Good Investing Talks - Joe Frankenfield, how much Value Investing is in Saga Partners?

Episode Date: November 18, 2021

With Joe Frankenfield of Saga Partners I have discussed his steps into investing and how he is approaching high-quality businesses.

This episode of Good Investing Talks is supported by In Practice. In Practice offers a selection of interviews with high-quality businesses. They focus on doing deep interviews with executives, people around businesses, people who have knowledge about certain industries. So if you want to know more about great businesses and their future and background, please click on the link below this video to get more information. about in practice and now enjoy my conversation with my guest welcome to have you all back today it's great to have um joe frankenfield of saga partners on hi joe it's great to have here hi toman

thanks for having me you've lived here most of your whole life in cleveland ohio you spend some time in miami or in phoenix i think you said to me but you never worked also never work there at a big hedge fund or a big tech fund but now you if i look in your portfolio you own some of the great tech and online companies and not only since 2020 how did you do that man how did i from this small place and being able to move into the right names and invest in a right way and also have this great performance but there's so many questions and as we will go into details, but you can try to give an answer. Yeah, that's a good question. And I get that often. It's, I've definitely, um, started from an unconventional place for managing money. Uh, I think it just

kind of was a natural progression of what my interests were and how I just kind of took it one step at a time. Um, I, yeah, like you said, I was born and raised in Cleveland. I, I, I spent some of my grade school years in Phoenix, Arizona and then went to Miami University in Ohio. And, I, yeah, like you said, I was born and Ohio. Some people get that confused with Miami, Florida. But, uh, and then, like me. Yeah, actually, it's funny. Um, uh, we, we hired an analyst just over a year ago. Richard Chu, he's great, very smart and love working with him. But actually about a month or two ago, he was, I don't know what brought the conversation up, but he messaged me or we were

speaking. He's like, I just realized that when you say you went to Miami University that it was in Ohio and not Florida. Like, why would Miami name themselves after a, uh, a popular city in the U.S., and the response to people that went to Miami University was Miami was a college before Florida was a state of the United States. So it's just kind of a random name. But anyways, I didn't know I was going to manage money professionally. I kind of just followed my interests. And I've always been one who likes to understand how the world works and try to figure out puzzles.

And I loved history in high school. And I was actually kind of turned off from the idea of investing in the stock market because my dad, he's a mechanical engineer, very analytical smart guy, but he always considered like investing in stocks somewhat to be gambling. And so that always turned me off when I was younger. And then in college, I studied finance and business. And I was interested in kind of how the economy works and how kind of money moves around and I'm just trying to figure out. why people are motivated by different things. And so out of school, I got a job in corporate banking. And I thought, I was during the Great Recession.

It was hard to find a job in finance at the time, but I was happy to find a job where I would be able to work directly with companies and kind of figure out what made a company successful and what made one not successful and kind of working directly with the decision makers of middle market-sized companies. And it was really interesting to me to be able to speak with, you know, the presidents and CEOs or CFOs of these mid-sized companies. And but at that time when I was right out of school and I started making money for the

first time and actually having a money that I could save and invest, I came about Warren Buffett's letters kind of, kind of randomly. We obviously, in business school, you study Warren Buffett and you study his success and how he thinks about investing, but it was really the summer after school, I picked up the book by Robert Hagstrom, who wrote the Warren Buffett Way. And that was kind of my first entry into the value investor world. And I kind of went down the rabbit hole of trying to understand how to value businesses and compound capital over long term. And what I thought was going to be a past time to invest my savings and grow it, kind of

turned into an obsession. And I think that's common for people that kind of get the investing bug. And next thing, you know, I was spending my nights and weekends reading filings and understanding industries and reading every book I could on Buffett, Munger, Peter Lynch, Phil Fisher, all the well-known value investors and just trying to learn and figure out a puzzle. Like, we're just trying to figure out these anomalies in the market that we think are mispriced and efficient. And I knew pretty early on that I thought that's what I wanted to do for a living,

for a profession. The question was, I was already in the business world, but I wanted to get into the investment management world. And so I went through the CFA program, and then after I got the CFA, I got a job on cell side equity research covering the transportation and logistics sector. and I really thought that job was going to be living my dream, right? Like, being able to analyze and study companies, try to value them and writing about them. And it was a great experience, and you get to actually work with people who are allocating billions of dollars.

These are, you know, the Fidelity of the world or the TRO prices or hedge funds. And so you get to understand how, like, people within the industry work. But it was pretty apparent early on that at that point where I already formed my philosophy and how I thought about investing, which is very long-term, fundamental outlook, was not how most of the industry operates, most of the industry, at least for the clients that we worked with, are very short term and trying to figure out whether a company would be or miss consensus each quarter, kind of momentum investing where money, why a stock was up or down five or so percent every day. And my response whenever I would talk to your clients, like, it's because

if stock is up five percent, it's because there's more buyers than sellers that day, like, for whatever reason it may be. And, and that makes sense because when you're on the sell side and most sell side shops function this way is that you get, you get paid by having trading activity, you know, you make a spread on the trading. And so you sell three, to your clients to incentivize them to trade with you and also give you, also research dollars as well. But anyways, I knew pretty early on. That's not kind of how I thought where I should be for the long term. And over the years, as I was managing my personal portfolio, I was getting more and more conviction in my ability to pick winners. And I was learning. I made mistakes,

like, as everyone does, and I still make mistakes. And I will continue to make mistakes. but I was beating the market by a wide margin in my personal portfolio. And I was gaining more conviction that I think I could potentially do that for other people and have confidence to do that for other people. And that might seem gutsy or, you know, people say, how do you have the confidence to do that? But I just thought if I could manage money the way I thought it should be managed, as though I would manage it for myself,

I would let anyone who agreed with that philosophy to come on board and hopefully form a small-type decade. record of compounding capital. And so I got to that point in 2016, so over five years ago at this point, and to start my own portfolio. And that's kind of where I went. And you can speak about saga partners and how we formed it and stuff. But that's kind of where I got to just managing money full time. Let's talk about this in a second, but I still have a question on your father. Does he still think you're gambling or did you convert him at a certain point of time? And how? maybe this heck is also interesting yeah when i was getting more interested in the market which was

in college um he would roll his eyes a little bit and then i when i was starting to manage my portfolio he would still roll his eyes and say it's it's gambling and but then i was having success and i would talk about the stocks or the different ideas i had with him and so he knew for years i was obsessed with just understanding how the world works and understanding these weird anomalies and solving puzzles And when I wanted to launch a saga partners, start my own portfolio, ironically, he gave me a significant chunk of his savings. And he was the largest investor at the time. And we've done well for him. So he's very, very, I think he's maybe turned from thinking of scamming to like maybe there's something to it.

So I think he, the way we approach investing, I think he's understanding that we're investing. We're not speculating and we will make mistakes, but if you can pick a few of the big winners, then you could potentially outperform the market over the long term. Like if he starts pitching Papa Saga partners in three years to you, you've made it. Yes, yes. Let's come back to Cleveland and being in Ohio. So where is this an advantage for you? That's a good question. People have claimed if you're outside of the major money center cities like New York City or Boston, that there might be an advantage.

I don't know. It's tough because in this day and age, information is at everyone's fingertips. There is no informational advantage for the most part in the market. So we get the same news feeds as people in New York and Cleveland. And I think that maybe Buffett has said being in Omaha has been an advantage you can think and not be surrounded by kind of momentum or group think and things like that. I don't know if that's the case or not, but I do think where you're born and raised and there's a culture and there's a culture within your family. There's a culture within the school you go to within the city. And maybe a Midwestern culture impacted the way I think about not having day trading or being kind of, I'm slow to buy a stock and I'm slow to sell it.

Maybe that's part of the culture. I don't know. But the same thing is we get the same information as anywhere else. You can manage money anywhere in the world with the internet these days. So I do like Cleveland because it's where my family and friends are. And I do feel comfortable here. It's funny because right after school, I lived in Cincinnati for several years, and then I moved up to Cleveland when I got a job on the south side. Yeah, so Cleveland had a bunch of cell side shops, and there's a little hub of finance in Cleveland, I think compared to other cities the size.

