, Spotify acquisition & more | (1:09:27) 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, April 6th, and today we have an interview with John Rotonti. One of my favorite discussions, not to downgrade any old interviews, but one of my favorite discussions in a long time. It really challenged my thinking, and I think we've probably titled this Rethinking Value, and hopefully to our listeners that are super value-oriented like ourselves, this kind of gives a little spin on things and allows you to sort of reshape the way think about the best businesses loosen up a bit also fun stuff on semiconductors didn't know john was a semi expert on the investing landscape of the semiconductor industry my expert like half of an expert like an expert on semis well both i'd say like he's not you know obviously he's not

like a in the industry but he knows a ton and it was a pleasant surprise talking about that we learned a lot about semiconductors which is weirdly a hot topic right now but i think any listener will as well okay and we are reshaping the episode today so we're not doing the traditional stories hot water stuff like that we are basically any talking points that we have we're just going to go back and forth after the interview put the interview first get the good stuff out there first right we know some of you decide to skip ahead uh we'll that insult watching the times yeah that insult we will uh we'll let it pass but we know that that's the best part so we're trying to save the the fun discussion between us to the back half of the show and we have our sales pitch so

seven investing just came out with new recommendations i guess a few days ago but uh there was one that i've been looking at over the weekend very interested yeah the team's wreck okay yeah we've actually discussed it between ourselves yeah i can't spoil what it is at all but yes i do agree it's something i really like uh and i know we've talked about thousands of companies in the past but we've talked about it before okay all right all right wow giving a little bit of hint yeah i mean i like simons and honor bonds um sorry honor bond if i'm pronouncing your name wrong we'll get that right at some point that one was a good one that one i've actually i heard some feedback about that one this weekend as well yeah so a good batch honestly yeah great

batch i mean i might not understand max's uh baby steps within the biotech industry but overall they're giving up great research and their performance speaks for themselves their total return over the last year plus is beating the market by 15 as of today and they put in mind or go ahead they it's the returns are benchmarked from the time that they recommend it so any new month recommendations they've only been whatever they've only had a month to perform so it's even better yeah they're putting their yeah and they're putting their cards on the table each month and they might time wait it so don't i wouldn't make that claim there might be a time wait there but either way i think i'm pretty sure i'm right on this okay well we're not yeah let's not guarantee

that uh there might be a disclosure they might time wait it or whatever but if that's true then yeah they are doing better than we even think but let's not belabor this uh you get ten dollars off using our code ccm at checkout that makes it only seven bucks for your first month try it out you can stick around. You can subscribe for a year, get another discount. I believe it's only, it's either $170 or $160 for a full year. We should probably know that. We should know that, but either way, great. I think the sales pitch is, I think that sold you guys, hopefully. So without further ado,

here's the interview. 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 guest is not formal advice or recommendation.

Now, please enjoy this episode. Okay, today we are welcomed by John Rotante. I believe the official title is Senior Analyst and co-host of Motley Fool Live. But I met John this summer. He taught, I think, three different classes on financial statement analysis and valuation as well. Also, Ian and Ryan said that was their favorite class. So just to give you some praise here to start it out. But why don't you give the listeners a little bit of background on your career?

So how did you get to the Fool? And then what all, I guess, do you do now? at The Fool. Well, first of all, thank you, Ryan and Brady, for having me. I'm really thrilled and honored to be on your show. So, how did I get to The Fool? I grew up sort of privileged, like growing up, and spoiled, honestly. So, you know, we grew up in an upscale neighborhood, and I went to a private school that was, you know, cost as much as a university. And by the time I went to college, I'd been to Hawaii seven times and I'd been to Europe twice at least, maybe two or three times. We weren't over the top extravagant, but we had everything that we needed. By the time I

went to college, I had had two cars. My parents bought me one used 4Runner and then a new two-door Chevy Tahoe. And so just to give you an idea of how I grew up. And so I went to college not knowing the value of a dollar. Everything was taken care of for me. I didn't know what a stock was, what a bond was. Literally, if someone asked me what was a stock, couldn't have even said one word, knew nothing. And anyway, I'm at college. I'm a freshman, expensive university, University of Richmond. And I start to get these hints that my parents are going through money trouble. And so the first hint was I had to go buy a book at the bookstore for class. And I was on my parents' credit card at the time. Like I said, I didn't have a job. I never worked. I was spoiled.

And I went to buy the book, like a textbook, like expensive, $100, $200, but the credit card didn't go through. And so I called my mom and I was like, mom, what's up? And she's like, she blamed the credit card oh the credit card company made a mistake and so i believe her whatever so i eventually bought the book and and then the second thing is i wanted to buy flowers for my girlfriend at the time for valentine's day i think or like our anniversary or something and i tried to order from like 1-800 flowers or 1-800 yeah flowers or whatever online company actually yeah i think yeah 1-800 flowers.com every sports or every sports radio commercial you get it okay yeah and didn't go through.

So I'll call mom again. She blamed the credit card company again. And the last thing, every year when I was growing up, my friends and I would try to go to a different baseball stadium. So we went to St. Louis Cardinals and got to the hotel with my friends, totally embarrassed, get to the front desk,

give the credit card, doesn't go through. So I eventually had a real serious conversation with my parents and found out that they had overextended themselves and took on too much debt. And we had been living beyond our means. And I had no idea. And they never told me before.

But I felt bad because they're paying for my expensive education. And so I said to myself, I need to find a way to help. So I went to the library and I read One Up on Wall Street by Peter Lynch. And the book changed my life. Changed my life. Ever since then, I don't know if I was 18 or 19, I have not stopped reading about investing. But that book showed me, when I was done with that book and I read it in like a day or two, I knew exactly what a stock was. I knew that I could understand their, yeah, yeah.

I knew that I could. Got it right here. We got a little bookshelf right here. Have it on their desk. I knew that I could understand businesses by just observing them in the everyday world, whether it's Starbucks or Buffalo Wild Wings at the time or whatever I was looking at. And so that book changed my life and I haven't stopped trying to learn about business and investing ever since then.

Graduated from the University of Richmond. worked in the family business for a while, which was hospitality down in New Orleans, so restaurant and a small hotel, like 14-room guest house hotel. But all I could think about was Lynch and Buffett and stocks. And so I went back to get an MBA and got an MBA at Tulane University. And then I graduated in a year and a half, went immediately to New York and spent five years in New York. And then I eventually made my way to The Fool. And I've been at The for seven years and now i'm a senior analyst all right yeah i feel like peter lynch is probably one of the best ones to start with uh you don't want to go right to uh well that's the thing when

you start with the intelligent investor that one can really throw people off they're like is it really like this it's not that hard maybe that should be like the fifth book or something totally totally agree yeah yeah when people ask me for their like the books to start with I always say Lynch, one up on Wall Street, or his other two books, Beat the Street and Learn to Earn. And then Joel Greenblatt, The Little Book That Beats the Market. Because that book, you could read it in an hour, and it's two metrics. It's return on invested capital and earnings yield, which is the inverse of the P-E ratio. And so it just simplifies it down to two key metrics.

And then the third would be the little book on building wealth. i think it's called um all about moats and compounders by pat dorsey those are my three like intro books love them right okay well we're ready to go the next question all right so we thought we'd switch to kind of more your style and then we'll get into the market in general some of the stuff you're looking at but how has health and fitness played a role in your investment career i know this is not something a lot of people look at and if you look at the you know maybe the best investor of all time you could argue he wasn't maybe taking care of his health but how, we're not all like Buffett, how does health and fitness play a role in your investment

career? Yeah. So, you know, I mentioned to Ryan that health and fitness is important to me. And I should start off by saying that when I was trying to save up money for my MBA program, I was a personal trainer. I became a certified personal trainer. And this was, you know, a decade after I got interested in investing or longer. And so, so as I'm a personal trainer at the whole time, I'm thinking about investing, I'm thinking about stocks. And one of the first things I noticed, whether it was from my own clients or just other clients at the gym, I worked at this small personal training studio. I met a lot of people, clients at the gym who had accumulated enormous wealth over the years.

They were maybe retired. They'd accumulated, in several cases, tens of millions of dollars. But they were in such bad shape and in such bad health that they really couldn't enjoy it because they were living in pain and they couldn't get around that well, whatever it was. And so the first lesson for me was to take care of my mind and my body and to try to age well. But the other thing is the math of investing, compounding interest. And the way that compounding interest works, by definition,

is you make money slowly for a really long time, for a really long time. and like if you want to you know if you invest ten ten thousand dollars i think um honestly i did this math several months ago i'm not gonna remember it exactly but if you invest ten thousand dollars and it you know it grows at like the market rate or something it'll take you like like 30 or 40 years to become a millionaire something like that but then what but then after those 40 years the way the math works is then exponential growth kicks in and so that's why Buffett generated 90% of his wealth after the age of 65 or something like that, because that's how the math works. And so, if you want to give compounding interest, which is this magical force,

right? If you want to give it as long of a time to work as possible, then we should try to live as long as possible. So, that's the second way that I relate health and fitness to investing. And then just finally, I'm fascinated by invention and innovation. And so I'd like to live as long as I can so that I can witness as much technology and witness as much marvel as I can. Yeah, I've always thought, and this is kind of a weird thing. We were born like right before the turn of the 21st century. It'd be cool to live to like 2100, but that's an audacious goal. But on the point of the health and fitness side, yeah, you get all the – say if you start saving when you're 20 and you're 30, you get those returns in like in between ages 60 and 80 if you're not really taking care of your body.

