Chit Chat Stocks - What Makes a Great Software Company? Plus, an Update on Constellation Software (CSU.TX)

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Starting point is 00:00:43 investing. Options are not suitable for all investors and carry significant risk. Full disclosures are in the podcast description. Welcome to Chitchat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the world of investing. As a quick reminder, Chitchat Stocks is a CCM Media Group podcast. Anything discussed on Chitchat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. Welcome to Chit Chat Stocks. Today, we have our weekly Wednesday episode, and we are joined by none other than Brayden

Starting point is 00:01:32 Dennis. He is the CEO and co-founder of FinChat. He's also the host of the Canadian Investors Podcast. And you've heard FinChat discussed here on this show before, so we're getting it right from the founder himself. Brayden, I guess, welcome to the show. How are you? Good, man. Thanks. Thanks for having me, guys. It's been great. I mean, we've been working together now for quite some time between the early days of your podcast and then now you're working for FinChat. But I don't want this to be some sort of FinChat ad. That's not what it is, by the way.

Starting point is 00:02:06 um i'm here to talk stocks i'm here for for chit chat stocks because ultimately that's why we started the product right was we came at this investor first and i still love talking stocks i love talking investing i mean that's why i'm on a weekly podcast myself too it's it's my nerdy passion so i'm ready for it yeah and for anyone that would like to know the timeline of this uh episode or just kind of the script we have going. We're going to talk through some of Braden's portfolio, some of the holdings here, for example, Constellation Software, Brookfield, kind of the two stocks that every Canadian is required to own.

Starting point is 00:02:49 And then we're going to, instead of talking about FinChat, everyone has seen the advertisements we've done. We're kind of going to use the experience you guys have had running a software company and trying to build it as looking at, say, what makes a good or a bad software company in the public markets because for 90% of our listeners, I think it's quite a black box. So Ryan, do you want to kick things off and get the first question here? Sure. And I'll also say, if you've been a listener for a long time, you may remember a Stratosphere ad a long time ago. That was the pre-FinChat. It's been since Merch. But we are

Starting point is 00:03:26 going to be talking stocks for the better part of probably half of this show. So when I came on the Canadian Investors Podcast, you took a stab at explaining me as an investor. I'm going to go ahead and flip it here. Here's how I would characterize you as an investor and you tell me where I'm wrong. I would say you are a quality first, probably 80% quality, 20% reasonable price. I love it. I think that that's a pretty good characterization. I'd like to say I'm fairly garpy from that perspective, growth, quality. I find quality and growth go hand in hand because to me, it's a mandatory aspect of quality companies is that they are growing, have a long-term growth runway. I think people kind of interchange those, but I think that that's

Starting point is 00:04:27 so important. 20% value, I think that's probably right. Aside from growth and trying to assess quality, what do you look for when assessing a company? Are there any green flags, if you want to call them that? Yeah, I think for the most part, I just got to understand it real well. Of course, a lot of people say that, but I do think you got to understand the business pretty well and have some sort of insight onto why the business can perform well into the future. And if I can't check that box off or have that kind of green flag that I know I can build conviction from day one on the position, continue to build my conviction over time, I'm just not in a position to own it. And I think it's been really instructive for me

Starting point is 00:05:26 over the last few years, I'd say my hurdle rate for quality has increased over time, I'd say in the last three years specifically. And my appetite for deeper, more extreme concentration has also increased over time. And I think that that's as a result of having that quality hurdle higher and higher and my understanding hurdle higher and higher because I really, really love looking at a portfolio of companies despite the performance that I'm just like, I'm really glad I own this company. I'm really glad I own this equity. And I'm trying to collect an ensemble of companies that I feel that I have that emotion with. When your quality hurdle decreases over time, you get more and more of the opposite of that

Starting point is 00:06:24 feeling. I'm just trying to seek that feeling of looking at my portfolio. If there's extreme concentration in something I have a hot lot of conviction in, that makes me feel good. I'm a very lazy investor. I'm very lethargic. I don't really do much all year. I do a handful of things in a calendar year in my portfolio. All right. And you've mentioned concentration. If we're going to share the chart or the table, we'll use one of the good FinChat visualizers to show your portfolio on Twitter for anyone that wants to see how you have your allocation. But the one thing that stands out is an approximate 50% position in Constellation Software. Now, this is a unique business that might not be, you know, it's almost similar to a Berkshire or

Starting point is 00:07:12 something else like that where it's a diversified set of assets. But I'm curious, maybe before getting into the thesis on Constellation Software, how did it turn into a 50% position? Is this capital gains? Is this adding up over time? Is this letting your winners run? How did it turn into the half of your portfolio? Yeah. I mean, this has become a very popular cult-like stock. You're born here in Canada, they give you your passport and then you get your uh you know one share of csu um i mean the performance has been nothing short of spectacular and i don't sell winners and i've never sold a share and i have no plan on it and it certainly didn't start that big and i haven't actually added to it over time i've continued to

