Motley Fool Hidden Gems Investing - Fool School: Finding Value Drivers

Episode Date: November 4, 2023

Trends come, trends go. So, how can investors spot the difference between another passing fad and something with real, sustainable value?  Patrick Badolato is an Associate Professor of Instruction at the University of Texas at Austin McCombs School of Business. Ricky Mulvey caught up with Badolato for an “investing classroom” session. They discuss: Different drivers of business value What growth rates ignore And the thing that Sweetgreen misses about automation Tickers discussed: PTON, TGT, DXCM, HSY, NVDA, CHGG, COST, SG, RENT Link to Fool Message Boards + Classroom Podcast Discussions Host: Ricky Mulvey Guest: Patrick Badolato Producer: Mary Long Engineers: Dan Boyd, Annie Pope Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. the higher that kegger it just might be you know that in that short period of time or that unique setting uh the growth rate was amazing but our question with valuation is not what did they do obviously have to do something first and foremost so i'm not discrediting it completely but look at it take it in but don't just assume that because there was this high growth rate which again could have been driven by a low base or a low starting point it must continue I'm Mary Long, and that's Patrick Badalato, an associate professor of instruction at the University of Texas at Austin McCombs School of Business and returning guest to Motley Fool Money.

Ricky Mulvey caught up with Badalato to talk about how investors can better understand drivers of value. They discuss how to weigh intangibles, spotting trends versus forever changes, and what's missing from commonly used financial metrics. The focus of today is how investors can understand drivers of value for a business. So we're going to explore some ways for folks to think about them. But you're an accounting professor and many put valuation firmly in the silo of finance. What is the role of accounting in this discussion on company's value? Great, Rick. I'd love to answer that question. When we talk about valuation, we're pretty much inclined to talk about things

like DCFs, discounted cash flow evaluation models, talking about cash flows and all that absolutely fits. But I would argue there's still a layer where accounting is really essential, which is, okay, what drove that value? And that's going to be a conversation around a company's ability to generate revenue, grow that revenue, and then create and maintain operating profitability, which is really a conversation where a knowledge of accounting and a knowledge of those pieces is absolutely essential in sort of making sure that we understand, okay, how does that happen? what enables those cash flows to be created? Are you a business that can generate revenue and have your expenses less than that revenue over time?

And when you look at these, some of the way that we can think about this with valuation, there's a lot of ways to think about it. One is looking at the free cash flow, which is just the cash coming out of the business at the end of absolutely everything. You could look at earnings before interest and taxes. You could look at net income. I guess, what should be the focal point for investors looking at this to start the conversation? Good. In some ways, I almost want to push back a little bit and say, it's less about how we end that, how we count it, what's our ultimate way of doing the scorekeeping, but more about the process of getting there. I'm going to throw in a quote from Kobe Bryant, which is, don't copy what I did,

but copy how I did it. And I think that it's the how that you determine those free cash flows or EBIT or whatever it ends up really being net income. It still gets down to how you do it. So to elaborate on my earlier comment was that if you look at revenue, what is revenue? It's your ability as a company to create value for customers, you know, value that they see that they're going to pay you for. And then what is the idea of achieving or maintaining operating profitability? Well, can you do can you create that revenue in a cost efficient manner? And if you can do that period after period after period, that's your core business. So that's more about the how you do that than what does it end up in. But to use another quote, I guess this one would

be from Bill Walsh. It's like the score takes care of itself. If you're doing that, if you're consistently generating revenue and controlling your cost and generating operating profitability, that's going to translate to profits. And most importantly, that's going to directly translate to your free cash flows. And so it's not a conversation of I'm only looking at income or I'm only looking at cash flows, but really how the business is run in a sense that enables you to have revenue, achieve operating profitability, and then ultimately translate those business activities to cash flows.

If you do that over time, I don't think there really are shortcuts there, but if you're able to do that over time, that's your ability to drive value, create value as a company. And so, you know, a discounted cash flow evaluation model, intrinsic model, when we talk about evaluation, that's a dense subject. The approaches to that, as we see in the classroom and we can see really everywhere, can get pretty complex. You've got a bunch of adjustments, complex treatments. It's not easy. And I try to remind my students really at all levels because I think the background knowledge coming in definitely has an opportunity to emphasize it. Like, let's focus on how the business is run.