But at the end of the day, I think there's probably a little advantage to wherever you're located. It's more about your process and about how you think and approach investing. So I imagine there's tons of amazing investors in New York City or Boston or anywhere. So I think it's just how you approach investing overall versus your location. So then let's move on to Saga partners and your process. How have you set up the firm to optimize it for great long-term returns? Oh, that's a good question because that's so important. And when you're young and you're trying to figure out how to establish the family,

and infrastructure for a firm, like you're just trying to learn from people in the industry. So it's very easy to potentially get bad advice. And what I knew is if I couldn't manage money the way I thought it should be managed, as though I was managing my personal portfolio, I would have a high level of conviction to outperform over the long term. And the reason why people don't do that is because of their investor base, who invests with you in the portfolio and what they are looking for. And so you'll find that if a lot of times, and this is just a general statement, but for institutional investors that often make decisions by committee, it's hard to be a generalist to go wherever you find the opportunity, because they often like to bucket you into a certain category of investing, whether it's value versus growth or large cap, mid cap, small cap, U.S., foreign, whatever is your bucket.

And I just wanted to invest the way at wherever the opportunity was, the opportunistic. And so I knew that your investor base is very important. And who we would let in Saga Partners was very important for our long-term success. And you can say that, you know, if you have a big launch of a hedge fund, and just to clarify, we're not a hedge fund, we're an investment advisor. So we do manage money through separately managed accounts. So we are fiduciaries for everyone who invests with us. But anyways, so who is in your investor base is a competitive advantage, right?

And so who you let in kind of forms the culture of your portfolio, which then also those people may refer people within their network, say, hey, this is a strategy that might make sense for you. So it creates this virtuous cycle where this culture becomes self-reinforcing, where you think long-term, you really think about the company's intrinsic value, you're not trying to trade daily. And so to answer your question, your investor base is really important. Also, the way that we manage the portfolio, I think, is where we have to survive over the long term. We have to think long term. We can't have our hands tied behind our back. And so the way we think about

using leverage or sorting or using options, that stuff could potentially hurt you if you go through really difficult periods like March of 2020. And so we have to survive all ups and downs. And so that's how we structure the portfolio. But really, it's getting the investor base, right, I think is key to how you structure when you launch a strategy. Do you have an ideal investor? You want to have an investor base?

The two things we look for in investors are one that they're looking for a long-term relationship. like they have a multi-decade outlook for this capital that they want to compound. And two, is they also think long-term. So they're looking to build a long-term relationship. They're not looking to get in and out of saga partners. And two, they also don't need this capital for five or 10 or 15 years. And so if they fulfill those two criteria, then they're probably,

and they align with how we manage money, then they're suitable. I think that getting that long-term, making sure you don't get hot money, if it's really easy to raise a billion dollars, it means it's probably pretty easy to lose a billion dollars. It could be hot money. And so we're just looking for long relationships. And it kind of creates this value chain of capital allocation. If you think about it, where those who are investing dollars in us,

we need long-term. So that way that in our investments, we can think long-term. So that way the managers that we invest in in the companies, they can think long term, right? So it creates this really virtuous cycle where like everyone's thinking long term and making these decisions that make sense for the long term versus if you have hot money that needs you to perform every quarter or every year, then you're thinking, I need to outperform whatever your benchmark is every quarter and every year. And then you start rethinking how your investment process works.

And that means your companies have to perform every quarter and every year. No, no mistakes, no, no tripping on, you know, through the race. Like, and so if management teams can't have to worry about making the quarterly numbers, that changes how they manage their business. And they, it's kind of scary when you look at, you hear stories about people that work at Fortune 500 companies and how management is so incentivized to make their consensus numbers every quarter, they will potentially like push costs back a quarter. They'll try to book revenue earlier.

I guess anyone knows, like they will change their accounting and change how they manage the business, not for the benefits of the long term, but just so that way their stock price doesn't crash if they miss numbers. And that's not how the economy should work. That's not going to create the most value. And so there has to be this value chain of capital allocation. We're just a drop in the bucket. But like, the more that capital is allocated with this mindset, the more efficient the economy will function and work. And so if we're looking for long-term investments, we need long-term investors. and then that means management can function over the long term.

And that's just so important, I think. So, yeah, that's kind of what we look for, investors. They also have this issue of short-time optimizing for nice results with the current shipping and logistic crisis, where all of the buffers have been taken out and optimized everything for short-term metrics. And shipping is a good bridge to the next question, because Staga partners has this boat as a logo.

We also show it here. Let me make a wild guess why you've chosen the boat. You live at the Great Lakes and if you're long-term successful, your plan is to own sets the boat and sail across the Great Lakes? Or what is the reason why you've taken the boat? That's a good question. I've actually never been asked that question, which is funny. But I guess that gets into the question of why we're called Saga Partners.

And it's when Mike, no way actually, my partner and I, We started working together. The first thing that we did was tried to brainstorm a name. And we're trying to come up with something that was, you know, short, clean, kind of like, I don't know, Google, like something like that was just like a short name that represented our philosophy. And we couldn't come up with a name for a couple of days. And finally something just could click.

And one of us said, saga, which is a word for a long epic journey. That's a Norwegian word. And so that kind of just sounded right, right? It kind of filled our philosophy of thinking long-term. I hope that we're on this beginning of a long-term epic journey and saga just made sense. And so then since it's, it's, uh, Norway, it's up, uh, the ship is kind of just a logo for like the Vikings, right? Like it's kind of like, and I kind of represented, um, the journey part of the idea behind saga.

So really it's not because of being on the Great Lakes or that we, I want to buy a boat one day. but it just was a logo that we could have really no huge reason behind it. Maybe I've created an idea in you. Maybe, yeah. I'm actually, we will see. You don't want to own the boat. You want to have friends that own boats. I'm not a boat person because I just, I don't get much, I don't get much value from the idea of having to maintain and take care of a boat.

I do get value from like skiing. Maybe that's like something I love to do, but boating is not one of my past times. But you're also a person that has a partner. You're not the typical one-man shop with Saga partners. You have your partner, Michael Novaki, and also an analyst with Richard Chu. Some know from Twitter. What is the advantage of such a setup and how do you all make sure that you build for the long-term success? Yeah, I mean, there is just, I think, a lot of benefits to having a partner, right?

You want to share in success. You want to be able to share ideas. And as long as you find the right partner who thinks similarly has a similar philosophy, there's a lot of, I think, value creation, one plus one equals three, that type of idea. And I have that with Mike, which is, you know, we met very serendipitously when I was looking to launch my own portfolio in 2016 through a mutual friend. And he was a big Buffett fan. We met together for coffee and just spoke hours about businesses and the economy and how to start a business. And we just kind of really aligned on that philosophy.

And so I always like the idea of having a partner. If you look at all of the well-known investors, they did have a partner. And so I get that with Mike. And with Richard, I never really thought we would hire an analyst because I kind of love. the idea of digging through the filings and doing the firsthand research. And I never wanted outsource thinking. But with Richard, he just, he aligns with how we think. And it was very just again, serendipitous and how we kind of came together. He wrote a research piece on Livango, which was one of the holdings we were researching. And it was really well written. We,

Mike reached out to him and, you know, said it was great. And then if he ever was, in Cleveland. He lives up in Toronto. And if he ever was in Cleveland, we should get together, right? And so I think it was two weeks later, he came down to Cleveland and, and met with Mike, and then met with me later. And you can just see his passion. And he pushes you and so impressive for his age. And he just is a great analyst and a pleasure to work with. So I think there's just this idea of a team. You cover more ground. You push each other. And what's important is just that you, you kind of just create more value working with others. And so, yeah, I get that with having a partner with Mike.

And I would mention, like, when we first launched Saga, like, Mike and I were, we were co-portfolio managers of the Saga portfolio. And Mike was already managing an investment advisory for clients before he met me, who had kind of tailored portfolios for their suitability. And the Saga was kind of a core strategy that we wanted to launch. That was our single, where we put all of our effort behind. And when you do have co-portfolio managers, there is like some, it's hard to have two CEOs of a company or in investment management to portfolio managers.