Starting point is 00:07:59 add to other positions because you know it's that half the portfolio i don't have a you know a lot appetite for adding more of it over time but it's just continued to go up i mean it's no no secret now that the company has compounded at you know absurd rates over time and the reason that this all happened with constellation is i used to work for the government out of college so three four years i was working as a nuclear engineer and i was working for renewable power mostly for for the government. And I had an option to collect like 20 bucks a month when I'm 65 or cash out like 60 grand. And this was when I was in my early twenties. So I cashed out the 60 grand and I put every single penny into shares, I think sub a thousand bucks. And that has

Starting point is 00:08:57 been the reason for the extreme concentration. I think I continued to add to it with money over the next following two or so years, but I haven't added to it since, and I haven't sold a share since. And it's compounded over 20% a year during that time and continues to have a lot of upside with things that they've done. People, listeners of your podcast will sure probably understand the business, but they're acquiring over a hundred companies, a hundred vertical market software companies a year, a very decentralized model to do this at scale. And nothing's too small. They'll grab some really small stuff, but they've been in recent years, really, really savvy doing these hundred plus million dollar carve outs. That Black Knight intercontinental deal

Starting point is 00:09:47 that they did to acquire some of those assets for in the hundreds of millions were incredibly savvy. You know, never underestimate a motivated seller when it comes to regulation. So I think that they've continued to prove themselves and go against the thesis of, you know, the mean, like they can't keep getting away with this. They have, and they've demonstrated that they deserve to be trading at elevated multiples, I think. Do you remember how you found it, how you came across it, or is this just part of the Canadian investing school? I think I was, I must have been 21, 22 at the time. I'm 28 now as of today's recording. And the Canadian market for software companies at that time, you had basically Shopify, Constellation, and a few other roll-up names. OpenText, EngHouse are some well-known ones. And those are like sub 20 billion in market cap companies,

Starting point is 00:10:59 but under the radar compounders. So there's been these like roll-ups that have just kind of worked in the country. And CSU was just the expensive one, basically. It was always the most expensive one. It always traded at the highest multiple, but it was well-known as having the best management team. It was well known as having Mark Leonard at the helm.

Starting point is 00:11:25 I think that that was well understood by everyone. And I think that that's an important point is CSU has been a lesson for me in best in breed management teams where stocks go up because they perform better than expectations broadly. and management teams that are particularly talented continue to be better than expected so if you add those two things together that's that's typically where you find a lot of alphas beating expectations and a few key outlier type personalities cut from a different cloth like mark is continue to beat expect he he surprises and surprises and surprises for a decade that's where you get that huge winner. Okay. Yeah. For anyone that doesn't know the company, I mean, there's plenty of, I think we've had it even a few times on our own show,

Starting point is 00:12:21 some deep dives into the companies. There's write-ups from our friend at Best Anchor Stocks, who's done quite a bit of coverage on them. But people talk a lot about the capital allocation skills with regards to buying cheap software companies and making sure you have a good hurdle rate along those lines. But as the company gets bigger, what other capital allocation decisions or strategies have they made? I know they have the spinoffs and stuff like that too. I don't know if it's make shareholders comfortable, but make sure everyone is aligned on this ride that everyone's taking over the last 10, 15 years. Yeah, definitely. Well, the spinoffs have been definitely, I would say, a successful experiment

Starting point is 00:13:05 so far in terms of unlocking value. But I mean, if you listen to the AGM, you have the six operating group CEOs come on the line and talk about their business. And they're true owners of each operating group. Yes, they report back to the hold co, but there's a lot of autonomy that's built out. And I've been fascinated by decentralized management teams for a long time. The first investment book I ever read was by the founder of Magna International, who's currently now in super hot water for things he's done over the years. So bad timing here on the pod. But it's been really interesting learning about decentralized management teams and what happens when you incentivize humans and give them autonomy and empower them to make decisions on their own. It's kind of amazing what happens.

Starting point is 00:14:09 People take ownership and pride in what they're building all of a sudden. And every really good company that treats their employees well, when you talk to them, they just have a different energy about them. It's like when you go to Costco versus – I was going to say Costco. Yeah. You go to Costco, you talk to someone on the shop floor versus someone in Walmart. The energy is completely different, right? And that's not just like one-off conversations.