I mean, I don't know. I don't say what's the point, but it's like, you know, it's better. The appeal for all that – the appeal for long-term investing isn't that great if you don't think you'll live that long. Right. Right. But anyway, I guess our next question is kind of more towards your investing style and maybe experiences. But what would you consider some of your biggest mistakes? And then also for anyone that doesn't know your style at all, what what area have you had the most success? Awesome. So the biggest mistake I've made as an investor was the hours and the days and the weeks.

and the months and maybe the years of my life that I wasted trying to get a discounted cash flow model perfect. I'm not saying that these DCFs, these discounted cash flow models aren't useful. I do use them, but I let them dominate my time and dominate my process. And that added zero value for me. Zero. It, in fact, took value. It's honestly frustrating for me to look back on the days, sometimes without sleep, early on, that I used to waste on these models for companies like Netflix and Amazon. And I'd use these ridiculously conservative assumptions because I was a value investor, right? At the time, I was this dyed-in-the-wool value investor. And so you have to use conservative assumptions and I would use these high hurdle rates because at the time,

I pretended like I had a clue what I was doing. And then I'd come up with some DCF value that was 20% or 25% lower than the stock price at the time. So I never bought. And to this day, I've never bought a single share of Amazon. I've never bought a single share of Netflix because I used to let my models and really my ideology, this like value investing ideology, rule my investing life. And it still returned for me. I mean, I think some of my biggest mistakes were these mistakes of omission. And so literally one time I told myself I'd buy Amazon if it fell 5% more, 5%. And it never did.

And that was a thousand percent ago or something like that. And so my biggest mistake was letting the time that I tried to like find precision, which you can't find in a model. Your models have to have like wide error bands and you have to do scenario analysis and come up with a range of values.

Well, you know, when I was a beginner, I was trying to come up with like to the decimal precision and it was a waste of time. My other big mistake was not taking enough risk when I was younger. And by that, I mean, I should have taken larger positions in some stocks. Like ones you had conviction in, but you just were afraid to size up? Yeah, basically. Today, this scar helps me. But at the time, I was scarred from seeing my parents go through those money struggles. And I can add more to that really quickly. My parents ended up filing for bankruptcy and their business filed for bankruptcy. And at the time, that was a scar. And so I was very careful with money. Now, that is – it's my biggest strength because I've seen my parents come out on the other side. And so I've seen what financial difficulty looks like. And my dad says, the market's not going to eat you. You'll survive. Just be careful. And so I think that was a mistake. I bought Visa, for example, which is still one of my

largest positions to this day, around the IPO. Not on the day or the week, but I bought it maybe in its first year of trading or something. But I bought $500 worth at the time. And so I had a high, high conviction in Visa, but I just didn't size it appropriately. So I do think that I should have taken a little more risk when I was younger. And then my losing investments, so those were mistakes of omission. But my biggest losers, honestly, I haven't had many big losers. I've had two stocks that have gone down more than 50%. And by more than 50%, I mean like 55%, maybe 60%. I don't remember exactly, but not 80% or 90%. Both of them were years ago. One was BlackBerry. And one was a company called Lucadia, founded by Ian Cumming and Joe Steinberg. It's

now called Jeffries Investment Bank, basically. I just haven't had big losers or blowups because I've always stacked my portfolio with the highest quality, most resilient growing businesses I can find. And I haven't been that wrong on the business, just honestly. I've gotten valuation wrong where I've paid too high of a stock price. But when you pay too high of a stock price for these resilient, high-quality growth businesses, the stock doesn't blow up in your face. Maybe the stock underperforms the market, right? Or maybe it takes me five years for the business to sort of grow into that stock price. And so, I have like small returns from the investment, but it's not a blow up. It's not a money loser. It's more of an opportunity cost for me.

And so, those are the types of mistakes that I've made. So, how long did that, how long did it take you to kind of make that pivot then? away from the conservative DCFs to, okay, this is getting me nowhere. I was right on management, and I was just way too conservative on the price. Was that too late in your career, do you think? Or have you been doing that for a while now? For a while, for sure. I'll say two things. I read a quote from Warren Buffett fairly early in my career. I started when I was 18 or 19. I probably came across this quote in my late 20s where Buffett talked about how his partner and vice chairman at Berkshire Hathaway,

Charlie Munger, how Charlie convinced him to focus on wonderful businesses and that, in the long run, it's better if you pay a fair price for a wonderful business than a great price just for a fair business. And so, when I saw Buffett make that shift, it was easier for me to make that shift because, at the time, I was a Buffett disciple, honestly. And there's nothing wrong with saying that. I mean, early in my career, after I read Lynch and stuff like that, one of my claims to fame was that I read everything that I could find written by Buffett or about Buffett. And so at the time, that meant like early internet searches, but it meant going to Borders Bookstore, it meant going to Barnes & Noble Bookstore, it meant doing Amazon,

trying to find everything he had written or that was written about him. So I felt like I had a good understanding of Buffett. And so when I saw that he made that pivot, I made that pivot. But here's what helped me more than that. My first job after I got an MBA was equity research in New York. I sold equity research into institutions. It's called institutional equity research sales. And basically, it's cold calling mutual funds and hedge funds, pension funds sometimes, or high net worth individuals to see if they wanted to buy our research. and my clients, so these hedge funds and the mutual funds that I resonated the most with, the ones that I developed the longest-term relationships with, several of them that I still talk to to this day, they convinced me on these phone calls about the advantages of investing in quality, durable growth businesses. One of the best things, I can't stress this enough, was the network that I built early on working in institutional equity sales.

I met some amazing investors. And to this day, I've stayed in touch with several of them. It seems like the ultimate quality investor are the Gardner brothers. I mean, has The Motley Fool influenced you there as well? Without a doubt. So I've been at The Motley Fool for seven years. But before I joined, At the time, we had five newsletters that were sort of introductory newsletters, meaning they weren't really high price point. So we had a dividend newsletter. We had a small cap newsletter. We had Stock Advisor, which is Tom and David Gardner picks.

We had Rule Breakers, which is David Gardner picks. And then we had a value investing newsletter. But it was a foolish take on value investing. I subscribed to all of those five for at least five years, at least five years. I'm bad with timeframes. It could have been longer, but I just really am. At least five years before I joined The Fool. And I eventually wrote a book on investing that I published in 2013. And Joe Major, who now runs one of our sister companies at The Motley Fool. In Australia, right? Yeah. In Australia. Yeah. One of the smartest investors I've ever met. He actually endorsed

my book. So Tom and David and that whole thing, definitely an influence on me. But you asked, when did I make the pivot? And so when I was working in New York in 2010, I was already a Foolish subscriber. But when I first made that pivot was when I saw that Buffett had made that pivot. And I was in my late 20s. And at that time, I was not a Motley Fool subscriber. I guess, yeah, that quote, I feel like resonates with a lot of people. And the only problem that I see is that sometimes people can extrapolate that to pay anything for the quality business or pay anything for the wonderful business. Do you still try to kind of use those scars that you generated from the conservative DCFs

in your philosophy today, or is it kind of more leniency on quality? I give leniency on quality for sure, but I don't pay any price. Well, if I pay any price, in that case, it would be a very small position. So, what I do is I have a checklist, and the companies that score highest on that checklist, it's basically a resiliency quality growth checklist. And the companies that score highest on that checklist, it's 10 questions. I make my largest positions at the outset, right? So some positions I've owned for 10 years and they've grown to be really large positions, but I'm talking about my initial investment for it to be a full position. It's got to score high on that checklist.

But if a company either doesn't score high on that checklist today, but I just have a good gut feeling about it because it's like a really disruptive innovator or something like that, or it scores high on the checklist, but the valuation just seems insane to me, it doesn't preclude me from taking a very small position. So, in those two cases, if it scores high on the checklist, but the valuation just doesn't seem sane, or if it doesn't presently score high on the checklist, but I think it will in the future, I still may buy a small position. And then hopefully if they execute, the price looks a little better. Maybe you enlarge it over time. That's the framework.