So there is maybe some confusion over like decision making. And you won't always agree, even though we agree lots of the times. But we did adjust that structure in 2019 where he was able to focus on a few other things that he was interested in as well as support the saga portfolio. So then I became the lead decision maker, the lead portfolio manager of the Saga portfolio in 2019. But it works really well for us. And I think just it's aligned with what your long-term goals are and what you want to do with the business. If I would ask Mike and Richard what they would say your strengths are, what would they answer also in relation to the team?

My strength is probably that I can sit and just dig through filings for hours and not make any final decisions until I finally see the light for something. I think it's hard for people to not be active, and I've always been able to just not trade or feel the pressures to trade. And so I think that that an interesting study, I think, is the marshmallow test, which was done decades ago. But it was when, you know, you would put a marshmallow in front of two or three-year-olds and tell them if they would wait 15 minutes or an hour, you would get two marshmallows. And I think I may not necessarily be the smartest business analyst in the world. But I do think I would just excel at that marshmallow test.

I would be able to do deferred gratification under see the light of the end of the tunnel. See how point A to point B, point C gets you to the end of the light and plan around that in an opportunity cost analysis. And so I think that's always been one of my core strengths is kind of looking long term, thinking long term. And that's, I think, something pretty important, I think, if you manage money the way that we do. That's good, good to know. When I was searching on Google for Saga Partners, your website showed up with the tag Saga Partners, Investment Management, Value Investing. When I looked in your portfolio, for me, the question came up in your portfolio,

Kavana, Tradesk, or Roku. How did you guys modify the value investing framework to be comfortable to still name it value investing in all companies like Kavana, Tritus, Roku, you name it? Yeah. The, I guess, like, gets to the question of like value versus growth, which has been discussed agnosium. I mean, that debate between value and growth. And like Buffett and Munger say, like, all intelligent investing is value investing. That's what we're trying to do.

We're trying to buy things for less than their worth to earn attractive rates of return. And I think the traditional value investing, obviously was based more on lower multiples and from current fundamentals. And I think that mental model doesn't necessarily apply as much as it did in the past. And for many different reasons, but we are value investors. But if you think about, I think the law of investing that will always be true is that the intrinsic value of any asset is the net cash return to owners over its remaining life. And that's what we're trying to figure out. And so with the goal to compound capital. And so when you look out in the investing universe and you're trying to find attractive internal rates of return, IRRs, I would be happy to own a no-growth company.

Like, we're not growth investors. The thing is, what would you be willing to pay for a company that you could see forever that was completely stagnant, stable? And what would you pay for those earnings? And historically, that's like the market has returned, let's say, nine or something. or 10% annually for equities. And so maybe a 10 multiple. Well, when you look at the market, those opportunities aren't available. And we're not looking for average returns.

We're looking for excess returns, you know, 20% IRAs plus. And so you'd pay five times multiple. And you'd have to have a lot of conviction that those earnings are actually owner's earnings, the earnings that can get distributed out to owners and not stuck in the company. And so that's like a good starting place for thinking about. growth and how you incorporate that into your intrinsic value analysis. But historically, when you look at the returns of the stock market, the best returning

companies over 10, 20, 30 years are ones that can compound that really have this growth aspect to them. They're not the ones that have been stagnant and stable in the public markets. And so that kind of leads you to kind of finding the patterns of what made these companies special. And a lot of times, and this makes sense, is the market will value something thinking that if it's doing really well, it will revert to the mean. Its fundamentals will revert to the mean. And that is a good, I think, mental model. That's good for average companies. It's often the case. And really poor companies will revert up to the mean because

other competition will go away and whatnot. It's just how the capitalistic economy works. But there's a few companies, very few, that have these durable competitive advantages that the market undervalues because they don't revert to the mean as fast over time. And so when you look at like what provides this nine or 10 percent annualized return in the market, it's actually very, very few companies, single digit percent of companies, five percent, two to eight percent. There's been studies and looking back at historical data provide nearly all the returns of the market. And you break it down, nearly 50% of companies that are publicly traded provide negative returns in the market. So the idea is like there are all these landmines. We have all the publicly, we can

invest in any public company and their prices fluctuate every single day. So we have all these options, but most of them are going to do very poorly. And you learn from my experience longer to do this, that the market's pretty generally, it's generally good at valuing businesses, but sometimes it really undervalues when you take this 5, 10, 15 year outlook and what a company could be. And so we found this in companies that really have the ability to scale farther than what the market is pricing into the price. But what's interesting to go further, like, it's scary. You don't want to project 20% growth returns on companies generally because if you look at historic companies, very few companies have the ability to grow 20% per year. But as you see in our portfolio, they're really these companies that have a lot of intangible assets.

They're a lot of times associated with the knowledge economy versus like Michael Mobison recently came out with his new book, expectations investing, and he would break down companies into like physical companies, service companies and knowledge companies. And obviously there's a blend for what a company does. be a mix of those, but the more intangible you have, it changes the economic characteristics of the business. And if you look at how companies scale historically, like say a very physically tangible asset-heavy company, they scale sub-linearly, similar to like living organisms. And so as it gets bigger, like the costs also don't necessarily benefit from economies of scale. Eventually, economies of scale turned into this economies of scale has become more inefficient through

whatever customer acquisition costs, bureaucracy, whatever may be the case. And so what the intangible companies have, their characteristics have become is that they're able to scale much larger and they benefit from network effects often. And so they scale like cities, which are super linearly scale. Cities are very durable businesses. And so a lot of our companies that we own have this business model of like a marketplace, a platform. And so in our view, that is a more durable more often than like a linear business, which is more tangible, asset heavy. But anyways, to get to hear a question, that's a long roundabout, but we are value investors. We're just looking for things maybe in a little different light. And I think

the market is getting a little bit smarter about some of these companies, obviously as multiples have gone up in many of the these intangible asset heavy companies in your answer you also said you would own a no growth company and i think that's also adding to a claim or a point you made in other talks that you say you're opportunistic you go where the market offers the opportunity but how does this go about with what i've observed from other investors that you need a certain and specialization, focus, deep thinking, and orientation for the long term to outperform and not really like a nomadic opportunity-driven investment style. So how do you balance this, just being opportunistic and the deep knowledge you need to

have to outperform? Yeah. So I think that if you manage a portfolio based on opportunity costs, so you're, constantly weighing what your best opportunity is in number two, three, four, five. Your portfolios likely, if you're doing it right, going to naturally consolidate. And so you'll always weigh, like, if you have a 20th idea, if you're actually weighing what your expected returns for those, your best ideas are, you're like, why don't I put more in my first idea? And I think even if you're right in picking these investments saying that you truly are

undervalued, but over time, those really good ideas are probably going to appreciate greater So that your portfolio will just naturally, naturally consolidate. And so I think when you make decisions based on that, you can really focus on your best ideas. And you do really get into understanding the DNA of every single business that you own. And we spend months and months of years and we'll own a company for years. And so you know it really, really well. No, like you as investor, you also have to have deep knowledge to say like one example,

you brought me to buy a Roku stick and you have to know how this stick functions, what software is behind it. You want to be mad about knowing where the suppliers are if there's any problem from the chip shortage and all these questions and these questions also lead to deep knowledge and the idea of the circle of competence that is somehow conflicting with the idea of being too opportunistic because if you're investing is something you don't know that deep. There's also costs to it. That's where the question wants to go.

Yeah. I mean, when you look at the best investments or the ones that we can understand, it's really you want to have deep knowledge and understand the DNA of the business. But really, it often comes down to just a few variables, one or two, maybe three. And what's the revenue drivers, right? Like, what's the, when you break down the unit economics of the business, what drives that? And the two questions we ask for every company when we're assessing about, like, you know, you're trying to invest in high-quality companies, right?