But before we get into those adjustments, before we kind of get bogged down with some of the complexities of valuation models, it just makes sure, like, can we create value for our customers and can we do so in a cost-efficient way? And those core ideas of revenues and expenses are still what's going to translate to our cash flows, the creation of value over time. We were trading emails before this, and part of it was about the Oswalt Demodaran's latest video about his valuation of Birkenstock. and you know there's an early part of it where he takes some shots at accountants like you i shouldn't say accountants like you i should say all accountants he's taking shots at the accounting profession but then he sort of goes back and there's there's a little bit of love for the accountants especially when he's talking about those intangibles um something like brand

recognition moats and the point is is that those should all show up in terms of revenue and margin so let's say you have a brand for a shoe if you have a brand then you should have a higher operating margin than your competitors. Yeah, Ricky, I agree. I mean, and we discussed that and I was able to work through it. And some of the beginning part was a little harder to work through. But I actually love the part that he got into right around 18 minutes, 49 seconds, which is just this, you know, coming out directly and stating that, hey, it's the company value is about are you able to drive your revenue and are you able to, you know, improve margins or charge more? And I think Birkenstocks is a great example to kind of talk about that. It's, you know,

what's their potential in terms of being able to charge more, get greater visibility. I think the motor did a great job of kind of fleshing out all those things, which is it's a conversation evaluation, which is, Hey, what about revenue and operating expenses? And if you can do those things and do those things well, you know, if you have that brand that resonates, if you have the ability to, you know, use different individuals to promote your sales, to charge more, even in the face of direct competition, you know, that itself is the business creating value. So, yeah, I appreciated that as he kind of got into the the application evaluation of Birkenstock.

It was a good reminder that, you know, in actions, the approach he's taking evaluation is very much. Yeah, that, you know, accounting information as expressed through revenues, I guess, more importantly, the drivers of revenue and then operating profitability or more specifically, the how of operating profitability, what specifically enables Birkenstock to have higher margins. You know, that is a wonderful intersection of, you know, how accounting and finance and valuation and all these other subject matters ultimately come together. You know, stepping outside of our silos that we can sometimes get caught up in academia, but realizing it's a comprehensive assessment of the business. And so I thought that the application of Birkenstock was awesome. So one way that we like that some investors, and I'm guilty of this myself, we like to

look for a sustainable long-term revenue driver or like a long-term competitive advantage is by really focusing on the compound annual growth rate of revenue. Simply, how quickly is this business growing revenue year by year? How should investors take this information and use that to make that decision? Another great question. One, as my students would know, I love to talk about in class. I'm going to maybe take a stance that most don't take, but I really try to de-emphasize and push back on a compound annual growth rate, or as many of us call it, a kegger, because it definitely shows us the what. How did we grow from a small amount to a big amount? But I push back on it a little bit because, one, it's greatly

affected by your starting point, your end point. So you start small, like virtually every startup. Almost every startup, just mathematically, is going to have a high kegger. So my pushback on a kegger is that just tells us the what. Back to that Kobe Bryant quote, which I absolutely love. That's just telling us the what, and it's not really telling us the how. And in many ways, the higher that kegger, it just might be that in that short period of time or that unique setting, the growth rate was amazing. But our question with valuation is not what did they do? Obviously, they have to do something first and foremost. So I'm not discrediting it completely, but look at it, take it in. But don't just assume that because there was this high growth rate, which again could

have been driven by a low base or a low starting point, it must continue. If I can kind of jump in with an example here, and talking about this the last couple of years in the classroom, but with covid we had we had a you know negative economic shock that made it even more interesting to look at so many different companies and one of the things we saw with companies was like the pull forward of demand and so that that you know covid was peloton such a great classic case like they did phenomenally well during during covid because competition was crushed you know we're spending more time at home disposable income was shifted towards home related purchases we still wanted community and fitness and stuff like that but you know their their connected fitness hardware just