For sure. And the other thing is, everyone talks about averaging down. And I've had some opportunities in my investing career where I've had great opportunities to average down. But for some of my favorite businesses that I've owned the longest, I'm buying on the way up too. I'm buying several times. and so like i said i started visa off at a 500 position but since then i've learned and i've i've bought visa probably 10 different times or something and and at higher prices than i initially did yeah that's a hard thing to do but we'll uh we'll pivot to maybe more of the market in general uh you know when you're researching stuff right now do you see any potential mispricings in the market if so where and maybe why do you think that as well so nothing slaps me in the face right now as terribly mispriced on the downside, like undervalued. It did in March of last year. And I deployed a lot of capital,

not as much as I wanted to, but I deployed a lot of capital in March and April of last year. It's quick. It happened so quickly. I think that happened to all of us. Man, I don't know. Yeah. So going into that, I had a lot of cash on the sidelines because at the time I was reading a lot of macro research about how there was just a lot of excess in the markets from a debt perspective, corporate debt and government debt and household debt. So at the time, going into the market crash last year, corporate debt was at a record, government debt was at a record, household debt and credit card debt were all at record. And then I thought valuations were kind of high, and so I just started kind of raising a little cash. I'm not going to say I timed the market. It was literally complete luck, but I had a lot of cash sitting on the sidelines just kind of waiting. And then, like you said, the recovery happened. It was the fastest 30% drop in history and then the fastest recovery in history. And so I was only able to deploy about 35% of what I wanted to. But yeah, but maybe we'll get another bite at the apple sometime soon. I don't know.

But yeah, so nothing is slapping me in the face right now. What I will say is, so I can't say XYZ stock is trading at a 50% discount to my estimate of fair value or something like that. I just don't see that today based on the universe of stocks that I focus on. I'm one person, right? I can only look at so many stocks. So based on the 50 or so that I cover, I don't see that today. Okay. Even if I did though, even if I did see, this is how I hope to answer this question differently than maybe some other people will. Even if I did see something that was like, okay, this is trading at 50 cents on the dollar based on my estimate of value. I don't think that would be the best opportunity. I think the best opportunities today and the biggest mispricing

today is not going to come from that sort of traditional value investing margin of safety, but something that is an innovative growth business that is going to fundamentally change the way we work or live. Actually, I think the biggest mispricing today probably comes from one of those businesses that seems overvalued, honestly. For me, it could be a company like Redfin with a market cap of only $6.5 billion or so when I checked yesterday. These are companies that I own, that I would put in this basket. Could be a company like Peloton in that $30 billion market cap range. Could be a company like Zoom or Shopify in that like 90 to 120, $130 billion market cap range. Could even be a company like Tesla in the $600 billion market

cap range. I own others, but the point is, I think all of those companies I just mentioned, redfin peloton i forgot zoom shop tesla um they're all fundamentally changing the way we work or live and i think they could potentially be multi-baggers from here although they all kind of look expensive if you look at traditional metrics yeah it's kind of the it's the thing that all not all but basically i kind of you know the there's a lot of people that maybe critique like the foolish style of investing are like, oh, you're just playing in stuff that's all, it's all overvalued, you know, extrapolating. And it seems like people get on their high horse about that. And I think everyone, including us have a tendency to do that. But the thing is, if no one's paying attention to

these businesses, maybe, you know, and they're like, oh, it's overvalued, forget it. That can leave an opportunity where maybe not as many people are looking at these things. Is that kind uh, some of that comes into play? Yes. Yes. Um, so, so there's two things. Um, one of the skills that I think Tom and David are exceptional at may be the best I've ever seen. And I should, I should say, um, I don't say that lightly. One of the things that I do, one of my responsibilities at The Motley Fool, one of the things I get paid for, at The Motley Fool is to study other investors, star investors, and to bring them in to teach these classes to our team and to bring them onto our interview shows and interview them for our

members. So I develop really good long-term relationships with some star investors. So I don't say this lightly. One of the things Tom and David are best at and one of the things they have taught the investing team at The Motley Fool over 25 plus years is to find companies, where the market is undervaluing the durability of the growth, right? So, we're really good at finding businesses that we think will grow faster than the market expects or longer than the market expects or both, faster and longer than the market expects. And so, what we're really good at at The Motley Fool is finding great businesses that we have

high conviction in and then paying more attention to what could go right than what could go wrong. So, yes, there's a lot of that in there. On the other hand, I do think there are pockets of overvaluation in the stock market today. Not everything that is priced at 15 to 50 times sales is going to be a world changer. At least I don't think so. Maybe I'm wrong, but not everything in that basket of SaaS companies that everyone loves right now

is going to be a world changer. At least I don't think so. Let me give you an example. So what is Clubhouse? Is it called Clubhouse? I haven't been on it yet. Yeah, Clubhouse. The audio thing.

Yeah. So I know it's not a public company, But just if we're talking about durable competitive advantages, I've never been on Clubhouse. It may be a fantastic experience. I know a lot of people talk about how they're learning and networking through Clubhouse. And it may be a fantastic experience. But in the last two or three days, I've read that Spotify is coming up with a competing sort of product.

I've read that LinkedIn is coming up with a competing sort of product. And Twitter came out with Spaces a couple weeks ago, I think. So these things come and go really quickly, and pure competitive products can pop up really quickly. And so, in my opinion, and I could be wrong about this, and I reserve the right to be wrong, the barriers to entry around something like that are really, really, really low. A lot of SaaS companies have multiple, multiple competitors out there. So low-code, no-code. Appian's a company I own. It's multi-bagged for me, multi-bagged.

Have really high regard for the management. Love what they're doing about democratizing engineering because now anyone across the business can become a coder, right? Love that concept. Microsoft has a product. ServiceNow is coming out with a product. I think there's a company called Pivotal Software that has a competing product. So I have a lower, personally, a lower conviction that Appian is going to be dominating what they do 10 years from now than I do some other companies, just because there's so many competing

products. So when I'm talking about these companies like a Shopify or like a Tesla, I'm really talking about companies that I think would be hard to replicate. if that makes sense no that completely makes sense the so i guess that comes back to do you have more like leniency on valuation for companies that have a history of executing like because you compare it to say a company that's coming out through a spec they got a great concept maybe it's a cool idea but if a company has a 20-year track record of or even a 10-year track record and they built up that competitive advantage,

are you more lenient on valuation then? Yes, I'm more lenient in a couple of ways. I'm more lenient in the sense that I'm going to be slightly more aggressive with my assumptions in my model. If it's a company that has proven it is adaptable, if it's a company that has proven that it can innovate, If it's a company that has proven it can take advantage of cycles, so, for example, when there's a down cycle, it goes into that cycle resilient and strong, and it is aggressive at investing in the bottom of that cycle when everyone else in the industry is sort of like struggling to survive. And it can prove that it's going to come out of that cycle stronger with more market share and faster growth in the competition.

If these companies have proven these things in the past, then, yes, I'm going to give them more credit in my model. or I may give them a lower discount rate in my model. Or I may just say F it and take a small position no matter what, if I believe in the business and the management. Okay, so we got to hit a small break here, but we have more questions in the back half. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices.

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Restrictions apply. Okay, we just left off basically talking about a little bit of leniency evaluation when it comes to these disruptors or competitively advantaged companies. So I would follow that up with saying, you're a little more, I guess, aggressive or optimistic in your model.

Do you actually still use DCF still at all or is it just kind of mental models? It's a really good question. Here's how I, yes, but here's how I use DCF. I use a reverse DCF to see what the market is pricing into the stock. And then I ask myself if that's reasonable. I have a really, really cool model because here's what I did.

And basically, I sent this to everyone across my team, like, I don't know, a couple weeks ago or something, but I've had it for a while. So I took Aswath Damodaran's model on his website. I think he calls it simple free cash flow model. And I love the model because the heart of the model is eight line items long. That's it. See, it's as simple as it needs to be. It's as complicated as it needs to be. It only captures the drivers of value, which is revenue growth, EBIT margins, tax rate, NOPAT, and then reinvestment. And then you subtract reinvestment from NOPAT, you get free cash flow. That's it. And then the model also, it's linked to return on invested capital. And so as the company grows in the model and scales, you can see if returns on invested capital are staying high or if they're increasing and scaling with the business.