Starting point is 00:14:36 You could have 99 out of 100 be completely different. All right. One more on – Oh, Brian, do you have a follow-up on Constellation? I have one more on them too. Yeah, I've got one. I guess you mentioned the, how do they keep doing this meme? What's the playbook from here? Is it the same, like just hundreds of small acquisitions, or is it going to be, they're going to try to size up? Do you think they're going to be able to grow at the same rate with the same playbook? Yeah, I think it's a combination. I mean,

Starting point is 00:15:07 if you look, they've bought over 650 companies since 2016. And that number continues to increase over time. You had a record high acquisition number in 2022. It was over 100 in 2023. That number continues to tick up. And if you look at the number of businesses purchased or just the amount that they're deploying year over year, you're seeing that that number needs to continue to go up to justify the increasing size of the market cap. And so I think that they've done that extremely well. Just to look at acquisitions in 2015, they deployed 236 million in buying companies. In 2023, they did 2.27 billion. That's not that long of a time. It's less than 10 years, where you had basically that number explode over time. And so they can't keep

Starting point is 00:16:05 getting away with this. Well, yes, I guess you have to continue to do what they've done and increasing the pace that they do it. But I mentioned that Black Knight carve-out deal that they bought. They did another thing. It was like an $800 million acquisition that they did there. Those types of moves are going to be more popular, more common over time. They've mentioned doing other industries outside of vertical market software. But look, more vertical market software companies are being created every day and at an accelerated pace. More people are building small niche VMS companies that do a few million in EBITDA and eventually want to sell when they get burnt out. These bootstrapped

Starting point is 00:16:52 venture-backed companies run out of money. Venture-backed software companies die when they run out of money, okay? Venture-backed startups die when they run out of money. Bootstrap companies die when the founder runs out of motivation. And Constellation takes advantage of that second point. so constellations just in their ear waiting for hey if you're feeling down today we'll buy your company it's a good strategy i get a message from an operating group salesperson or they're on the investment team to buy or to at least explore the opportunity of acquiring finchat every month or two wow that's persistence right there i guess that's part of the strategy different

Starting point is 00:17:37 operating groups not the same group that's the decentralization too yeah that's interesting have i guess one quick follow-up to have they moved international is that a big thing for them are they basically focused in north america right now and want to move to europe latin america asia or is it a global company already oh it's already super global at this point yeah all right and then one i think final question on constellation that's more of a philosophical one now i was pulling up while you were talking here, the total return chart. And I'm only going to use the last 10 years. I know from the start, it's been even more impressive. But over the last 10 years, the total return, which I don't know if they pay any dividends, don't know the company too well.

Starting point is 00:18:18 They paid a joke of a dividend, but yeah. Okay. So it's a small factor. The total return has been a 34% competent annual growth rate. If I look at the drawdowns over the last 10 years, they've never had a 25% drawdown. And so for people that care about that, that's also a huge plus. What do you think, because this company wasn't too undiscovered 10 years ago, more like it would have been in 2010 when it was pretty obscure. What did people miss about them over the last five to 10 years? Why, say someone like myself, I've never bought it, although I will say I wasn't really

Starting point is 00:18:53 investing 10 years ago, but what did we miss? Why and what could maybe any listener learn from this to find another opportunity like it? I think people maybe underestimated that when they said they had a hit list of 40,000 software companies that they could buy tomorrow, that they actually did. And when they said, hey, we're more aggressively going to buy than any of our competitors, they executed. So there's been a narrative that there's going to be more and more copycats. And Mark's talked about the copycats at extensively and there are there there's been more competition for deals they've had a tougher time even some with some of these smaller deals because you have all these

Starting point is 00:19:42 search funds of someone who wants to just like a regular person as well who wants to you know lever up on five million and buy some software company for a few million bucks those they have competition from those smaller players as well but they have just had their tentacles everywhere in having their name in the conversation for all these deals. And when that bootstrap founder does wake up one day and say, I want to take my $8 million off the table, I could collect that and sell a discretionary earnings

Starting point is 00:20:17 over four years or three years, but I'd rather just do it now so I can go on and live my life. There's not a lot of competition for those deals. like there's a ton of competition as you go up higher up the scale from from private equity but those smaller deals it's you need to have a system in place like theirs for it to make sense or else you know you have a couple hundred software companies a lot a lot of value can be destroyed really quickly if you're not capable of doing it at scale like they are all right new sponsor alert this episode is brought to you by our friends at Yellow Brick Investing. Yellow Brick is an

Starting point is 00:20:58 aggregator of the best stock pitches across the internet. By tracking thousands of blogs, newsletters, fund letters, podcasts, and more, they collect and summarize the best stock pitches and bring them to you in a single place. Think of it like a modern value investors club. I genuinely use Yellow Brick every single week here to try and discover new small cap ideas for the weekly Power Hour episodes that we do. And the best part is you get tons of features for free. Try it for yourself. Simply go to joinyellowbrick.com and search a company or ticker that you're interested in. You are bound to find a great report on just about any company. That is joinyellowbrick.com. Okay. Let's shift gears a little bit to one of your other largest holdings,