absolutely skyrocketed the kegger on that is i don't know off the top of my head but amazing but the challenge is like the bigger that was it was almost like the harder it was going to fall and so we can't value that continued performance we have to think about well if that marginal person you know bought the bike or the treadmill whatever else like that they would have probably bought it without covet in six months or two months or something later but like we pulled forward that demand. So they're just a really great lesson I think we can all kind of learn from of why just the what of the revenue performance isn't good enough to figure out, to determine exactly what comes next. And to a simpler example of that, I think, you know, Target really struggled

to a certain extent, especially in the summer-ish of 2022 with its home goods, where, you know, the same thing, like we bought more patio furniture and, you know, stuff like that. And it's just harder for them to keep that up. Now, for them, it's just a segment of their business, but a meaningful one. It's like, we have to think about, hey, what drove the growth? That's so much more important. What drove it will continue than just whether or not mathematically it was a high rate of growth over a certain period. Yeah. And I think there's also an important narrative component to especially the Peloton example, where at the same time, all of these gym stocks were getting essentially crushed,

like no one would ever go back to the gym. So, you had essentially a story that the market was telling, which is, everyone will be working out at their home forever, and things have completely changed. For me, as I've been now a stock investor for a few years now, that's something that I'm trying to be more keenly aware of. When is the market saying that something has changed forever? That's an awesome question. It's just never going to be easy to answer. I had a student who actually said this, I want to share this. I was finishing a conversation around Peloton, and someone said along the lines of like so is this just the next shake weight uh and some of our listeners might know

what that is or not but everybody can look it up it just was crazy in that it's like yeah but the the fitness industry itself broadly defined seems like looking back at least with hindsight bias like one that's constantly shaped by fads and so i think that's what we're all after like is this going to keep going is this you know a phenomenal stick at stick around or is it just kind of a unique circumstances for the times and i think a challenge with with peloton and more broadly the fitness industry is that we're humans. We're pretty fickle with that stuff. So it might be one where that sustainable competitive advantage might just be a challenge to pull off. Um, although to their credit, I think the community and the classes and that kind of stuff is, uh, you know,

that may be, that may give them the staying power, not necessarily the hardware component of it, but the, uh, but the subscription component of what they added, uh, and the convenience that offers for somebody. I mean, I think less so the COVID aspect, but like, isn't it more convenient to do some of that stuff at home than going to a gym or whatever else. Yeah. And I'd say there's two things that are going to change forever because of these developments for some businesses. One would probably be the weight loss drugs. And you're seeing that with a lot of consumer package goods stocks like Hershey's been hit, even companies, the medical device company Dexcom, as people are able to lower their blood sugar from these drugs. Maybe they won't need devices so much.

And then the second story is artificial intelligence. And there's been the positive side of it with a company like NVIDIA, which is the leader in the chips for this. But then there are some losers. And one of them might be a company called Chegg, which Patrick, to put kindly, offers homework help for students. And the big question for them is, is this service needed when maybe a student can just ask, you know, let's say I'm in your class. Hey, what are the adjustments that I need to look for in Walmart's revenue in order to pass this homework assignment that he's given me. And maybe I don't need to ask that to a separate human on a website. Yeah, great application of this. Not the expert in AI, but I think it's a good one. I was just

having this conversation with my students about Chegg. And interestingly, they were all telling me about their friends and roommates who had used Chegg, but no one had themselves used it, in just a joking manner. Some of them did admit it. But it was just interesting that it's convenient. it offers a shortcut for those looking for shortcuts. And I agree with the sentiments you express, which is, you know, that's our big challenge. You know, is it sustainable in that couldn't there always be the next disruption? And AI certainly may present that. I think in the short term, and as my students, you know, anecdotally surveying them were kind of saying is that, yeah, but it's still kind of ready to go with their needs now. And so I think the AI