But what I did is, if you're familiar with that model, there's an input page and you have to answer like 30 or 40 questions, yes or no, and all these things. I just got rid of that whole input page. Got rid of the whole input page just to simplify it because I don't want to spend a lot of time on my models, right? So now my input page is put the ticker in and put the date in. That's the first thing I did to change the model because his model is perfect as it is. I just simplified it. The second thing I did is I added five years of historicals. So now when I put in the ticker and the date and hit enter, five years of historicals pop up.

because the third thing I did is I linked it to CapIQ, to S&P Global. And so I have this great model. Then what I do is I pick a tax rate and I run it across, like keeping everything simple, just run it across 10 years of the model. I pick a discount rate, just run it across 10 years of the model, same discount rate I use in the terminal. So the only thing I have to then plug and play in this reverse DCF is different revenue growth rates and different EBIT margins. Because the tax rate, I'm running

the same across the model, just keeping it standard. Discount rate, I'm just keeping standard. Sales to capital ratio is basically a measure of how efficient the business is. And the higher that ratio, the more capital efficient it is. I keep that standard basically across the model. And that drives the reinvestment rate, which is how much you subtract from NOPAT to get your free cash flow. So I keep everything sort of frozen across the model, except revenue growth rate, EBIT margins. So then I can just plug and play numbers to see what the model is baking into the stock price, what the market, I'm sorry, is baking into the stock price. And then I ask myself if that's reasonable. And I do some scenario analysis around that.

The other thing I do, so that's one thing that I always do. The other thing I do is I use free cash flow yields, enterprise value to free cash, the inverse of enterprise value to free cash flow would be the free cash flow yield. And that's because empirical research from five or six different sources, more than that, but several, say that free cash flow yield is the number one determiner of future returns. And so I do free cash flow yield plus my expected growth in free cash flow that the company will have over the next five years to come up with a forward rate of return, basically. So, if free cash flow yield is 5%, and I think the company can grow its free cash flow at

10%, then I'm expecting roughly a 15% annualized return over the next five years. Now, you've got to be careful with free cash flow yield because, for example, GE, crappy business. It's trying to recover, but it's sold off to survive. It's sold off a lot of assets, a lot of business lines. So if you look at its free, that's cash inflow. So if you look at its free cash flow from a couple of years ago, it was massive, but not because the business generated any free cash flow, because they sold off all these assets. And so if you would have done a screen for free cash flow yield, it would come at like 30%. If you're using a trailing free cash flow number. So you have to be aware of where that cash flow is coming from. On the other hand,

Disney spent $70 billion buying Fox. And if you're calculating free cash flow correctly, you're subtracting acquisitions. And so Disney, if you're looking back a couple of years ago, would have this negative free cash flow yield, which is ridiculous because Disney is generally one of the top 30 free cash flow generators in the S&P 500. So you can't just screen for free cash flow yield. And then the third thing is, depending on the business or the industry, I may add a third tool, right? So let's say a company in that industry was recently acquired, then maybe I'll do like an acquisition multiple. But you don't always have those to go off of. But always I'll do a reverse TCF and a free cash flow yield plus expected growth.

All right. Where do you see the most innovation going on now in the market, I guess? My concern is that there is a lot of theoretical innovation going on where it's like SPACs and they're disrupting the old way of doing business. Well, they're disrupting IR presentation slides and everyone's going to grow their revenue 100% by 2024 right i guess what i'm asking where do you see innovation versus where uh where do you see innovation really taking place yeah yeah i think just like everything right like there's there's levels to innovation right like uh you know you know a college athlete you know gets gets sometimes gets a rude awakening when they when they enter like

the pro leagues right just like everything there's levels um now some college athletes are superstars and they and they just dominate the pros but but for the most part when you enter the pros it's an it's a different experience it's a new level and i think like like that there's levels to innovation as well and uh i see innovation taking place in lots of different places across the market. So Elon Musk's companies, Tesla and SpaceX, there's no question those companies are innovating at a very, very high level. So that's one example, and I do own Tesla. But one of the places I see the most innovation is in hardware, honestly. And by hardware, I mean equipment or machinery, that becomes the common tool used by nearly everyone in

an industry. And so, in healthcare, for example, intuitive surgicals, minimally invasive robotically assisted surgical systems, all doctors are trained on the da Vinci robot by intuitive surgical um and the the robot provides precision and provides vision that is highly highly innovative way above and beyond what um what humans can achieve beyond what a traditional arthroscopic uh surgery tools can achieve so there's real innovation happening there um illumina in healthcare uh their gene sequencing equipment um it has you know 90 market share or something like that that equipment is highly highly um innovative and

both of those companies by the way are on my 30 stock resiliency portfolio that i published on on fool.com um but the best example of these machines um where the innovation wows me the most is taking place in the semiconductor equipment space uh and and and before i go any further uh let me say that these technologies are really pushing the bounds of physics and so it's hard for me to wrap my head around and so what i did was i reached out to people that know far more about this than me over the last several years and learned quite a lot about the industry. The team at NZS Capital, they're experts at semiconductor, especially semiconductor capital equipment. In addition, I've spoken to several

PhDs at Gartner. I've spoken to several people that worked in the semiconductor industry for decades, some of them at Gartner as well. I've spoken to other portfolio managers from large funds, some of them on my show, to learn about the semiconductor industry. And so, I'm really standing on the shoulders of giants with what I'm about to say. But these companies are literally bending the bounds of physics. They're doing things that were thought impossible years ago. And so ASML, a European company, is the only company on earth offering extreme ultraviolet lithography, EUV lithography, which is tiny wavelength of light that is shined through a mask or a filter, basically, to stencil or trace a pattern onto a silicon wafer, onto a semiconductor wafer. And the way it works is, honestly, I hope you're as wowed by this as I am, a tiny microscopic drop of molten tin is hit by lasers, and those lasers vaporize the molten tin and turn that molten tin ball into a ball of plasma, shining so bright that they create this extreme ultraviolet light source. the science is so complicated and and magical that no one else has figured out at scale how to do it

and moore's law moore's law which is the law that says that semiconductors um you get this right they become twice as two times more powerful and uh half and the cost is cut in half every two years That's what Moore's Law says. Yeah. So, Moore's Law would not exist, would not exist without these machines made by one company on earth. So, oh yeah. And by the way, this whole process that I just described, it happens between 30 and 50,000 times per second. So, these machines move at like G4 speeds. A silicon wafer is like 12 inches in diameter. Right. And you can get 500 exposures. So it happens 500 times across the silicon wafer.

And so you cut the chips out of the wafer. This is happening 50,000 times a second. It's really, really magical. Another company in the semiconductor capital equipment space is Lamb Research. And they make these etching tools that etch patterns. So the ASML, the company we just discussed, they trace the pattern. onto the wafer. And LAM research then goes in and its tools etch or cut away at the pattern that was just drawn onto the wafer. But they do so with precision surgery.

They drill a trillion, a trillion with a T, perfect contact holes all the way down. Oh, I should say these silicon, these wafers, these chips, for the most advanced chips, they now have like 200 layers. Think about it like a skyscraper. They have 200 layers and billions of transistors. And all of these transistors through all of these layers have to connect and talk to each other. And so LAM has to drill a trillion holes, perfect holes, from the top to the bottom of these 200 layers of deposit or of deposition on this chip. and and these holes each one is one thousandth of the diameter of a human hair so this is truly precision surgery happening at an atomic level and and and these machines are are are magical

they're bending the laws of physics so that's one area where i'm seeing a lot of innovation is these hardware machines that everyone in the industry has to use whether it's the healthcare industry with Intuitive Surgical and Illumina, or the semiconductor industry with ASML and LAM Research. Not only does that tech sound fascinating, and that type of tech is how they're getting the chip size down to like nine nanometers, down to seven nanometers, correct? Or am I wrong?

Is that kind of some of the inputs into that? Yeah. So now there's a company, Taiwan Semiconductor, that that is doing at scale five nanometer chips and they're they're going to open they plan to open a three nanometer fabrication facility in in the second half of 2022 okay what that means is that the distance you know i just said these are um these holes are are one thousandth the diameter of a human hair um the distance when you're putting a billion or billions of transistors i think the m1 chip from apple had 16 billion when you're putting billions of transistors

on something the size of a thumbnail or or a stamp a postal stamp um the space between the transistors is getting smaller and smaller and smaller and smaller thinner and thinner and that's what you mean when you when you're talking about going nine nanometer to seven nanometer to five nanometer and we will get to three nanometer and beyond maybe euv asml the extreme ultraviolet lithography, the thing that makes it so innovative is the wavelength. In order to be able to create this pattern, when the transistors on the chip are so close to each other, the only way to do that is to have a light source with a really small wavelength. And so that's what ASML did. They found a way using molten tin and lasers to create an, it's called extreme ultraviolet. It's basically crazy thin, the wavelength of that light source.