Starting point is 00:21:44 It's not quite the size of Constellation for you, but it is the Brookfield Corporation. And I guess Brett and I visited this or kind of did a show on this a while back. And we thought it was a little bit of a mystery. Tell us why you like Brookfield and maybe could you try to demystify it a little bit for anyone who doesn't know? yeah well first it's it's easy for it to be a mystery the critics will say it's a black box for shareholders and i can certainly see that point i don't think it's necessarily as black boxy as people think because most of the business units do have their own publicly listed subsidiary it just takes a lot of work to understand all of them and then roll that back up to the mothership

Starting point is 00:22:33 corp if you wanted to own it it's confusing right like the ticker used to be bam for the mothership was Brookfield Asset Management, they spun out that asset management business and took that ticker for the asset management business and then gave it a new ticker for the mothership of BN. It's a complicated story, right? Especially for newcomers into the name. It's like one of those things where you're looking at it. And I did this when I looked at the Adani Group, the Indian Brookfield company. And I'm just like, you guys are doing too much. This looks like a fraud. And so Brookfield is an asset manager of renewable assets, real estate, infrastructure, think like pipelines and ports, rail, and real assets, right? Like

Starting point is 00:23:24 real assets you can touch and feel, typically infrastructure-y names that make the world go round. I think the reason I like it is the management has a very savvy track record of going against the grain. I don't think I'm a particularly good deep value investor, but Bruce Flatt is. It's almost like that 20% Henderson, he can handle that for me. They've made themselves billionaires in the process of running the ship now for 25 years. Bruce is 59. He joined Brookfield in 1990. He became CEO 12 years later in 2002. It's been a 25-bagger under that tenure. Now, the stack has lagged recently, primarily from difficulties in the real estate portfolio, which they ended up taking fully private under the Mothership Corp.

Starting point is 00:24:19 And you had shareholders and pundits alike go, this real estate portfolio sucks why would you take it take it private and it's like have you guys not recognized that this is what they do they buy assets when everyone hates them that's that's what they do like why are you surprised that they're taking private the ugliest part of the portfolio like by far the ugliest part of the portfolio everything else is you know second places way, way down the list. And so they've earned that track record in terms of scooping up unloved real assets. They did this with some pipeline assets that were extremely unloved in 2019, 2020. That turned out to be amazing given the track record.

Starting point is 00:25:12 People ask me all the time, which subsidiary makes the cent? Which one should I own? I mean, just the hold co-corp is the easiest to own, in my opinion. To your original question, like, why is it misunderstood? I think that folks are typically putting them into the traditional private equity bucket of real assets, which they are. But those assets, ports, rails, utilities, data centers, power stations, solar farms, towers, they have over 250,000 employees, 240,000 of them being operators of those assets. So this is a company that acts like private equity for a trillion in assets under management, has the ability to raise capital on a dime, but they also have really, really deep operating expertise of those assets. I think that that's a pretty rare combo. Ability to raise capital on a dime, deep operating expertise of these real assets, and have the scale of a trillion of assets under

Starting point is 00:26:21 management. I haven't been able to find anything quite like that. And I like software businesses. you know what's pretty software business-y is asset managers. It's collect recurring high margin fee-bearing capital. It's one of the best businesses ever made. Yeah. Make money with money. Yeah. Make money with money. And I'd say the two or one overlapping quality between Constellation and Brookfield is the... And I know it's so hard because it's purely qualitative and And it's almost like I get a good feeling from these people. It's the trust in management.

Starting point is 00:26:59 And we've talked about that on our show time and time again. Maybe 95% of the management teams you look at in public markets, you go, I don't know. Are you just doing boilerplate stuff from McKinsey? I'm not sure if you actually know what's going on or really even care. But with these two companies, I mean, at least you can say they got skin in the game. They've been here for the long haul. Whatever the critiques have, people have of them. um and they're going to try to do what's best for them which is also the best you know best

Starting point is 00:27:27 thing for the shareholders all right and it's different when their capital allocators are like founder capital allocators that have this kind of savvy skills like like mark um you know bruce you can basically call him that now you know given you know he's been there since 1990 and run it since 2002. The founder instinct decision-making plus really savvy, astute capital allocation decision. Again, rare combo, not found that often. And when you get one right, it really works. All right. I have a question on, we have one on TerraVest we might hit, but I think this one's going to be quite fun. I look at your portfolio. We got the two ones we mentioned, Visa and MasterCard, SMB Global, Microsoft, Alphabet, Autodesk, ASML, Uber for some examples

Starting point is 00:28:17 here. I see a lot of quality. I see a lot of stuff that might be, you know, Garpy growth at a reasonable price. Now for anyone that's going to be a, you know, a hater in the comments there, I think the prices today for some of these might be higher than what Brandon actually bought them at. But we have something about your watch list and I would maybe flip it to be a slightly different question what stock do you wish you owned but you don't that you maybe missed or you just are like why didn't i why didn't i buy this five years ago i mean well the easy answer is costco but i've been saying that every day for too long and the forward p is like 53 today i think it's just it's getting dragged up by the qqqs i think it's like the ninth position by market cap