Those are the ones that are likely to do well over the long term. And we're trying to answer the question, one, why, like, what is the problem this company is trying to solve? Why are customers hiring this company to outsource a problem? And two is, why can't other companies solve this problem for that customer today or far into the future. And so we're just trying to figure out why this company, on the spectrum of quality, you can think of from a commodity business to a monopoly. We're trying to get as close to a monopoly business. And if you can understand why that company is able to provide a product

or a service better than other companies, and that's a durable thing, then it has pricing power or it has attractive economics. And so that often comes down to really focusing, on a few of the drivers of value. And so does it because they can offer a lower price for the product more than others, like a Costco or a Walmart or an Amazon? Is there some type of economies of scale? What protects that advantage? And so when you do specialize in the companies and we're generalists, you can get into the,

we don't need to know how to code the right software, but we need to understand the economics of those businesses and why they're able to provide that product or service while others aren't necessarily able to to the same extent. So we're looking for differentiation. What is different about the specific business and why that will continue to be the case far into the future? When I look back in your letters from 2016, I had the feeling that you did give up some kind of investments

and to make a shift to the companies you own now. Why did you give up this investments? And was it worth it in thinking of opportunity costs? Yeah. When we launched the portfolio at the beginning of 2017, we probably had 14, maybe 15 investments. And Mike and I were working together at that point for like three or four, maybe five months at the time. So we were putting this portfolio together to launch. The thing about investment ideas are they just don't come when you want them to. And so we love love is a strong word. We liked the companies that we launched with. But as you do this every single day and you're constantly looking for ideas. and analyzing what's going on in the economy. We're always trying to improve the quality of our portfolio. And so we're weighing our ideas and we'll replace the ones that we like less with the ones you're like more.

That's how you base or manage a portfolio based on opportunity costs. Similarly, I think what your question is like the types of companies have somewhat, obviously, migrated more into these marketplaces, these least platform companies over time. Because, you know, maybe in 2015, I remember having this debate of, like how is Amazon able to scale so fast? Why is Google so successful? Facebook and Microsoft and you're looking at the economy and understanding, trying to understand what makes it like these companies special.

What are they doing? And I just ponder this for over and over. And you're analyzing these other businesses. And so over time, you know, we found companies that exhibited similar characteristics like the trade desk. It's probably our first notable example in 2017 where we replaced it and found like the qualities that trade us to be very exceptional and durable while the market obviously at the time didn't really agree based on where the stock was trading at, but

you're just constantly trying to learn and understand why these companies are creating value. And what we have found is as the longer we manage this portfolio, the saga portfolio, the lower our turnover becomes. We constantly are trying to improve the quality of the businesses are in it. And so for the next best idea to get in it, as we better have been the last idea. And as you do that longer and longer, you kind of form this solid portfolio where it's hard to get into it. In the first year or two, maybe we did switch out in and now of some businesses. And quite frankly, when we underwrote certain ideas, it might have been like a 15% type of expected return.

Because those were the ideas that we could find at the time. But as you find better ideas with higher expected rates of return, those companies that we look back at, it's almost, they just wouldn't make the cut today. And actually, going back to our old investor letters in like 2018, it's almost like you just see how you change as an investor you evolve and learn and become better. And that's what we're trying to do. So like in five or 10 years from now, I hope we look back and say we are much more improved. And when you, I read the letters from 2018 where, you know, they're fine. But like, I also like, you can, it's a good way to timestamp what you thought at that point and then what actually happened and looking back,

you learn from that and you get better. And that's part of the benefit of writing these letters and your investment bc's is you can go back and see this is what I thought. And I think I was looking back. I think before this is looking back at our old investments. And I think we've probably made 25 or 30 or so investments. We currently own eight. And but of those, like they have all done generally okay. There's never been a huge blowup, but you can see where the huge returns come from. It is that power law where a few companies drive most of your returns.

And so if you can focus on those companies that drive most of their returns, you won't get it right all the time. But if you think you have a strong level of conviction that you found one, concentrating on it makes the most sense. And so that's kind of how we've evolved over the past couple years. So looking back, do you see any mistakes of selling any of the companies you hold before and the opportunity costs are high for not holding them anymore? So I think of all those investments, we talk about our mistakes.

And I don't like calling things mistakes because all that it really happens is we have this investment thesis. and its expected outlook, and as we get more knowledge over time, it might revise our long-term outlook. And so if we call it a mistake, it's painful. People don't like to be wrong, and we are wrong because the future is a messy place and it unfolds differently than you may previously believe. But as you get new information, you just have to readjust your long-term expectations based on where the stock is today. And if it's no longer attractive based on this new information, then you should readjust and

reallocate your portfolio accordingly based on your revised expectations. So that's basing all our decisions on opportunity costs. But we have made mistakes. And I think like when we have sold companies, it was generally the right decision because we reallocated opportunities we thought were much more attractive, even when those companies performed well after we sold them or decently well, because the ones that we bought on average have done much better. And so, I mean, that's how we think about it and mistakes and selling and just constantly

trying to revise our outlooks. But if you find that your long-term outlooks are constantly changing materially, then it makes you rethink when you have new outlooks initially for a new investment. What are the chances of this actually succeeding? And the more you look at the history of investments in business, the more you realize it's very hard to have a few good ideas. And so when you do find the good ideas, concentrate on them, but also have this appreciation that it's hard to find things that are really mispriced.

And yeah, that's kind of how we think about when thinking about reallocating the portfolio and selling things that we think are less attractive than new ideas. You said you're looking out 10 to 15 years with the companies you're investing in. So let me ask a question where are some of your investments in 2030, 2031. One, you can pick two or three Fridays you want to choose to answer this question and talk about them. Yeah, that's a good question. And I think what investors do when they're trying to make a decision is it's kind of, you have like a decision tree, right? And you're trying to find each node, you might have two different outputs.

And you put a probability on whether a company will. reach a certain, I guess, key performance indicator. And I think the short term, like short quarter or annual, it's random, right? It's a 50, 50% chance whether a company will go up or down. I think you do have the ability to place higher probabilities when you think long term, multiple, five, 10, 15 years. So they can place higher probabilities on a certain outcome. And it's often these companies that have these durable,

competitive advantages. And so you have to think about what is Jeff Bezos has a famous quote about saying what are the things that are not going to change from a consumer demand standpoint. And it's likely they're going to want lower prices, a better wide selection in a great process or experience is the word that he uses. And those things aren't going to change. So why are if you can focus on continually improving those over time, those few variables around all the noise to get there, that is key and making that assessment. So could you envision Amazon continuing to do that in, let's say, 10 years or like that's like Costco keeping prices low or Geico or these companies?

And I think Nick Sleep may have coined this term of like scale economy shared where these companies are able to continually use their scale to offer lower prices to competitors, which makes them more durable. So you look back at the history of businesses, like even going back to Standard Oil with Rockefeller in the late 1800s, like he obviously did very well by consolidating the refining industry throughout Ohio. He's from Cleveland and Pennsylvania, New York, and consolidating the supply, the refining oil, but he actually passed on those savings from his ability to negotiate attractive transportation with the trains and retail at retail outlets with customers.

So actually the costs of kerosene to actually use for lighting before actually it was used gas was used for cars, but like he was actually brought the costs down for consumers. He had economies of scale shared. Ford did the same thing. And so if you can find these ways that these companies are able to continually offer more and more value to the customer, that's something that's interesting. And so when companies that we look for, so I think, I'm trying to think through our portfolio for a good example, but one of the easy example, if we want to stay with retailing. I know a few of your people who have interviewed have spoken about Carvana. So we've owned Carvana for a while now.

And you think through why will Carvana succeed for the next 10 plus? years and the question is is will they be able to make it easier to transact used cars on they're essentially turning into a marketplace obviously they're vertically integrated today but they're making it easier to transact used cars and and is there an alternative to that model that what's the alternative to customers and historically that's been brick and mortar used car dealerships and that's not been i mean they're infamous for not having a good customer experience. And the question is, is in 10 years, what would compete with Carbana? And I think it's almost so clear to say that alternative, if they continue to succeed and execute, the alternative

is going to be so much far worse, right? Whether it's trying to find something in a newspaper to do a private transaction or use a traditional brick and mortar car dealership, which doesn't have an inventory, the selection of the process, also is more expensive. It's like it seems so clear that they will have this value proposition if they continue just to execute. And so I think that's what we're thinking about. If they can continue to lower the frictional costs of transacting cars, they'll be very successful. And the question is, if you can get to that point in your analysis,

the more important question in 10 years is, will people even be driving or owning cars in 10 years? And that's a real thing to think about, especially with this metaverse stuff going on in the press where if people are just functioning in the Metaverse, will they be driving? So you have to think there are autonomous vehicles and all those things that could impact car ownership with Roku, which I think you held up earlier. Here's it again. Yeah, there's, I convinced you to buy a Roku stick.