thing is a massive long run threat, but it may take a little bit of time for that to play out only because, you know, the, the, they really specific, my students specifically were stressing that, you know, for any of your kind of more common questions that are used in test banks, kind of across the nation, like Chegg is basically really good at answering it. Uh, the pushback too, though, is that like, Hey, but for, you know, MBA related things or any more of the involved applications, I think that we try to do in our class, you know, analysis and synthesis, not just answering questions. Um, it just doesn't have that repository. And what I'm curious is, you know, will AI be able to solve both obviously the simple ones, you know,

effectively come up with the big solution, the solutions for all the big textbooks, but also, you know, be more nimble in terms of answering like your more unique or uniquely curated questions. So, yeah, I think Cheggs, I mean, it took a hit, but I think the challenge we have there is this long run sustainability of its business model. It's a shortcut, you know, in academia, But is it too focused on just academia? And the big challenge it faces with AI is, in the long run, its competitors aren't going

to be, you know, Coursero and Quizlet and that kind of stuff, but the behemoths. And they may not be as specialized as Chegg, but they're still going to be there potentially creating, you know, dynamic AI applications that can, as I say, you know, do both the basic stuff and the more nimble or curated stuff. So let's move on to a product then that you love, which has been a sustainable long-term revenue driver for Costco. And it is a grocery store, a retailer that is unlike the others, primarily because it has a membership program. We talked about this a few weeks ago with Bill Mann about how that affects the company's valuation. But let's focus on the membership

program as a value driver for Costco. Yeah, great, Ricky. And full disclosure, as a shareholder of Costco and a longtime member, I'm biased here. This company, I could just gush about and I have in front of many audiences. So I'm sure the six listeners that I may have brought on to this are groaning right now, but I could keep going on. A lot of times people will talk about Costco, the membership program, and talk about the correlation of the membership program and the profitability. And that's there. But I want to add a little bit of a layer to it to kind of talk a little bit more about the how of what they offer. And I truly think that Costco is one of these incredible, sustainable, has created an incredible, sustainable competitive advantage.

And what's fascinating about what they've done is they've done it by focusing on driving revenue and simultaneously keeping their, you know, their bottom line profits at a very low margin, two to three percent. And actually those go hand in hand. So the membership is less, I want to argue, less about just the profitability that it brings, but more about how do you get that, I would argue, you know, relationship with the customer. And where does that relationship start? Well, it starts with the membership. But then as you have that membership and then some cost fallacy works to their advantage, I paid for the membership. I got to get my money's worth. You start showing up to Costco and you start enjoying the treasure hunt and stuff that you, Bill Mann, and you talked about, which was an awesome conversation a couple weeks ago. And you enjoy that. And they have some unique things that can market pretty well.

But I want to add another layer to it is you're getting something else that Costco offers that most places don't, which is that they have curated the product selection so that they're only offering one or two shopkeeping units or three or four or whatever else. But in many ways, we can kind of trust that they're likely the three or four best possible ones because the person whose job it is at Costco to find those, like they spent so much time and research. And more importantly, Costco's economically on the hook. If they were, you know, to stock two different items and one of them was terrible, like that's a huge loss to them, where if another company is stocking 45 different types of peanut butter or detergent or whatever else, you lose one, it doesn't have the same impact. So they're like all in on the product categories. In addition to that, though, that also means that they're almost surely going to be the

biggest buyer, like even bigger than a Walmart, not in terms of the total amount. And Walmart's another really well-run company that's not in any way a knock. But take a successful story like that, and even bigger than a Walmart in terms of that product category, because they're only buying one or two. And if Walmart's buying more, the relative pricing power that Costco is going to have over the supplier is going to be significantly greater. What does that translate to? The consumers walking in, getting a curated set of goods at arguably the best possible

price. And as you see that period after period or shopping trip after shopping trip, ultimately, what should that do? Well, that should translate to saying, like, I appreciate the value that Costco is bringing to me and I'm going to give back to a certain extent. I use the word relationship. I want to keep that going here. I'm going to give back by giving them more share of my wallet. So I might start at, you know, one hundred sixty four dollars each trip or whatever it is. But that's going to creep up and that's going to increase the ticket size or the frequency of the trips. On that, I would say what's really fascinating is they're able to generate value because they can do so at the store level. So you guys constantly, I love these conversations, talk about like good capital allocation, capital allocator, sorry, capital allocation, the same thing.