Starting point is 00:29:03 in the NASDAQ 100 index, which is just going higher and higher. So that's the easy example. But I'll go to another example. I mean, I've been inspired by the Buffett-Berkshire AGM question, which I'll summarize as, what would you be doing if you're managing a few million dollars or less today? And the answer was brilliant, but it comes down to basically looking at small stuff and being concentrated in just a few and people these days more than ever and it's been a it's been a recurring theme for probably six seven years now but more than ever now people are complaining or pessimistic or bearish on u.s large caps just given the performance discrepancy from the rest of the market of these mega cap names but i think people need to take a hard

Starting point is 00:30:01 look in the mirror and go, it's not because the market hates you or you think you're smarter than everyone else. It's these companies are deeply embedded into personal and professional lives of billions of people on the planet now. And they're growing at startup rates with world-class margin profiles. I look at some of these smaller names and the top line is slower than Microsoft's TTM and the next two forward years on the top line. And so it's a really, really hard hurdle rate to overcome. But I'm interested in two categories that are kind of beaten down right now. High quality US companies that money's rotating out of into semiconductors, chasing that. Lots of high quality software names actually fit that bill. I saw you guys did a post on like John

Starting point is 00:30:48 Deere. Those kinds of names. You have these world-class companies, industry-leading companies that are trading at, I don't know, maybe 10-year low on EV to EBIT, but the business has still done extremely well. The second category is fintech. Some of it's been getting smashed, getting interested in Adyen, Wise. Every time I go to buy these companies, I just think, I'm just going to buy more Visa and MasterCard, which I also like here, again, quite a bit. So I think that there's a big discrepancy between some of those mega cap names, but also huge companies that are trading at pretty attractive multiples here. Yeah, I think, what is it? The equal weight S&P is only up like 2% year to date. And the market cap weighted is like 35 or something insane. So that's where I'm looking. I want to get excited about small caps, but I turned over a lot of rocks in the last two months. And nothing's got me over the finish line there yet. Yeah, there's a lot of criteria you need, especially if flows aren't going to be there.

Starting point is 00:32:03 You need a good management team. You need one that's going to probably buy back some stock. And you probably need a very, very cheap valuation just because the quality of some of these larger cap names is going to be so much more. You need that valuation discount. At least that's my personal opinion. I couldn't agree more. Let's talk quickly about a company I know you like because you mentioned it when we

Starting point is 00:32:26 were in the office a couple months back. TerraVest, give the explainer here. What is it? And then maybe generally, what is with you in serial acquirers? What draws you to them? If I look at my portfolio, yeah, there are a lot of serial acquirers. I'd say a third of the list basically fits into that bucket, maybe even close to half. TerraVest certainly fits into that bucket. It is a market cap today, around 1.4 billion CAD. So you're looking at around a billion USD in market cap. Now, the company is a small cap rolling up manufacturing and distribution and servicing of primarily storage tanks, boilers, and HVAC and compressed gas containers. If you go on the highway and you

Starting point is 00:33:27 see those tankers with those cylindrical compressed gas containers or some liquid nitrate, sorry, liquefied natural gas, propane, these kinds of things, those are made by someone somewhere. And that business is extremely, extremely fragmented. It's usually mom and pop shop owners. And the magic of those businesses is the services that need to always be there. High margin, recurring, highly regulated, very, very regulated because of the dangers of compressed gas on the road. um what that does is it forces a very recurring nice high margin high ebit uh service services business now what's exciting about the company from my perspective is dustin haw is a very good early on the rise manager he seems to be cut from a different cloth if you're looking for those managers that are like still small but you you get that kind of Mark Leonard fiery passion when he talks.

Starting point is 00:34:43 Dustin Haas certainly got that. He's what I call the perfect mix of blue-collar operations of these types of business with that white-collar CFA savviness. And he has those credentials, which is nice to see. So he's been really, really good so far. The one thing that's exciting about this business is what ties together fuel containment, processing equipment, HVAC, boilers, storage tanks, is the main component is steel. Dustin says the business is acquiring steel. It's not about storage tanks.