Have you tried it? Yeah, it's good. I'm notched. Honestly, I'm nudged into using it more as other services. Like I went to prime directly, now I lose Roku and Disney directly, now it was Roku. You have to talk about this later. Yeah. With like a Roku is they're building an operating system on the TV.

And it's a similar playbook, I guess, when you look at personal computers with Windows, Microsoft Windows, or then going on to mobile phones with Android and the iOS. But with Roku is, are they able to aggregate the proliferating supply of content, TV content, right? there's so many, content is just becoming so abundant and will they be the platform to be able to filter that for consumers better than alternatives? So like how will TV transition over the next 10 years? And if they are successful in providing the best consumer experience that will attract more consumers, which then obviously makes suppliers of content want to be on Roku, which then obviously attracts more customers and creates a purchase cycle.

And so then Roku will be able to monetize, better monetize that marketplace, that platform that they're creating. And it kind of does get into Ben Thompson's aggregation theory where the power players going forward with technology are ones that provide the best customer experience. You know, you can look through the history of business, and what technology does is it democratizes these products and services. It empowers the consumer. And so, thinking through, like, let's say a Roku, it's like, are they able, and the KPIs, like, key performance indicators are they able to continue to take or grow their market share in the TV operating system? And that is kind of the different data points on our road to 10 years.

but the vision is, how will people consume TV in 10 years? And will they consume TV in 10 years, right? We're just trying to think through these questions and make an educated guess, a probabilistic guest on what could potentially, what Roku can look like in 10 or 15 years. For talking about how we've transitioned in some of the businesses that we've owned, I have just gotten less and less comfortable with linear

businesses, businesses that control their, their, um, that actually have to manufacture, like have it, they have a, in their valley chain, they, they buy goods, they do something to lose goods and they sell them for more because it's, it's more likely for that to get disrupted, right? It's, it's easy to copy a TV monitor or our computer monitor or, or physical goods in manufacturing. Um, obviously some businesses are very good at building these really high tech, tangible goods, but creating these customer-friendly platform companies, I think, are more durable. And so that way the terminal value risk is less. So I feel less comfortable owning Ford or general motors that manufacture cars versus a platform or marketplace that helps transact cars. Because,

like I said earlier, that companies, typically linear companies, scale sub-linearly like living organisms, while cities scale super linearly. The bigger they get, the more powerful they get. It's that Brian Arthur increasing returns to scale. So these marketplaces actually scale like cities. They get stronger, the bigger they get. And once you establish that marketplace, it's really hard to disrupt it unless you actually have some paradigm shift. And so that's what we're looking for is like the actual potential risk of complete disruption in the paradigm shift. And that's what we think about in 10 years. But I get more conviction in these types of platforms.

And you know with there are other examples in our portfolio too. Like I know we've spoken about potentially like the trade desk or good RX or things like that. But that's how we think through these business models. For the ones who are interested in trying out Roku as well, I will add a link in the show notes. would love to hear your feedback or Joe even would love to hear it even more from the Europeans who are listening to this because they just started in Europe. But I also want to use the option to show video to you and combine it with a question. It's you and one of your hobbies.

I think it's handball. Call it in the US. And I want to combine it with the question if it looks like a video like, this we can start to play it here where you hit the ball very hard and are intense and really fight does your how does you your building of certainty in you you want to make sure that the vision you have for the companies you invested in that it comes true and you build this certainty how does your research process look like it's a bit like this this game where you really hit it hard and tested dive even or how do you do it i could make that type of i guess analogy with so this is that

on youtube you said you found that yeah yeah there are many videos of you yeah i play good in that i play handball which is that sport it's it's like racquetball but with her hand and it's this kind of like underground sport it's not very popular it's it's but my dad played all throughout my life and then i started playing more in college on our college club team and It's my favorite pastime outside of like snowboarding. If snowboarding you can only do during the winter months, but I play a handball probably once or twice a week if I can get out. And it's it's such a fun sport.

It's the one, it's like I find those activities to be like freeing and releasing. Like because like I'm so, my mind is always turned on to what's going on in the world and like trying to understand things. And when you actually can focus on like a sport or an activity, it helps like just kind of, it's therapeutic. So anyways, I play handball. But I guess if you want to like make a relate that to how I invest in handball, it's a very defensive game. So like unlike racquetball, which is an offensive game where you can shoot and kill that ball anywhere in the court with a racket because the racket's this big and you can reach, you know, the whole court with this long racket. With handball, you're trying to hit it right here on your hand.

And so you have and you can only reach so far. So it's actually, it's very challenging to make accurate shots. So 80% of that court from the front to the nearly the back of it, it's defense, right? And the only time you actually shoot and try to kill the ball for an offensive shot is when you're perfectly set up. And so it's defense, defense, defense. And then your opponent makes a mistake and sets you up and you go for the kill shot. So I guess that's pretty similar to investing where I guess like how we manage the portfolio. And in this kind of very concentrated manner owning eight companies, mostly concentrated in five,

six names. It's that we're actually very risk intolerant. We don't like risk averse is a better word for it. We're very risk averse, very hesitant. And in everything, 99% of, I mean, we look at hundreds of ideas. In fact, we go through the thousands of listed companies quarterly to look at different ideas and then what we say no to everything because we don't understand them. We can't get conviction on them.

But when we do get an insight where we go for it, right? Because it's like when, from my experience, since I've started investing, like, the best ideas are like, they just like pop out and they hit you on the side of the head and you're like, oh my God, like this is something very special. And those typically have been very good investments. It happened to me with the trade desk. I happened to with Carvana. It happened like you're looking at these metrics and you're understanding the story. You understand like the vision of the management team. They lay it out there.

And like, you're like, there's something special. I remember the day we were looking at the trade desk for the first time. I was listening to the investor presentation from Jeff Green, the CEO. And I remember I turned to Mike and I was like, this is our Geico. I literally said this is the company that will compound. It is a look from our initial look. It looks like something very special. And then we spend months analyzing the ecosystem because it was fairly complex on the surface.

But when you break it down, it's just a few key important variables that have to go right to make it work as an investment. same thing with Carvana, same thing with Troupanion, same thing with these companies. And so we're very defensive, at least that's how I approach investing, very risk-averse. And then when we get an insight that is differentiated from the market that is unique, we just jump at it. And we'll buy into it a certain position as we gain that conviction level. So that's kind of similar to Handball, I guess. If you approach portfolio management in the same way, so. But if you have this end of fiend cake and this, this, this, this, this, this, this is the great

idea, it's, it's sometimes hard to judge it as a rational investment because, like, if you're falling in love a bit with an idea and the inside you have, you have to also control it, make sure that this company is a company can have like, own it in 10 years and it's getting stronger and bigger and gives a great return. So how do you, what is the process to make sure that you're not falling in love with the wrong one yeah that's a very common bias right like the new shiny syndrome like the new thing that's really you know it just attracts your attention you think it's the best idea because it's new and so and that we're all you know we all have to deal with these biases and and try to protect yourselves from from them in a certain believing you're

less biased than others is a bias right i guess it's like these heuristics and um One thing that I kind of have incorporated in my, I guess, portfolio management, like when we come across a new idea, and I think it's an amazing idea, I usually like to sit on it for a couple quarters, right? Because I want, like, the, the shinies to go away. What is the probability that this new idea is better than the trade desk or Carvana or these other companies that we own are good or X? And it's probably not very high, but sometimes you do come across these ideas.