Is it replicable? I mean, could someone else do it? um no one to my knowledge is is is even close right now so there's there's basically uh three lithography companies and asml has 85 percent market share of lithography which are these light sources right okay 85 percent market share of lithography has a hundred percent market share of extreme ultraviolet lithography no one else in the world is doing it um the only other company that tried was nikon and and they abandoned all efforts this this was thought to be impossible this was thought to be impossible right so the uh kind of the way i'm thinking about it from an investment perspective yeah you know the tech the tech sounds awesome and but the way that people

have to you know get trained with this stuff the way that uh i guess the best example is intuitive surgical where all the doctors get trained with this. That seems very moaty. Do you think that gives them a competitive advantage where the people that are getting educated have to learn how to use this stuff and then it's like, all right, we're not going to switch. There's just giant switching costs here. I think there's a moat to the companies that you just said, intuitive surgical and ASML. But

they can't hide behind that moat right like they have to continue to innovate they have to keep moving they have to keep adapting they have to stay ahead of the competition they can't just rest on their laurels so um i mean we can talk more about my my thoughts on moats if you want but if you're asking me if if i believe this is my opinion that intuitive surgical and asml have moats yes i do but i think they have to they have to work really really hard to maintain them they got to keep digging to use it exactly right they got to keep digging then i guess we'll spin into moats then do you think how would you define a moat it feels like that it feels like how people look at moats is changing now because what you used to see is just something that's undisruptable

you know sort of the berkshire type uh or the buffett model of a moat but now it feels like the people that are innovating the fastest are the companies that are doing the best and you can't really pin down on it yeah because you know we watched stuff with like pat dorsey he's kind of the moat expert i think and he wrote he wrote that book that i mentioned yeah the little book of building wealth yeah i love him so he said and i kind of thought this was right that technology isn't necessarily a moat, but could that evolve over time? I don't know. That's kind of a tough question. Yeah. So, is the technology itself a moat? I'll say this. The technology itself is impressive. The technology itself in a lot of these companies is mind-bending. It makes my hair

hurt to try to – I mean, like I said, I reached out to PhDs, people that work in the industry for decades. It's the only way that I could understand it myself. So it did make my hair hurt. But is it a moat itself? I don't think so. I think moving is the moat and adapting is the moat. So my thoughts on moats have evolved, but I've always been somewhat skeptical of moats. So I published a book in 2013. And in that book, I do mention that it's harder and harder to find sustainable moats in the internet age, right? Because Amazon could just come in and disrupt you. And I said that. I said, one of the questions that I ask in that book, I share a brief checklist in that book. And one of the questions is, can you be Amazoned, right? So all the way back in 2013

or before, because it took me at least a year to write the book. So in 2012, I guess, and maybe earlier, I was questioning the durability of moats. So that was 2013, my book came out. And then a few years later, I read Complexity Investing. It was a 40-page white paper by the team at NZS Capital, Brad Slingerlin, Britton Johns. And that is the single paper that has influenced my investing philosophy and really how I look at the world more than anything else I've ever read, probably. The paper basically argues that legacy moats are not as strong in the digital age. They could actually become a vulnerability in the digital age. These sort of legacy moats just based around pricing power and using your strength to squeeze your suppliers to death or

something like that, like using your leverage, not treating all of your stakeholders well and just trying to eke out every point of price you can from them, right? And so, he says they argue that in the digital age, that sort of legacy mode framework, which is really just all about trying to increase prices whenever you can, it's not going to work and it's a vulnerability. Rather, they think that adaptability, which is what we've been talking about, and what they call positive non-zero sum are the two strongest modes in the world today. Positive non-zero sum is just basically creating as much or even more value for your customers and your key stakeholders as you do for yourself.

I basically adopted that hook, line, and sinker. It just really resonated with me. uh and then so so i must have read that in like 2016 for the first time or or something like that maybe 2017 uh and then like a month ago i had tiernan ray on on motley fool live and tiernan follows like 300 tech companies uh he's been writing on tech for over 20 years or something like that um he is the author of the technology letter.com he's absolutely wonderful knows tech inside and out. And on my interview show, he said, and I quote, there are no moats. And then he goes on to explain companies just have to keep moving and keep adapting. So just

like the stuff that NZS Capital is arguing. So I do think that that adaptability is the most important moat. I don't think there are no moats, like Tiernan says. I think all the companies we've discussed, ASML and Lam Research, and we mentioned Illumina and Intuitive Surgical and Taiwan Semiconductor. I think they all have moats, but I don't think they can hide behind that legacy moat. They have to constantly innovate, constantly adapt, keep moving forward if they want longevity. They have to go out and actively find new growth streams and build new moats and build new castle walls over time. I think about it like a boxer, honestly, because I like the sport of boxing. So you can be the strongest boxer in the world and the hardest

puncher in the world. But if you just stand in the middle of the ring and let your competitor just take shots at you, you're either eventually going to get hit hard and knocked out, or you're going to get hit by too many small blows. And over time, those small blows are going to chip away at you and knock you down. So either way, whether it's one big blow or just chipping away over time, if you don't move, you just stay in the center of that ring, you're going to have a short career, no matter how strong you are today, no matter how hard you punch today. But if you look at the boxers with some of the best longevity, like a Floyd Mayweather or bernard hopkins he was fighting in his 50s uh or a manny pacquiao they're constantly moving

around the ring so they can't get hit again that's a good analogy the good uh example of that is when you look at the largest companies by decade over the last 70 or so years it's changing they just always change yeah i guess yeah maybe the difference today is you know someone like i mean i think costco or someone definitely has a moat but you know they have one but they're also pleasing continually pleasing their customers so it's like you have to have both you can't just have the moat and then just exploit it maybe like a century ago you could do that but now it is you got to continually please your customers if they raise that hot dog and soda deal they could ruin everything that's true it's like a buck 50 or something uh that's right they have to keep

pleasing their customers. And so that's that positive non-zero sum, right? Take care of all your stakeholders. And if you do that, you know, everything will work out for the, for the company. Okay. Should we hit the wrap up questions? Yeah, I got nothing else in my mouth. I think we covered it. Okay. What is one financial saying that you disagree with? Okay. So I'll, I'll, I'll, I'll give you two. So, so the first one is Warren Buffett said something like invest in a company an idiot could run because one day it will be run by an idiot. That's just something that I disagree with on a cellular level because I think people build great businesses. I actually think leadership is often the most important quality I look for because the

founder or the CEO, they set the mission. They set the purpose. They determine the business model. They determine the strategic direction. They set the corporate culture. They determine when to push the growth pedal to the floor, when it's appropriate to throttle growth back. They determine the balance sheet strategy. They choose to either pursue profitable growth or growth at any cost. They build teams. They allocate human capital. They allocate financial capital. I mean, the list goes on and on, right? They determine how they're going to treat their stakeholders. They're the ones that do the adapting, the innovating, so that they do remain relevant

and that they do have moats going forward. So, yeah, I don't agree with invest in a company an idiot could run because one day it could be run by an idiot. If I'm invested in a company personally and an idiot takes over, that would be a reason for me to sell, and I rarely ever sell. The other one is this whole idea behind margin of safety in the traditional sense. Um, I've always intuitively struggled with the idea of buy at a discount and then sell as it approaches your estimate of fair value. Like you, you even start to get out before it reaches your, your estimate of fair value. And, um, so back in 2016, I published an article for the fool and I said, um, I'll read this

quote, shareholder returns or wealth creation will be determined more by the size of a company's moat than by the size of the margin of safety. In other words, for a high-quality business, a sustainable moat is the margin of safety, end quote. So it's that sustainable moat. It's got to be sustainable, though. And then in March 2018, so about three years ago, I guess, I wrote about how there's tons of research showing that quality businesses outperform the market over time, despite trading at high PE multiples. So they traded these optically high multiples, but they still beat the market. So I concluded that means that the high multiples investors pay for quality are not high enough. In other words, investors could have paid a higher multiple

and still beat the market. And so, yeah, I just think that margin of safety in the traditional sense is misguided. I think the margin of safety comes from that mode, comes from that adaptability, comes from that innovation and from the management team. Yeah, more of margin of safety in the business instead of margin of safety in the startup. I think we talked with you a little while ago about how the intangibles can kind of like, if you're using book value now, that's really not the traditional margin of safety, discounted book value, tough stuff since the 1980s that has really kind of maybe even misled people um totally if you're just screening for book value because you know we've our economy has shifted from one of of of assets physical

assets like machinery and equipment and you know industrial manufacturing type of assets to more software and services and in the older economy the manufacturer in manufacturing industrial economy businesses invested through the balance sheet. But now, in the software and services, businesses are investing through the income statement, R&D, research and development, or sales and marketing. And so, those are intangibles. They don't show up as tangible capital. And so, if you're using book value, you're possibly getting misled. Yes. Okay. And the last question here, what is one piece of advice you have for anyone considering

a career in the investing world, just anywhere in the investing world? You know, a good piece of advice I used to give people was to take a speed reading class because my dad convinced me to take a speed reading class when I was in middle school. And it helped me read faster. I wouldn't say that I'm a speed reader today, but I'm a fast reader today, and I can get through a lot of information quickly. The reason I say I used to give that advice is because now there's so many ways to learn about investing that doesn't involve reading. Podcasts, for example, y'all's awesome podcast. Um, and so I think if I had to give advice today, it would be, um, so, so I speak with

a lot of students, uh, cause I speak at, you know, I, I speak at universities a lot. Um, and I, our new analyst, the Motley Fool. And one of the things that, that I, that I noticed without fail is the first time a new, uh, analyst analyzes a business for the first time. they fall in love with that business. They fall in love with that business. And that's because they have nothing to compare it to if they're really beginners. And then the other reason is because they feel this sense of accomplishment, as they should, because they just spent weeks or months studying a business for the first time. And that's fun. And that's an enlightening process.