Starting point is 00:35:26 It's not about HVAC. It's that the main input cost for the manufacturing of these businesses is steel. and they get massive economies of scale on day one post-purchase across all their assets. So he's talked about how they might buy something at seven times on day one with input costs, it's like four times. But the synergies, maybe they get to that to like three and a half times on something that's growing. So the math is really good on these targets. And so I guess the downside is that maybe there's not 40 000 opportunities like constellation but it's probably around 400 in north america alone so they get those bulk discounts on steel once relative to

Starting point is 00:36:11 them operating as a tiny company once they become a part of terabest they get that cheaper cheaper cost on their most important uh input so yeah because most of these are like you know 10 20 million dollar buyouts of these mom and shop but sometimes smaller and then they've done something as like like they bought highland tanks a year and a half ago or two years ago now for 110 million i think was that was their biggest one they've ever done so uh again nice to see that they're able to do the larger and the smaller deals and make them both both work all right good elevator pitch uh interesting one to follow and as i looked up on finchat the kind of the basic details on it the most important thing is it's also canadian i believe right yeah yeah let's

Starting point is 00:37:00 move off the canadian names here is that it looks like i have extreme home country buys but uh i think i think i have like a third of the portfolio in tsx names the rest are us uh constellation some of those they've been quite strong performers we call the the trinity right shopify constellation brookfield that's what everyone's required to own yeah exactly finchat.io is the complete stock research platform for fundamental investors they have all the standard financial data on more than 100 000 stocks globally but beyond that they have company specific segment and kpi data on 1800 stocks want to see nvidia's data center revenue finchats got it like to track spotify's premium subscribers they've got that too and they just added etfs

Starting point is 00:37:47 to the platform as well. The breadth of FinChat's data is truly one of a kind. We use FinChat every day, and I've personally been using the AI Copilot more and more to summarize earnings calls and conference transcripts. To get 15% off any paid plan, go to FinChat.io slash chitchat. That is FinChat.io slash chitchat. To get 15% off any paid plan today, the link is in the show notes. earlier in the show you heard us talk about the investing platform public.com that's where you can trade options with no commissions or per contract fees and you get a rebate of up to 18 cents per contract traded nerd wallet recently gave public five out of five stars for options trading if you want to see why go to public.com and start getting a rebate of up to 18 cents per

Starting point is 00:38:36 contract traded paid for by public investing options not suitable for all investors and carry significant risk full disclosures in podcast description us members only all right do we want to talk uh building a software business and identifying good software stocks i guess the first question is you started finch at two three years ago i know it's kind of been a little bit it was called stratosphere stratosphere at the time it's been a winding road to today changing the name, as Ryan talked about, he knows a little bit more details on that. That's a bigger endeavor than is actually you would think. But what has the process been like? How you've raised money from venture capitalists, all that stuff. Can you give the listeners any insights into what

Starting point is 00:39:22 is a bit of a black box for people that just know public market stocks? Yeah, definitely. So I mean, the fundamental rules of business and gravity continue to exist, no matter what type of company you're operating. With software, it's one of those things where, yes, it is high margin. Yes, it is recurring revenue, those things that people really seek after. But in the Zerp era, that translated somehow into no operating profit, as we've seen. And so the reality of that is human resources in this space is very, very expensive, if you want the best and brightest.

Starting point is 00:40:07 And we've built the team in an extremely lean way. I mean, Henderson, you can speak to that. We just brought a bunch of more people on that are starting in the next couple of weeks. But I think Silicon Valley's come up with the traditional hire fast, fire fast mentality. I think we like to do hire slow, fire fast because we can't pay Google 400K plus RSU option packages out of school.

Starting point is 00:40:44 It's just unrealistic for us. So that's been one of the challenges, I think, some of the biggest challenges have been around building the right team and people, especially because not me, but my co-founders are so high quality and so incredibly smart. I think I'm pretty good at having a vision for what we should do, but I'm lucky that the people that work for me are a lot smarter than I am and actually capable of executing on that. But no, to answer your question, it's been a fun journey. It's been challenging, but it's certainly better than working the job that I used to do, used to clock in. What would you say have been the drivers of success thus far?

Starting point is 00:41:33 Like what were the moments where FinChat kind of took the next step and became what you think is a better business? It took a pretty core step once we really had the product. I'd say the product became something worth paying attention to at the end of 2022. And that was an instrumental change before it was... The feature parity required for this business is very intense in terms of what other platforms may have. And the edge cases, this business is all about edge cases because we have 65,000 companies that are on the platform, right? So there are so many edge cases when it comes to data,

Starting point is 00:42:25 different templates, data quality, things coming in. This company has an earnings call, this doesn't. There are edge cases everywhere. And so you have to squash them and come up with a good product. So that was the first big change. I think the next seismic shift in the business is our API. So people want to be able to interact with FinChat in other ways, whether it be other FinTechs who want to adopt the platform, you know, the Robin Hoods around the world. They want to adopt the platform and then asset managers on the enterprise side

Starting point is 00:43:06 who go, okay, what you have is great. And the co-pilot is the best that we've seen. the AI tool is the best we've seen. But I want to layer on all the research house stuff we do at the firm. Sally's making a model over here. Joe's making a deck over here. Rick just made an investment memo over there. This person just gave a demo to the client. This other analyst just put out an initiation buy report on Uber. That's a lot of intrinsic value that right now in a SharePoint, Microsoft file, yeah, people can go look at Henderson's work over here and Brett's work over there, but they're not because it's too much friction. What if I'm able to now