And so I try to be slow into making sure I understand the situation. But you're right, like for me to get comfortable with a company, it has to. I need fundamental proof of concept, at least initial. And I wrote about this in the last investor letter where companies, like everything that's alive, companies are living organisms too. They are made up of people working together and interacting. And they follow a similar growth pattern as organisms, the S curve. and a lot of times they'll hit that inflection point and it'll hit reach scaling when they

reached product market fit they'll scale and then once they've saturated their end markets they'll hit a stall point and then become more mature and so what I've spoken about before is like these companies are able to scale for sometimes decades have often been undervalued by the market because the market usually doesn't want to weigh the probability of it being able to scale for a long period of time so it potentially is undervalued but I need to see the unit economics, right? I need to see proof of concept. So, like, for example, you know, a company, True Panyan does a great job of really explaining how they invest and how they get return on those investments.

They really break down the unit costs and the lifetime value of each pet that they acquire, or at least each cohort of pets. And so when we invested in True Pannon, that's been three some years ago, they showed a track record of being able to continue to scale and they broke it down so we could see, oh, people do value being able to buy pet insurance, right? The concept seems a little funny to some people that you would actually buy health insurance, essentially for a pet that lives for 10 years on average. but like people do value that and you can see that proof of concept and their ability to invest and they were scaling similarly for like carvana like when we're looking at it when we invest in it and they're still barely break even i don't think they are still like they reached i think third quarter of 2020 for the first time at least ebid up break even but we could see this track record they were scaling their fixed costs there was a strong demand for this product and the

question was how they were able to scale and build their infrastructure which is expensive to do. It's a very tangible, heavy infrastructure to build the IRCs and the transportation network. Anyways, but we could see, like, extrapolate those trends that have happened since they were founded in 2013 to potentially in the future where not only they would be able to be break-even,

but then reach a tipping point scale and become cash flow generative once they reach a certain point. So we need some proof of concept. And where we have made mistakes is where we didn't have as much proof. um we weren't able to really get conviction in those fundamentals but the thing is that they're still very early in their life cycle right so like we're just trying to extrapolate these trends into the future um but i can't so we own facebook as another because let's talk about i guess small

we have a relatively small position in facebook we have a proof of concept i think it's pretty well accepted that they have won the social media game at least for um user profiles and even businesses and And, like, you look at Facebook, and, like, there are a lot of haters on Facebook and, and for many different reasons. But this company, if you actually look at when it was founded and how big it is today, it's actually one of our younger companies that we own. And we invest in companies relatively younger than, let's say, S&P 500 companies are like 10, 12, 13 years old and average. And Facebook was founded not too long ago, and it's going to have $100 billion in gross profit. it. So like the fundamental speak for themselves, I think. But the question is now we're trying to extrapolate that and see where the prices relative to the cash flows that potentially

will be returned to owners. But now there's all this obviously had my news of the Metaverse and changing their name to Meta. I wouldn't invest in Facebook. Yeah. I wouldn't invest in Facebook because of the Metaverse. I like the idea. I trust Mark Zuckerberg to allocate capital, I think, more because he has a track record of being very successful at doing it. He's much smarter than I am. And so I trust his ability to allocate capital, but I wouldn't invest on this optionality. I'm investing in their advertising model, which is very cash generative. And I think shares are selling below the core business.

But I love the idea that this owner-operator, founder-led company, crazy that he's 37, managing this one of the largest businesses in the world, is thinking, or 15 years out. He's thinking through this and investing some of his profits of the core business into this new potential paradigm. And I've tried to read a lot about the Metaverse just to understand how it can impact all of our different investments. Like if there's a Metaverse, how does that impact car ownership? How does that impact TV watching? How does that impact anything? Software companies? It gets really sci-fi. It gets really into like this crazy potential. You can go down a crazy rabbit hole. But anyways, to

answer the question, it's like, I wouldn't invest because of that optionality. Like, similarly, like, I would think that Carvana has so much optionality. So does Japan and so does trade. They have this optionality based into the business model. It's a very entrepreneurial culture, but that's upside, I think. And so, like, with Carvana, like, what if they

are the transportation network direct the consumer for even new OEM cars? Like, what Ford and GM potentially use Carvana because it's more efficient than doing it in-house or using third-party haulers that don't have the infrastructure. That's optionality. I don't think that's faked into just exchanging used cars. And there's a lot of things that business models can evolve. And that's part of like, what are they trying to do? And that's trying to lower the frictional costs of transacting cars, trade dust. What are they trying to do? They're trying to lower the frictional cost to allocate

advertising dollars. And that is their mission. And how they go about that may evolve over time. But so anyways, that's just how we think about optionality and the different variables that we look for, like the KPI's. And I think, I guess, specifically addressing like certain indicators that we look for is in these marketplaces that we are invested in. Market share is a really important indicator to see, to get conviction, a lot of times it's this winner-take-most dynamic. And so you can see quarter after quarter for years, whether a company is taking market share and however you want to evaluate what the market is, so like Roku, you can say the market share is TV operating systems owned, or it's the connected TV ad dollars that go over and get allocated

where Roku has dominant market share in the United States, at least, in both of those categories. And you can see how that trends. And then you try to extrapolate that. And for these marketplaces, that's very durable. establish yourself as the winner. So I need to see, like, a lot of times before a space becomes more mature, there's tons of companies. And then usually one, at least a marketplace, will emerge as the winner. And we can get conviction in that winner. So for Good RX, they're a cash card company that helps, they're lowering the price of drugs by aggregating pharmacy

benefit managers, but I guess my point is 10, 12 years ago, there are a lot of these cash card companies, and it was hard to determine who is going to emerge the winner. It's obvious that it's Good R-R-X now. They have 70% market share based on however you want to weigh it for this specific thing that they're doing, which is helping consumers find cheaper drugs. The next largest company is probably a quarter of their size, and Kitter-X is accelerating. You can see that they're getting stronger, the bigger they'd get. And so that gives us conviction in the long term once they establish themselves as the winner. I wouldn't have invested in Roku or Gooderax or Trade Desk, unless I could establish that.

I thought they were the winners. Like Trade Dusk in 2017, there were a lot of other demand side platforms. You can go from Datazoo, Media Math, or whatnot. But we saw Trade Desk was taking market share. They had a differentiated model that put them a more advantageous position than competitors, and it was a consolidating industry. So we had some fundamental proof that this was happening, and we extrapolated that. And that is what has happened where other independent demand-side platforms have been either acquired,

largely by content owners like Google or AT&T and Verizon, or they've gone out of business because they can't compete with TradeDus. the cost to do what trade dust, the operating leverage of trade dust, like smaller companies can't compete. There are these barriers to entry and they're growing barriers to entry. And you can go down the list of our companies and see how others can't compete with what they're doing. It's too late, right? And so that gives us conviction and like these fundamentals that we try to extrapolate into the long term. What concepts generally help you to identify winners and to make sure that you are invested in winners? Hey, Tillman here. I'm sure you're curious about the answer to this question, but this answer is exclusive to the members of my community Good Investing Plus.

Good Investing Plus is a place where we help each other to get better as investor day by day. If you are an ambitious, long-term-oriented investor that likes to share, please apply for Good Investing Plus. Just go to Good minusinvesting.net slash plus. You can also find this link into show notes. I'm waiting for your application. And without further ado, let's go back to the conversation. Maybe let's move to talk a bit to the topic of portfolio and portfolio construction. how does this idea of thinking 10 years out reflect with your portfolio construction or do you size

companies that you have more certainty and conviction where they be in 10 years higher how does reflect on the way you construct your portfolio yeah the way i think about it it's similar to i guess you've heard of like kelly criterion or the kelly formula and and and that mental model or that thought process is similar to how we think about it. So what that Kelly criterion says is you're trying to assess the excess returns in a certain opportunity, a certain investment, anything, and then your conviction surrounding it. And then you kind of allocate the portfolio based on all of your different opportunity sets. And that's how we do think of it. And so we do have a general idea of our expectations

of what the future expected IRR is for each of our holdings. The thing is we never went to, I have seen so many poor investing decisions based on this kind of cash flows and assumptions that are made on those. So a lot of times you might have the best opportunity available. And like because of one assumption, like the terminal growth rate or the discount rate or whatever, you find it overvalued or undervalued or whatever it may be, I find like we're looking more at the qualitative inputs to investment to assess what our desired quantitative outputs will be. The quantitative output is an attractive return, which is the cash generated and return to shareholders over time.