And so they just get very excited about what they're learning. And it's the only business they know because they're beginners. And so they want it to be great, right? They want it to be great. So they fall in love with this business. And it may turn out that they did identify a great business on their first try. But the truth is, there are just not that many great businesses out there. I think there's only 4% of stocks have accounted for all of the net gains in the stock market going back 100 years or something like that. And so my best advice, I think, is to not form a strong opinion on whether you like a business or not until you've studied 25 or 50 or 100 businesses across different industries. And then once you've done research on at least

25 businesses, then you can go back and rank them by conviction. That's an exercise that helped me out. And I think it can help out others too. That's perfect. Yeah. I think that we all, I mean, I did it. I did it. It's without fail. I did it. Everyone does it because it's so new and you get so excited about it. Yeah, definitely. Okay. Well, I think that's all the questions we have, John. Thank you for joining us. Had a blast. Thank you all for having me. This was great. All right. Thanks again to John Rotante for coming on. Very much enjoyed the discussion. but we are moving to topics now um and i guess we can just rattle them back and forth so the first one you have is very interesting sort of the banter of fin twit the last week big yeah

this has been the biggest story we're gonna uh close the loop uh that's an inside joke for a few people uh on bill huang hope i'm saying that right and i hope i say archie goes right uh if you're laughing that's okay but you know who i'm talking about news has been slowly leaking out over the past week or so on the bill huang or archegos blow up he was a quote you know tiger cub from the tiger global who was one of the managers at tiger asia in 2001 his strategy as we know now is concentration target heavily shorted stocks or short stocks as well and then juice returns with leverage and then i put here bro down but the bro down part didn't really happen this time so for example in the past the vw short squeeze i believe that was either and it was like in 2008

or maybe 2011 so there was allegations there or sorry that really blew him up i think he was short there and then there's allegations of an insider trading scheme that led him to return money to investors from tiger asia after that he started archegos capital and i believe they started with like 200 million dollars so a good amount but then they grew that to i might have been 10 billion Well, they didn't grow it. Well, they grew some of it. They're putting up fantastic returns, but sometimes leverage, as we know, can mask average returns and make them look fantastic. And his preferred investing method was to partner with prime brokers.

So this is Goldman Sachs, Morgan Stanley, the investment banks, to do total return swaps. There's been a lot of confusion out there, and I'm not going to go down into the nitty-gritty because I don't understand how it all specifically works at that level. But what are total return swaps? Because I think, I mean, we're all confused unless you were like a derivatives trader, which most of us listening, I think, aren't. So essentially, a total return swap gives Archegos, or sorry, Archegos gives money to a prime broker who then invests in the stock, but then Archegos gives the prime broker a fee.

And then in return, the prime broker will give back any returns that the stock has or Archegos is required to pay more if the stock loses money. So basically they're paying them money to buy giant blocks of stock for them and they can do it on margin for you. It kind of streamlines the process I guess is the way and there's a lot of other complications. And it doesn't show up as you being the shareholder. So ArcaGhost, no one knew, right?

I'm getting that right. You see that under, say, Goldman Sachs holding it. Yeah, so it makes it more of a dark money or whatever, but it's not like evil or anything. It's just kind of hidden from, say, SEC filings or something like that. So there are some other complications, but that's kind of the simplest way, I think, for us as non-derivatives traders would understand. but it is an easy way to add leverage with secrecy and this is kind of the problem that happened

where the prime brokers he went to six of them and they may or may not have known that they were all doing total return swaps for him some of them may have known some of them may have not but that means that he was able to get these levered up positions way higher or to have way higher of an exposure to single stocks than people otherwise probably would have let him so this led him to have 68 of the gsx which i believe is some sort of chinese company i'm not sure about that uh what exactly it does i think it's something with education technology so he had 68 of the float of gsx 29 of the float of viacom so you can see why viacom was skyrocketing the last few months And then they were part of the downfall as well.

So they ended up having a $10 billion stake in Viacom. A lot of this was on leverage. The total amounts of what was leverage and what was actual capital are unknown. But when Viacom announced a $3 billion equity raise, the stock fell, putting Archegos into a death spiral. So at five times leverage, you know, all you need to blow up is a 15% drop. And that's where we are today. he went from not necessarily nothing i think maybe he's i think he did start from nothing you know nothing like he didn't come from a wealthy family so i think he kind of made his

way throughout the industry and then he got to be worth on paper like 21 billion dollars in a short amount of time and then lost it all in one day kind of crazy or maybe five days something like that i saw a tweet today that says if you lose whatever it was 20 billion dollars in net worth within a week you didn't earn that money you borrowed that money that i mean it's it's hard to do that with earned money um but yeah how much ended up coming out of the whole liquidation it was north of 100 billion dollars well that was a rumor of the total losses from the financial times that hasn't been confirmed or anything like that so that's just i think they got a source um that number might may or may not be correct but we do know that

it's at least tens of billions of dollars and archer goes had exposure to i think 8200 billion dollars of these stocks maybe they lost it all but lessons here what do you think it's nothing new but i don't leverage just it feels so dumb to lever up well that's something that there's no guaranteed ready to return yeah or like you don't have i mean it's a it's a stock yeah who cares what the var is i mean he wasn't even he was basically just yelling as he was basically a wall street bets trader but yeah i don't know like you whatever people that are anti-leverage in general i think you should you know you probably own a mortgage so you have leverage or an auto loan so but you know and some maybe a 1.2 times levered portfolio or 1.6 times levered portfolio depending

on your strategy can be fine but five times in a concentrated basket that's and tough yeah and the and the other part is like leverage in general i don't necessarily think it's a bad thing um it can kind of propel growth but if you have like you have reliable cash flows that's fine but there's no reliable cash flow yeah just a basket yeah yeah i don't i it's not that surprising he blew up well what's interesting is that he could have gotten out but he just kept like so he yeah like he put up okay so say he had 15 percent like of the 100 of the basket he had uh try to visualize this say 85 of it was debt at the start and 15 of it was pure capital if the basket doubled as it did then you have 200 like then that leverage is covered you can basically you're in

clear and your returns are phenomenal but the thing is he kept doubling down like he was at a roulette table and it seems like it was like a trip like a quadruple double down at a roulette table with so much money um one more year and he could have he could have made it well it's like it's like it is like at the roulette table where there's no like most people you know you can build a big whatever pile right if you get lucky a few times i mean a coin flip might hit five in a row you know what i mean what you call but the thing is there's no like rational way you got to that point so there's no it's not like it was just all looked you know kind of like there's no reason to stop because you were taking insane risk to get to the 20 billion dollars that

i mean you kind of believe why why why can't it go to 40 but then eventually the people that are investing like that or i mean gambling like that lose it all but before we move on to the next part what are the thoughts on the tsrs total or did i get that trs's trs's total return swaps uh i don't know i mean it seems like a interesting concept but used in the wrong way it's probably not i'm sure there is utility for it but like all things on wall street that utility gets it gets overdone someone finds a way to overdo it too much of a good thing the what i thought yeah i mean it seems fine also if you're maybe there's a reason to use it as a manager but if you're someone that uses total return swaps maybe like i don't know like why you have to pay the fee to them anyways

but i guess it's a good way to use leverage although the funny part was goldman basically getting out early right they were kind of none of this is confirmed because no one's going to come out and say it that they're the ones that you know broke it and basically said we're going to sell the 10 billion dollar block here it's just this is this is margin call i know it is margin call the movie at a lower scale than the entire u.s economy but yeah and then the i mean the funny thing was they came out and downgraded the rival investment bank from japan like the next day no namura uh no nomura uh okay i hope i'm getting these names right but they downgraded them the next day goldman sachs themselves which that is they're not afraid to um they're not

afraid to get out i guess is the interesting thing there because they supposedly all came on a zoom call together and that they were like i don't know who proposed it to do the you know selling of it in an orderly fashion and then on friday morgan stanley and goldman sachs just said yeah no we're going to sell the 10 billion that we have the morgan analyst was like hey goldman will you stick around after the call maybe to discuss a few things so we got to discuss that bond deal they wink all right well yeah that's not i don't know lesson learned i hope it's not i mean i hope it's not a long-term capital management deal where it turns into a systemic thing uh but it's a feel bad for the limited partners well i guess maybe they should have