Starting point is 00:43:49 create the intrinsic value of everything coming in that everyone on the floor can interact with all the data with that natural language? Say, pull up Brett's slide deck. Oh, and layer on Henderson's model. Boom, boom, boom, boom, boom, boom. Next thing you know, you have an actual useful product. And I'm generally bearish on large language models and generative AI for most industries. I think it's been a little bit overhyped to throw in a chatbot on things that don't need a chatbot. Investment research is not one of those examples. I find it to be maybe the best use case that there is. And so we're excited about that long-term trajectory for that. Okay. Now, as you're an investor, as you said, you have two, you're not only running the

Starting point is 00:44:38 business, but you still have this hobby and you love public market investing, as we've talked about earlier in the show. How has growing a software business helped with your personal investing? And maybe, what do people misunderstand about these software stocks? Do you see people hyping up any sort of you know bad company that's training at say 15 times sales or something like that and they're they're way too over their skis on it and you just go okay there's a few things i'm seeing on this pnl or what they're saying that is like okay this software business is not as good as people are saying i think in 2020 2021 zerp era people were mistaking all like because it's a software company, that that has inherent quality to it. The business model is attractive,

Starting point is 00:45:35 but the business might not be high quality. In fact, the things that change the fastest are actually in tech and not like a CN Rail and a Kansas City that's been in the ground for 100 years and probably going to be in the ground for another 100 years. Those things are a lot more Lindy than some high switching cost software company. So I think there was a discrepancy around how high quality some of them were. In terms of what it made me look for and think for when I look at public markets now is my thesis was these companies need to grow at good clips or they're going to get smashed. That's exactly what happened. The tide came in, a lot of the growth was pulled forward. The top line goes from 25% a year to six or seven,

Starting point is 00:46:25 smashed, destroyed. And that's exactly what happened with a lot of these names. Now, there's going to be money picking up the pieces on a bunch of them because some of them are really high quality. I look at a name like Autodesk and just thought, if someone ran this with a little bit of shareholder care, the stock would crush. Maybe that companies turning a corner right now. I think in terms of, hey, look, customers have to be happy. Employees have to be happy. But you're a public company. So do shareholders. That three-legged stool is very important. And software companies have messed up the three-legged stool in the past couple of years. They've completely messed it up. Bad capital allocation, expensive acquisitions

Starting point is 00:47:11 that don't make any sense or have any sort of accretive value creation and stock-based compensation that is just completely ridiculous. And it comes back to, they're trying to compete with talent, the same talent pool that Amazon's competing with. Who wins that fight? We all know who wins that fight. So roundabout way to say, these core business capital allocations still really, really matter for these companies. I think people were a little bit too excited about the quality of some of them. There is a lot of quality in them, but they have to keep growing. I look at my business and all that matters if investors are happy is that top line's got to keep growing. My main goal is to keep growing the top line. Don't run out of money. Don't be an

Starting point is 00:48:05 idiot with the cap table. Don't spend like a goofball like people have in the past, but you got to keep growing, especially at our stage. So now when I look at some of these software companies and they're growing at Walmart clips, not interested at all, not even remotely interested in them. Now, we've seen a lot of people argue over the years, probably maybe just the last five to 10 years that you might see a company with 80% gross margins. Sometimes they can massage that, But let's say it's legit 80% gross margin, but their operating margin on a gap basis might be negative 20, negative 30%. As someone who's running a business of smaller size than some of these large cap software

Starting point is 00:48:51 companies, but how hard is it to actually go? Because you seem like the investors, they kind of go, well, they could just flip a switch and then just, boom, 40% gap operating margins when they want to. How hard is it to actually get there? Is that even possible? Or are these investors, I think, getting maybe misguided of how efficient a company like that can get? well i think that the right to say guys you got to be a little bit more efficient i think that

Starting point is 00:49:15 that's that's a fair assessment but let's look at the you know let's go down the income statement here so cost of goods sold um is is low and that's why you have the really high gross margin that's that's the the beauty of software is like yeah after you pay for your cloud computing and you know some some input costs that go into making the product and scaling it out relatively relatively low however the most overpaid that's not the right word the people that get an outsized amount of the unit economics of the sales people because they're actually not overpaid at all they're but they get an outsized amount of money because sales is hard enterprise sales is hard And to be successful, you have to push a boulder up the hill for months and months and months to finally close a deal. And so they're compensated accordingly. Let's go through an enterprise deal. Say it's $100,000, Brett, I sell you in software. I just signed the contract today.