But it takes all the qualitative input. So we have a range of ideas or a range of expectations for each of our holdings in the conviction. And then we try to assess our conviction surrounding those and then allocate the portfolio accordingly. and I think a helpful exercise in assessing like those expected returns and not putting too much weight into like saying something's going to have a 15% IRA or 20% IRA or 25% IRA is like go back and try to forecast Google's revenues and operating fundamentals when they went public or Facebooks or any of like the really big winners obviously helps having hindsight 2020 to look at the ones that have won but Google IPOed I think at maybe it was $4 or $5 billion in sales. And that was in 2014 or 15. I may get those years a little bit off. You know what their revenues are going to be in 2021?

About $250 billion. Right. And so for most of Google's existence as a public company, it was considered overvalued. It was very contrarian for value investors, the traditional value investors to invest in Google in 2010 or 2011. 11. Same thing with Amazon. It's only really been more recent, I would say, even in the last two or three years, that these fang stocks, or maybe they'll have called manning stocks, I don't

know, whatever that new acronym will be with the meadow. But it's only been fairly recently that it's been more of a consensus. It's better. So it's easy. It's a feta. It's only been more recently that these have been consensus buys. Like these have been the best companies. Only the last two or three years. And so things change. And you find these, these, but trying to like extrapolate or forecast these, these fundamentals is because of these different qualitative characteristics that these companies have. And so if you can find them, these same characteristics in different companies, and it's very hard to find.

You have to be very, you know, we look at thousands of opportunities, but you find a few that we get this conviction. Then who knew what expected return of Carbana was going to be when we bought them, you know, two plus three years ago or two panion or trade dust? They've had amazing returns. but are they exactly what we expected? What we did know is that they had qualitative characteristics that made them have an attractive value proposition

and the alternatives were not nearly as attractive. So the business model was durable. And so that's all we're trying to do when we're trying to wait the portfolio and assess where is the company selling today and kind of our range of expectations over the next five, 10, 15 years. And managing the portfolio,

I'm more cautious about trading activity, I find often I try to leave it alone and kind of let it do its thing unless there's something materially happens. Like, let's say a company's price goes up 10x, then we really do need to re-evaluate what expected returns are, or if something becomes way disproportionately large in the portfolio, which is bound to happen in these big winners, and like to reassess. But that's infrequent. Like, we actually really don't trade.

It could be months. We don't trade. And we really might only find one idea. We've only had one new idea this year and maybe one or two in the last year. So it's just, I try to have a hands-off approach and only make decisions or material decisions when I have a material insight. You have this range of holding five to ten companies in your portfolio. On which side of the range do you feel more comfortable on the five or on the ten? So to answer that question, I think what's interesting,

is managing, comparing managing money privately for yourself and then when managing money for others. And it's different, right? Because you don't have to be so public and it's it's about what your holdings are. And if we have 100 plus investors, they can all see their portfolio every single day. So you know like there's other eyes potentially watching the portfolio. What I've found like my best ideas have generally almost in almost all cases have done much better. my top five ideas in our last five ideas are the top 10 versus the last 10 because you have conviction. And so it actually hurts results by obviously diversifying if you're right in your top five. And that's been the case for me, at least specifically, or specifically. But I do consider

the idea that I'm trying to manage this portfolio as low as my own money, because it is my own money, but also doing it for others. But when we launched, we had more diversification because we didn't have the best ideas at that time or as good about ideas as concentrated more and more over time. And our investors understand how we manage the portfolio. So they get more comfortable with our decision making and our investments. But yes, I have more and more significant conviction in the top five ideas than the next five ideas. And so it's hard for me to add to something that I have less conviction.

And so like that just found to happen over time. Um, yeah, that's just kind of how I've managed a portfolio. With five or 10 stocks, you must often say, no, no, and no, uh, you have to do this a lot. Um, and you're not really like a rude person or, uh, uh, you're a nice person. Thank you. But you control yourself, uh, to have the ability to say no, a lot, even staying a nice person. Well, thank you. I appreciate that.

You're a very nice person, too, Tillman. Thank you. We have a nice audience as well. Hello, audience. I've actually, you know, through your interviews, I've watched, I think, most of them. And you do such a good, you know, you interview, so it's such impressive. At least one guy. And I've had the privilege of being able to speak with a few of them.

You know, like I think we were introduced not through you, specific, well, one of them we have through you. But just because, you know, we've someone. one either reached out or I reached out to them. And it's so great to engage with the people that you've interviewed. And I think having this network of investors, I do think there's a common strategy either. I try to hope that we're not in this echo chamber because a lot of these people that you've interviewed

have had these 30 or 40% compounded annual rates of return over the last five or 10 years and super impressive returns. There is some portfolio overlap. So it's just interesting that we have very similar ways that we manage a portfolio, so you don't want to get into this echo chamber. But I think, like, when you want to actively manage a portfolio, this is the way, and at least my opinion, and this is what we live, is like, this is the way to do it. Because, like, if you go to the mutual fund type of strategy of managing money and having

100 or 200 different stocks and not really having much aligned incentives, that's unlikely to do very well, especially when you have a free option of just investing in a Vanguard ETF fund. So anyways, I do think, like, having this very, like, targeted strategy where you find things that are mispriced, these anomalies, and focusing on them, like, I don't get great investment ideas often. It's very hard. And we look every single day. I spend 99% of my time looking, researching, thinking. And I have found through personal experience and also just analyzing the history of investments in stocks and companies, it is hard to find a good idea. I have owned things that I thought were undervalued and they were not.

And it's very humbling. And so the more you do this, the more you realize you don't know as much and the future is very scary. And so it's having this appreciation for how the market's generally pretty, generally efficient. And I always want to approach every idea as like the market knows more than I do until I have some different insight. Something is it makes this specific. And I'm looking for these companies that have so much, that are so undervalued that if they doubled in price the next day, I would still find them attractive, right? The question I asked myself before every investment is, how would I feel about the stock if it doubled tomorrow, same expectations? If I don't find it attractive, and my holding card is hopefully 10 plus years, a double in 10 years isn't very attractive IRR.

Now, if it goes up five times, I would find it very attractive, but twice, that means it's probably not like I don't think it's like it. undervalued. If it halves, let's say the next day it halves and my stomach drops and I'm like, oh my gosh, like I think I made a mistake or what's, you have to make a decision. Like is the intrinsic value still the same and it's now more attractive or has the intrinsic value? Was it really lower than we expected? And this market's now actually realizing that and pricing it more efficiently at a lower price and then you've lost your capital, right? The actual intrinsic value is not going to go back to where you thought if the intrinsic value is actually that low. So having this appreciation and realizing that it's very hard to, like, have these insights,

I think it's important. And that leaves you to obviously only focusing when you do have a few other insights. And on average, if you are very targeted and find these really good investments, your portfolio should do really well. You won't be right all the time because even if you do weigh the probabilities of the future correctly, let's say there's 80% chances is one of the best investments and it doesn't work. out may not have necessarily been wrong. It's just that the 20% outlook of being a poor investment actually is what the future unfolds. Like the future has many things, but the present only can be one of those things. So anyways, that's how I think about it, of going about not having to be

active, realizing when I'm looking for investments, I will be happy. I hope when I buy a stock it's still in my portfolio in 2030, if it all works out right. The only reason why it wouldn't be in my portfolio, hopefully, it's because I found better ideas. You find better opportunities. And over time, it's harder and harder find best ideas. And so I'm okay not finding new stocks or new companies, as long as the ones in my portfolio are still attractive.

I'm always just weighing the opportunity costs of the portfolio. You're also one of the investors who tries to focus on high quality companies. What is your definition of high quality companies? Yeah. To break that question down, the question is why it's not a secret that high quality companies do really well. So the question is, what makes a high quality company? And I think even like, why do high quality companies provide excess returns from an investment perspective? And I think from a purely quantitative viewpoint, it's a company that just a company that just is a cash cow, right?