own better but all right um my topic or one of my topics uh is the spotify acquisition of locker room and so this week they acquired locker for i think 50 million dollars that's what wall street general reported with potential to have it be 80 million if certain incentives are hit and they got that from some insider okay uh but that wasn't like the official disclosure and then uh anyway if you don't know what it is it's basically just a live audio app for sports discussions so like andre vidala came on one time there'll be athletes that come in people can like reflect after a basketball game or something like that and some people do like hybrid announcing type deal right kind of where they're not the official broadcast but they have a discussion going on during the

game yeah i think there's a lot of ways to use it but it was mostly designed for sports and so spotify's now acquired the tech well technically they bought the parent company i wouldn't even say it's a parent company it's like 12 engineers and some other people in the company as well but basically they're all known for locker room um and they're planning to roll out the tech to pretty much all other areas on spotify so podcasts artists songwriters musicians athletes uh they can all still use that i think listeners could also create their own as well um so they are going or they're trying to go social uh but basically they've now gotten live audio and so people are making fun of it for oh they invented radio well yeah i mean but the thing is like the yeah we're

we do podcasts so it's we think we're pretty biased towards the growth of podcasts but i mean this is a minuscule part of spotify's business and to the people that think like why would anyone do this instead of a social platform like twitter and i had this sort of discussion on spaces which is uh well for a lot of our listeners on here they're not all on twitter yeah and so we have a large audience that would be engaged that aren't on twitter i know in the twitterverse it can kind of turn into a bubble you feel like everyone's on there but they're not um i mean what's the user count 350 million to like no it's a how much da use does twitter have twitter is 190 million yeah spotify probably has a little and it's tough because they do monthly active

users but i think a lot of those are daily active users at least i'll call myself uh the i mean you think it's probably i don't know 275 million maybe daily active users it's tough to tell they have a larger audience and it's more well i know twitter's pretty global yeah i mean but it's i don't know what are your thoughts do you like the choice to acquire their way into live audio instead of building it themselves yeah i mean 50 million dollars is it's not nothing but it's not it's not a time for them yeah it'll be fine it's i okay it's three billion yeah i mean i've kind of become not very bullish on this stuff just because there's too many variables have to come into play to get you know like you have to have everyone

come in at the same time you have to everyone know what the topic is beforehand most of the times i go in and listen to one of these things i'm like what is going on so i'll take the flip side of that and i'll say well for okay yeah for podcasts i'm not sure it makes that much sense because you know it just doesn't it's different yeah podcasts they're designed to have a little bit of structure whereas these should be sort of free-flowing conversations but in terms of engaging with uh artists i think this is a really good platform and it could be you've got i mean it's sort of a backdoor way to subscription social media through well through because they start as the music platform yeah and now let's say this works out and people are engaging with

artists that they love musicians songwriters they're asking questions they're getting a chance to maybe live concert or something like that that that feature is kind of social and everyone's talked about well why doesn't twitter go subscription now spotify's done it but by going through music first yeah i don't know i don't know there's a lot of ways this could happen and yeah there's just scenarios where i mean it uh i don't know it seems like it's just a kind of a hedge in case this stuff totally becomes the new thing where they have a asset now that can compete with it if everyone goes to these type of things but if it totally turns out a like clubhouse it's like nothing twitter spaces stays super niche or something like that then

it's not going to change the long-term trajectory so i mean as a shareholder i'm happy with the acquisition for sure yeah i mean i guess the other question then is like how is this the quickest that you've seen sort of a new phenomenon like clubhouse in this regard uh get crushed and i know it hasn't been crushed yet but the fact that every service is now pouring on the exact same clubhouse basically as like a bolt-on feature to their platform i have a hard time believing that clubhouse will be able to sustain that user base maybe i'm wrong well the thing is clubhouse they're gonna have to get creative they're gonna have to do something else to keep the people there they need to they they got to really be i don't know if it's nimble but there's a lot of

pressure on them i think over the next year to come up with a differentiated platform because it got copied fast it's pretty easy to copy yeah they gotta have i don't know what the way is maybe they got a good team over there but they gotta come up with a way to differentiate the product it can't just be we got celebrities here or something i don't know it's not really a product here's the other thing i've been thinking about is when you have if you grow too fast and you're too popular and you're too exciting i think that's like you're almost building your own grave yeah you're almost digging your own grave right like you're building this gold mine for someone to be like oh shoot thanks for letting us know that we should be doing this

whereas like spotify was such an unattractive business for so long well it wasn't big at all it only hit 20 million subscribers like i don't know in 2015 or something like that no it wasn't that small but i think that's 2016 they had 120 oh i'm looking at i'm looking at wrong here then but it i think point is i mean like they everyone was like you're just going to be under the heels of the labels the whole time like it was so unattractive to be in that position that they were able to amass 400 350 million users with without people paying that much attention i mean i guess apple apple dropped the ball on it if apple dropped the ball lack of effort but yeah it's different it's different it's different social is different than like on demand media

i think it's a little different but i do still think you're correct that clubhouse they've been so successful and it's built up a lot of momentum but that momentum can stop fast and you can and you can crash all right what's your next topic okay so i saw this good analysis from unhedged i'm not sure exactly what this is i just saw it as a link through twitter they're talking about young software companies over earning their free cash flow margin so the the big question they had was who has been over earning so the way this works is if you have a say you're a sas company or just a software company in general and you sell basically subscriptions or it could be multi-year deals where you get money up front

but you have to recognize the revenue according to accounting standards over the time period of the contract. That means you have to defer revenue and put it into this liability thing on your balance sheet and then realize that deferred revenue. So it makes your earnings, if you're growing quickly, it makes your earnings look a little worse than they are But free cash flow always stays the same because you add back that deferred revenue. You can look at it on the income statement and balance sheet.

It's hard to stay in audio form. But the key is you want to make sure that a company, even if they're generating a lot of free cash flow in a certain period, still has a business where over the long term, even if they stop growing quickly, are still going to be, you know, have strong profit margins. So free cash flow, the definition of that is just operating cash flow minus CapEx. and you can then take out stock-based compensation whatever your style is and their back test which i don't think it was they did like a probably a few dozen companies i don't think they did it like as a scientific study so their back test said that it was a simple gross margin minus

operating cost plus stock-based compensation minus cap x is what long-term free cash flow should converge to so again that's just taking out you know you're at basically gross profit you subtract operating costs you can add back stock based compensation but really when you're doing free cash flow you should either both add or both subtract from these two variables and then you could take portion out but yeah you can take some out yeah just do it equally throughout these two different metrics and then you subtract capex and that should converge to long-term free cash flow so the reason you'd want to do this is you can check if you know say company a their free cash flow margin is a lot higher than this gross margin minus operating costs, plus stock based

compensation minus cap x thing, if it's a lot higher, then you might say, okay, well, maybe their long term, you know, operating margin or profitability isn't as good as we think, or if it's a lower, okay, maybe it will be higher once they finally transition their business model or things smooth out over time, over time. So who was over earning according to this method? zoom video crowd strike service now there were a few examples they chose the similarity was they were all growing quickly right now so yeah the businesses are doing great but maybe that free cash flow margin over the long term you know it still looks like these companies likely have strong you know profit margins but it's maybe not as good as these current few quarters make

them look to be what are your thoughts does this make sense i'm probably not following but so when you say over earning you mean that those short-term free cash flow margins look better than they will over the long term okay based on amplified deferred revenue so if you're growing quickly all right you have a ton of upfront deferred revenue but then when you start growing slower how long are those subscriptions that's like that's my thing is like if they've got if they just took a bulk of deferred revenue but that those subscriptions i mean they purposely cap them out like if someone you're not going to let someone sign up for a 10-year contract you know what i mean so i don't think like let's say the max is two or three years that you can sign

up for it's well i don't that doesn't really matter it's just the so it's just because they have to re they have to re-sub at whatever that higher cost is later well i mean it's just i i don't think that necessarily matters here where it's all about how much deferred revenue they have and how fast that is growing versus it so it's just yeah but the deferred revenue if that's only expected over the next two years or whatever that life cycle is shorter no it's i know it doesn't matter what that life cycle is it's all about how fast they're growing revenue where say zoom growing like at 100 they're you know they're gonna have a lot more upfront revenue versus their revenue that wasn't growing if you know what i mean so that bucket of

like stuff that was there the year before almost where once they mature the deferred revenue as a percentage of revenue is going to go down so on the flip side of say like a company has a few quarters of revenue declines it can over earn on income right yeah i understand so like when activision blizzard in 2018 i had that slowdown so that's why this it really can it can make either net income look better or worse i understand yeah i understand how those two differ but if they if it's not like this deferred revenue extends out 10 years oh i know so i think i don't I just don't think it's as big of a deal. I don't think there's a huge – I don't think there's going to be a huge skew in the over-earning.