Starting point is 00:50:22 Okay. Let's say 20K comes off the top in cost of goods sold for me to service that to you via maybe compute or whatever it is. There's a long list of things that can go in there. Now, another 10% of the gross booking comes right off the top for the salesperson. 10% of the total 100K. So now we're down to 30K. If that salesperson is over their quota and now in an accelerator face, it's 15%. So now we've lost 35% of the deal just right there in COGS and sales. Now I got to pay all the developers. Maybe there's another 2.5% kickback that the head of sales gets. I got to pay all the developers, all my operating staff, all the executive comp. um maybe i have my office that i gotta pay for pretty soon and by the way these are high paid

Starting point is 00:51:23 people pretty soon there's nothing left in the 100k pretty quick now if i'm doing that at a scale of 100 million i can make the scale work in those fixed costs for developers office uh you know those kinds of things but the variable costs around cogs and sales is pretty extreme and i think that cogs in software is a bit of a lie because everyone in enterprise software right off the top 10 to 17 and a half percent is being is being taken right off the top to sales people and commissions so you think that should be included in cost of goods sold or almost adjust that down when making your own model? Because if it's scaling with the business, I mean, it doesn't make it a bad business, but it feels to me like it should be part of the cost of goods

Starting point is 00:52:17 sold. Yeah. It's a fixed amount of the booking, the total gross booking amount. So I think for sure that you see that SG&A line just so massive on these companies, it probably should be higher up the income statement because it isn't optional because that's the market rate. I can't go hire a bunch of salespeople and say, hey, you're going to get 2% of the gross booking. I'll get two middle fingers up to the sky. So yeah, I think it should be probably moved higher up the income statement. Okay. This isn't necessarily like a business building podcast, but I do want to ask one question because for anyone that's ever maybe curious or wants to build their own someday, this might be valuable advice. What are some of the things that have most surprised you

Starting point is 00:53:07 since you decided you wanted to pursue this you wanted to go out try to build a business on your own what were some of the hardships i guess in doing it how long do you have uh no i i mean look i i i can i can complain and say you know building a business is really hard and all this stuff. But I'm not going to do anything else. So I'm not going to complain because it's exactly what I want to do. And I think folks get a pretty harsh reality of how difficult it really is, especially when you're hiring people that are making a lot more money than you. I paid myself essentially zero for a couple years. And then I think I paid... The year you started Henderson. I think my total amount that I paid myself was like 20 grand that year because

Starting point is 00:54:06 I just started paying myself salary. And so when people go to start these businesses, you got to have a little bit of a nest egg to work on because I was expecting not to pay myself for two years and it actually ended up being like two and a half years. So I saved like mad when I was thinking about it for two years i you know penny pinch as much as i could to get myself like a good amount of runway to work on the business because if i didn't it would have been so difficult it would have been such a nightmare i have the like you know lucky situation of like i did this before i have kids before i have a family all that stuff i think it's a lot more difficult for those folks but but not impossible i think sam altman has said you know the number one

Starting point is 00:54:59 trait of successful entrepreneurs is determination it's like you have to be just smart enough to pull it off and just dumb enough to think you can like you need that sweet spot of naivety but like also good enough or like talented enough to get people to care about what you're doing. All right. I think that's all the questions we have, Brett. And he's giving me the thumbs up here. So Braden, that is going to do it. Where can people find you? And I will take this moment to shamelessly plug finchat.io slash chitchat if you want to get 15% off any paid plans. But other than that, where can people find you? I'm on a weekly podcast called

Starting point is 00:55:47 a Canadian investor. And if you're listening in Canada, that might sound appealing to you. But if you're not, 90% of the stuff we talk about is actually US stocks. It's like at least 85%. A lot of macro stuff. And so that show comes out twice a week on Mondays and Thursdays. I'm on the Monday episode and I've been doing it for, if you include what it used to be called and the whole thing, like almost 10 years now. So I really enjoy it. damn you must have been one of the first podcasts around when i started my podcast for six years no one listened to it six years that makes us feel good we were only like a couple years so no one listened now i think i think it's about 10 million downloads on the on the player but like

Starting point is 00:56:38 no one listened to it for probably six ish years i think like one time my mom listened to it and that was it. It was for me. It wasn't for anyone else. And so with all these kind of passion projects, it's got to be for you. If it works out, you make some money, hey, that's the bonus, but it's a grind to keep it up. Exactly. It's also the beauty of compound growth. Stay at it. Good things can happen. All right, Ryan, do you want to wrap things up? Sure. I haven't done the disclosure in a while, but anything we say here on Chit Chat Stocks, It's not formal advice or recommendation. Myself, Brett, and Brayden are not giving any pieces of advice, and we are not financial advisors.

Starting point is 00:57:25 I don't think, Brayden, unless you're a financial advisor, I don't know. He's shaking his head. So anything we say, as I said, it's not formal advice or recommendation. Do your own due diligence. Thank you all for tuning in, and we will see you all next time. We'll be right back.

Chit Chat Stocks - What Makes a Great Software Company? Plus, an Update on Constellation Software (CSU.TX)

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