The return uninvested capital is really high. And that's the definition that people use for a high quality company. It just spews cash. It can grow and also provides a lot of cash for owners. And so the question is why that is the case and why that's a good investment. And a lot of times it's a good investment is because the market is typically trying to discount those cash flows, right? It's motivated by smart people trying to assess the future cash flow. So in theory, it should value the price of the stock to that company to be fairly efficient to provide the 9% annualized return that the market will typically provide.

But it doesn't do as good of a job of that because these quality companies typically have a longer, I think Michael Mobison's word for is a capital advantage period where the market might revert to a mean quicker. than what the company actually does. So it has a more durable competitive advantage where it can provide these excess cash flows for longer periods of time. But from a more of a qualitative viewpoint, we view quality on a spectrum where there are companies that are commodities

and then there's companies that are monopolies. And a commodity is undifferentiated. Customers don't care between widget A or B. And a monopoly is there's nowhere else to get this product or service. This is the only company provides it. And so it gets to the questions of what is the problem that a company is trying to solve and why can't other companies solve that problem today and far into the future. And if

we can answer those questions, then there might be something interesting. I think Warren Buffett even writes about a franchise. And the question is that he asks, because a franchise is a company that provides a product or service that is highly desired or needed. There's no close alternatives. and they are not regulated so that way they can have pricing power and price accordingly based on the demand. And so those creates a franchise, something that's highly desired.

There's no cost alternative. And so those qualitative analysis of understanding why is Amazon a quality company versus, let's say, Walmart or Target and why one company can do something more, do something better than another company. And so that is what we look for in quality, right? And that's why we find companies that are essentially, we're looking for natural monopolies.

There aren't close alternatives. Customers love the product and highly desire the product. And that's how we go about trying to analyze quality. But the thing is, what's hard is that quantitative definition of high return on invested capital. It has been debated in value investing in circles is like these companies. It's like this Carvana, high quality company. because if you actually use their return on invested capital, it obviously doesn't have a return right now

because it's absorbing so much cash. But in the analysis of what we do is there's a huge difference between maintenance expenditures and growth expenditures. And so you want to bifurcate the difference by actually trying to analyze the company that is investing their cash flows or growth because it's an attractive investment for the company and seeing what is the company

from just a maintenance perspective and then you can kind of understand the unit economics of the business. And so the question is, can the company reinvest those cash flows and scale and grow? And eventually, if your analysis is correct and they are allocating capital well,

then the company will grow fundamentally and eventually it will reach maturation where then most of those operating expenditures will be maintenance. And then it should reflect an attractive return on invest in capital, if it's a high-quality company. And so, I mean, that's how we go about and thinking through it. And it gets into the conversation is like, how long do you have to wait for an investment

to pay off? It's the same thing for when someone looks at a portfolio manager investing in stocks. And like, how long do you give before you have to provide this outsized returns? That's the goal of business and investments. And you don't want to think short-term quarterly annually, obviously, because it's largely random, in our opinion, but eventually you need to show the results. So like if we're investing in Trupanion and they're claiming to continually be reinvesting in pet acquisition, but their sales or gross profits are stagnant and you're not seeing any cash flow, then they're not allocating

it appropriately over the long enough time period. You have to give them, you know, some slack and being able to like invest. But if they're investing all this cash and you're not seeing it as owners, you better hope that their earning power is also growing. And if it's not, then they're not investing appropriately. And the actual owner earnings are like business are probably much lower than what you think. Similarly with the Carvana, they're investing so much today. If they weren't growing, then where is the cash flow going to? It's not to the owners. It's not to the shareholders. And so similarly for a portfolio manager, like we're thinking five, 10, 15 years out. We're continually, and that will always be the case. But in 10 years from now,

the thoughts that we had in 2020, hopefully are paying off by the time it's 2030. And if you're not outperforming the market within a certain time frame, then what are you doing? What's the value you're adding? And then what would it take? And it's possible that the market is crazy in 2030

and you aren't outperforming. Maybe we're in like a dot-com crash or bubble. So like the market's really crazy. And that's the argument a lot of people that underperform for 10 years make is that we're at this point where we're in this crazy bubble, which we aren't, in my opinion, but, you know, valuations may be high, but, like, they think that it's going crash,

and then they'll have the value investor excess returns from, like, 2001, 2004 that will have, like, the traditional value investors did well during that period after the dot-com crash, which was late 90s was a crazy time frame. And so, like, my point being is eventually you have to show results, though. Like, you have to, like, look at the track record. And so there was a quote, I think it was in Twitter recently, where Buffett and his 92 Berkshire letter said that,

Alice from Alice in Wonderland was listening to the Queen discuss about jam tomorrow. And then Alice eventually said, eventually it has to be jammed today. If you're constantly thinking about the future and you don't have, you have to eventually show the results. And so, yeah, that's just I would think about thinking long term and then investing in quality and reinvestments and growth. And eventually you have to see the fundamental results of both business and portfolio management. So to put us in a question with the 10 years framework, thinking about a high quality company, it's more about qualitative factor in culture than just fundamentals and maybe also at understanding unit economics as a key ingredient.

Exactly. I think about it from like a sports team, a basketball team, football team, and your desired output, the quantitative output are wins. You want to win the championship. But how do you get there? It's through the culture of the team, a winning culture, working together. And so when you're looking at any match or game, you're looking at the field and you want to see how they are able to function. And the best team in the world may lose sometimes, right?

They may get sick or something happens. It's bound to happen. But you're still hoping that they win the championship. And maybe they may not win one year, but they'll win next year. And so, like, we need the quantitative results. But it is, I think, what's more knowable are the qualitative factors that potentially are the inputs to the company that we can kind of assess that give us the quantitative outputs. So it's like a passionate manager who's aligned with shareholders, that's entrepreneurial. It's this culture of being winning and changing and providing this value.

it's it's it's all these different qualitative factors that potentially provide the quantitative outlook that we're looking for i have asked many of my questions and for the end of our interview i want to give you the chance to add something we haven't discussed or say any aspect that's important to you the floor is yours well thank you yeah this has been a lot of fun and i think we spoke a lot about how I think about managing a portfolio and how I go about my investing process and what I've found and I think what is important to think about is that you have to do what makes sense for you, right? Like one approach doesn't necessarily make sense for everyone and you have to understand your specific suitability or how you want to go. So basically what I'm

saying is like my approach doesn't necessarily work for everybody. It works for me. And those to understand what I'm doing and want to invest in saga partners that works for them and making sure they understand how a portfolio is managed. So there's a lot of ways to go about investing. You don't have to just invest in high quality companies that have high growth outlooks. You can invest in low quality companies that are turnarounds or that you try to improve the quality or that are selling below their net asset value or things like that. That's not my game. But there are many different ways to go about investing and allocating capital. And so I just have to do what makes the most sense for you and try to understand

how the world works and have your viewpoint and get to the right answers because everyone has their own perspectives and their own opinions, their own background, their own way their brain is wired. And all that really matters is the real answer of how the world actually works. And there's a, I like to use the saying like snakes, what they see in heat. maps, bats, see in sonar, dogs, see in black and white, we see in color. All of those are different perspectives, and they're all right. You know, no one's wrong. They just all have different interpretations of what the world looks like. And so what's important is just trying to get as accurate of a picture as possible by getting opinions and getting the information

and the data interpreting it and trying to get to the right answer. And so, like, you do that in however you want to go about investing or managing capital, or just thinking about how life works through mental models. And thank you very much for your insights and our great conversation. I hope you survived my bad jokes. Thanks, someone. This is fun. Yeah.

And thank you very much for the audience to listen to this podcast till now. And to all of you, a good week. And bye, bye, bye, bye. Thank you. As in every video, also here is the disclaimer. You can find a link to the disclaimer below in the show notes. The disclaimer says, always do your own work. What we're doing here is no recommendation and no advice.

So please always do your own work. Thank you very much.