And I think Costco is phenomenal at that because what it's doing is it's realizing like once the store is in place, we can generate incremental revenue growth, not by adding new stores, which is a whole nother incremental unit of capital. But by getting the customers at that store to both stay, extremely high membership retention, but then share of wallets, spend more. So they have an awesome graphic. And I'm a big fan of footnotes that you and I have talked about before. But if you want to check out a footnote, it's pretty cool to see. I forget the page. I apologize for that. But in their 10K, they've got a graphic in the beginning somewhere.

But it just shows that like the millions of dollars of stores, of revenue per store. But they hold the store-based content. So they're not saying, here's our total sales, which could be juiced by adding more stores. They're getting into, look, if you just hold our one store constant, I'm going to use a representative store, and the number is actually 164. If you hold one store constant, in 2014, that store was generating $164 million. But let me say $164 for a Costco trip. Yeah, but then by 2023, that's $268.

That's a huge ability to generate more revenue with, and importantly, without adding any stores without you know adding any more capital to the equation so ultimately what does that do the amount of their ability to give a great value proposition to the customer translates to us buying more from them but us buying more from them means that on a per store basis they're generating more revenue keep those margins constant which is part of the equation like we know we're getting the lowest price there keep the margins constant what happens there then each store is actually generating more profitability and costco the corporate company is creating value for shareholders by focusing on its obsession with creating value for its

customers. You've looked into this a little more than me, but my understanding was that Costco breaks out the membership fee on their income statement. And the reason they did that essentially is it's great that folks are spending more there, but pretty much one going into a Costco basically breaks even. So all of their margin is going to come from the membership fee. And that's why there's so much Wall Street pressure on it. And every single time, Craig Jelinek just retired, but there's Costco leadership on a call. They say, hey, when are you going to boost that? That's why Wall Street cares about it so much. Yeah. I think it's there. It's reported. An opinion I have is they're just reporting it

to remind us of the fact that, hey, we basically sell you stuff at virtually a break-even amount. The other way to think about it is, why would you report that? The customer is looking at that. I'm not saying most customers look at the footnotes or the financial statements. But it's like the other reminder of that is like we're we're operating a roughly break even store where, you know, a little bit of G&A and overhead stuff like that. But, you know, we're selling you a good we're selling you for like just what it costs us to get it ready for you to buy and nothing more. And I think that's almost like part of the the the long run relationship here is that this isn't you know, they're not trying to price gouge or, you know, kind of run gimmicks. It's what's the best thing to do here is keep the membership around for years, you know, give them the highest quality, highest, the most amount of value per price spent, and then they'll keep coming back. So, yeah, I think the membership is a critical part of it.

But I think the way I always look at the membership conversation is it's a part of this whole equation, but it's much more about a relationship with the customer who's going to spend more. And Costco reciprocating on that relationship by sort of showing and do it and following through on like, let's keep prices the lowest possible. You know, the supplier part of that, the product curation part of that, all those other aspects as well. We've gone from revenue. Let's now go to operating margins because there's a company that has a lot of questions surrounding them. And that is Sweetgreen, the chain of restaurants that's big on salads. They also serve other things like a miso glazed salmon, which might not be as good for you as a slice of Costco pizza. That's a conversation for another time. However, they have found an interesting way where they

have started to expand their margins by offering what's called an infinite kitchen. So basically, you have a few folks working with the customer experience side, but we can make salad with these tubes of ingredients where the salad rolls through and then a robot will mix it up. There might be a better explanation for that. But the big question is, does this meaningfully improve the company's path to profitability, because right now, it does operate at an operating loss as a restaurant chain. Yeah, let me back up for a second just to add one thing in. We've discussed this in class. Empathetically, it gives Sweetgreen a chance here. The initial idea is the Chipotle of salads, but it's way harder to do this in salads because Chipotle's main ingredients,