I don't think it's going to – Well, it was pretty – I mean – 15%. Some of it was, yeah. I can't remember what the numbers were. But I mean some of them are pretty stark. And when you're putting in your model like, all right, this company is going to have 40% free cash flow margins, maybe it won't. You know?

But they do. Well, in this time period. No, they do currently. Yeah. but i yeah so the key is that currently the free cash flow margin looks better than what this their theory of what they've kind of back tested where say like adobe and autodesk they're a little more mature they went through and yeah so free code free cash flow margin at first it was either a lot better or a lot worse but over time it converges on it once the company matures these

two variables yeah that's where the that's where the cycle matters right not now because if you're deferred revenue whatever let's say you have right now zoom has 50 free cash flow margins i know we should move on but and someone has to re-up in a year that they might have recognized the cash early yeah but it's all it's all about new we've done in a year it's all about new like it's not about happen again in a year i know but it's all about so say like the new contracts are coming in it's all about new versus like steady state because if you have a bunch if you're growing quicker free cash flow is going to look larger versus say if you're growing at 100 it can inflate those free cash flow margins versus if you're growing at 10 where it's going to converge more on your

operating income because all the new revenue you know what i mean so that's where it can convert Yeah, I guess let's just move on because we don't want it to go too long. But yeah, I understand that there will be that sort of a version. So that's the whole point. You don't want to look at a current quarter's free cash flow margin and think this is what they can have. Yeah, I mean, super high deferred revenues are obviously kind of a concern. Well, it's not a concern. It's just you got to track kind of what the actual expenses are.

Okay. All right. well i guess this is a hot water then uh do you have anything else on that or no okay uh paris hilton is long bitcoin saw it on cnbc right yeah and great analysis the only gripe the only gripe that i have with this was it's not on the paris hilton side but everyone's response was every every person without a thesis that owns bitcoin was like oh gosh here we go this is the bubble i'm like how's it's all how is her thesis any different than your thesis oh it's all there's no yeah you're all it's all stupid i don't know it's all speculative like the speculation is the

same yeah i mean if you're if she's right you're right yeah it's all i mean i i it's all stupid i don't know it's not it's not there's no it's it's i like the kind of look i respect i like just because someone likes bitcoin doesn't mean i don't like them and i respect people's their intelligence there's so many smart people that like bitcoin but i think it's so dumb it's it's it's this stuff is so this stuff specifically is so i can't get over i just laugh whenever i see it it's ridiculous all right what's your next topic point okay talk about good ceos or i don't know maybe the number one good or uh talked about ceo in 2020 am i correct on this when i'm he's a legend for sure yeah so trevor milton has sold 49 million dollars of his nicholas

stock congrats he is now with adam newman adam newman i think sold 700 million so he's not up to that level yet but you know he's selling his stock with no remorse nicola is now down 61 percent from june of 2020 but it still has a market cap of five billion dollars so i mean i don't know it there's no analysis to be had there uh but the only serious question i have is how many other nicolas are out there because i honestly think they're maybe not the same size but there might be a few dozen well if they're just sound motors for starters and other well that one's pretty big too right the hard hat edge yes yes the hard hat tell that was the best i mean we were making fun of cnbc for having paris hilton on that was the best clip of the past few months was that guy in

the hard hat she's probably got better returns than uh whoever the lordstown ceo is but i don't know it uh yeah it's mind-blowing that some of these things are still worth five billion dollars the i love that there's these fake investor relations pages being built on twitter now for all these frauds right yeah it's like the nicola ir page whenever someone tweet the fake nicola ira page they're always like please take this down this makes us look bad like yeah dude it's crazy that like two years ago the people in my like senior engineering class we all could have gotten together and said look we're gonna just make some cool like this stuff we're gonna do a rendering we could do we could have all made some renderings like as a team and we could have

found some spokesperson and gone out at a five billion dollar valuation maybe a billion i don't know we all could have been rich the 25 of us i don't even know if you need the engineering degree well to make the renderer no but i mean the team i mean you don't need necessarily an engineering degree but those things it's not like you need adobe well it's more like solidworks but yeah similar stuff yeah yeah all right well uh this is kind of old news but uh have you seen all those in vesco qqq ads on march madness that's uh you can tell that the nasdaq's doing well it doesn't seem like a i don't know it feels like you shouldn't be able to advertise securities no it's a fine line there's actually like they i think there's a rule into some of

these type of etfs where uh you have to add like two percent of your revenue has to be spent on advertising but it is strange to see these type of things advertised where it's like yeah i'm investing in growth i'm investing in innovation it's uh it's tough but hey the qqq has uh i can check right now how much aumn has uh they're they're they're doing quite quite well so i don't know what are your thoughts i don't know it frustrates me it seems bad to have to advertise the security yeah it should just track what the security the whatever the security tracks the price should track over time you don't need to advertise to get more buyers yeah but you're competing against other nasdaq utfs i don't know they got 155 billion

in eum i don't want to what is their fee different than pure oh yeah if someone's advertising their stock that is a giant red flag but it's i mean it's being done sort of inadvertently now see what's their what's their fee is their fee 155 billion oh management fee net expenses are 0.2 90%. That's pretty good business. Not much to do. No, it isn't. What's your last topic, right?

Yeah, what is it? Oh, yeah. We've got another SPAC. I saw this one. I don't know. I think I saw tweets. Yeah, I was doing my research. I had to put some stuff out there.

But what is... Oh, wait, no, no. What is it? It's AeroFarms. It's going public via SPAC. Now, this one, it is interesting. So what is AeroFarms? it uses quote proprietary data science driven technology to address the 1.9 trillion dollar

total addressable market opportunity for leafy greens with a sustainable indoor growing solution you can get this highly differentiated business for 1.2 billion dollars in value on the nasdaq coming soon enterprise values like 860 million and get this it is only trading at 2.6 times 2025 Estimated sales And only 10.6 times Estimated 2025 EBITDA Are you in? This stuff

You shouldn't be allowed to do that SPACs, it's a loophole They're going to close the loophole soon Don't they SPACs I'm willing to bet I'd be willing to bet good money That your estimate

Is completely off well we've seen the specs that went out last summer and fall they've had to do real earnings reports now and they've totally revised once now that they have to be and they tank yeah yeah if you're gonna do a spec they yeah back without being overly promotional or is it like written in the rule the whole point of doing a spec is that you can be over promotion promotional so that leads teams that will want to be promotional to choose the spec because it gives them that freedom i got some other quotes from here aerofarms sensor network feeds a vast library of data collected over 15 years of operations allowing the company to understand

plants at unprecedented levels and solve agricultural related supply chains problem another quote this is my favorite the ag stack system enables a fully connected farm this stuff isn't software guys i you know i hope they're right like if they do what they say they're going to do it would be awesome it would help you know with climate change with these vertical farms it'd be great you know they're they're talking about doing genetically modified stuff to get a bunch of different options to consumers uh saving water costs stuff like that it'd be great it'd be so great and as a health guy i would love it but i'm so skeptical uh but good on the SPAC corporation

to essentially donate hundreds of millions of dollars to them it's kind of like charity charity that just takes

retail investors money yeah that retail investor yeah but what do you think the biggest laughing

moment there was yeah they're a B Corp actually as you expect but what do you think

the funniest part of you know there's other parts of the investor presentation but of what you know what do

you think the funniest part is because I think it is the $1.9 trillion addressable market for leafy greens, which is just spinach and salads. Well, I mean, that wasn't even their potential TAM, which is all vegetables. Yeah, no, they actually talked about the berry TAM. They had berries TAM in the presentation slide.

It was awesome. So they're like, this is actually conservative. Yeah, no, they're talking about berries TAM once they expand the addressable market. I think we have 50 berry incubators or something like that. They're working on strawberry varieties. I'm pretty anti-price-to-sales, but then when you start giving TAM numbers, I almost like it. Let's get back to the sales multiple.

Forget earnings. People hate on price-to-sales, and maybe you should use EBITDA sales. It's good to use both to see what the debt is and the net cash. But if you just add price to sales, gross margin, operating margin, free cash flow margin, those are the four metrics. Maybe some tax rates. Those are the four metrics. It's all fine, guys. Yeah, we just talked about that with John Rotante.

Yeah, we did. That is true. We didn't talk about sales multiple. But anyway, I think that's going to do it, unless you have anything else. No. Please, guys, stay away from these SPACs. So if a company is pre-revenue, please, please be cautious. That's all I have to say.

All right. Well, thanks again to John Rotante for coming on. If you guys stuck around for the banter, I hope you enjoyed it. Before we move on, I guess as a disclosure, we are general partners at Arch Capital. So LPs or investors in Arch Capital might have positions in the securities discussed on this podcast. We're also not financial advisors. So anything we discuss here on Chit Chat Money is not formal advice or recommendation. Feel free to reach out to us at Twitter, at Chit Chat Money, wherever you want.

Thank you guys for listening. We'll see you next time.