rice and beans, are universally available, extremely cheap, great shelf life, etc., before they're cooked. So they're starting with a base. If you look at a burrito of like effectively very, very low cost ingredients, and then it's just adding on a little bit frills on top of that. But sweet green has just that perishability, the cost of kind of their core stuff. So that's the bigger challenge in the space. And so one of the things that I think we're talking about broadly across the restaurant industry, we've tried to weave into a couple of classes is, yeah, what's the role of automation in things? And is this one that's going to change, Uh, you know, what food prep, which might be a relatively, you know, simpler task compared

to some other things. Um, I'm curious about this. Uh, if I can just refer to their Q2, uh, June, July 27th conference call, uh, they got into this conversation and they basically were saying they have one of these and the second one's supposed to roll off by the end of this year, I believe. But is that the comment they made here? And I'm going to read this because I think it might be easier. The restaurant level margin for their Naperville, the infinite kitchen location

in June was 26%, significantly higher than any new restaurant opening in this first month. And so as restaurant continues to ramp, we see additional opportunities to significantly improve the margin. So in that conference call, they're talking about improved margins, restaurant-level margins in the Infinite Kitchen location. First, this is a conversation now we're getting into about operating profitability. That seems to bode really well, right? Is that the value unlock, the solution for? And I really want to push back on this. It's actually related to our first time you had me on as a guest, conversation we were having with Rent the Runway, which is issue here is that we don't know. And we don't know because their sweet

green is excluding the depreciation from the restaurant level margins. And the specific problem with that is that this is more automation, but more automation means more costs of using machines. And so naturally, I would argue the result of this, and I was a little surprised no analyst really pushed back on this call when i wasn't listening to it live but reading the q a after it occurred is that what they really express is more of the result of math which is that as you have more machines and less humans if you exclude the cost of using those machines your margin that excludes the cost of using machines is mathematically going to look higher and so they said they had one-third less workers and they directly said that so i would say that you

one-third less workers i expect that your margin will be higher but what do we need to see here And I'm curious if they'll move towards this, because will they be able to kind of show us the full depiction of the operating profitability? And what we're going to need here is for them to include the depreciation of these machines, the cost of running these machines as one of those core recurring operating expenses. And I know we have lots of metrics that kind of ignore depreciation, none of which I'm a big fan of, because I want to look at, hey, what is your core operating profitability? which in the world of automation is going to have to include the cost of using those machines, or as we refer to it, depreciation expense. So I would love for them to give some flavor into what are the operating profitability if you include the cost of the machines? Because naturally, with more machines, if you exclude the cost of machines, the profitability is going up.

But I just don't think that's diagnostic yet. I'd love to see on a more apples to apples basis here. So the accounting argument for this is that they implemented these very, what one would assume are these very expensive machines that have a certain life expectancy. And that there's a cost that they implement for each year that these machines exist eventually as they go down to zero. But now when they're putting out their income statement, they're able to say, you know what, we're going to push that cost to the side and say, look at how much we've made up for with labor, like with the costs we've saved on labor. Yeah. I think you laid it out really well. It's not, you know, you can't from a U S gap standpoint, ignore something like depreciation,

but lots of companies use a bunch of different, you know, non-gap metrics, which is totally legal and sometimes actually value enhancing where they're saying, Hey, look at this, not that there's always the required stuff that's there, but it's, it's shifting the perspective, right? It's, you know, it's never a situation where they're, they're not in any way saying they're not reporting correctly. They are, but they're saying, Hey, look at our restaurant level margins. And in the conference call, let's talk about a restaurant level margins. But what's missing is that the restaurant level margins are not including all the expenses of running a restaurant.

Before this, you and I were kind of chatting about what they were doing with general administrative. And I would say, hey, I'm OK with evaluating a restaurant level profitability and setting aside the corporate general and administrative expense, not because it will never matter. But the increment of growth or the increment of profitability really here is, can you have like a positive contribution margin? Can you generate profit to the restaurant? And if so, as you grow restaurants, then you should be able to kind of hit break even, cover your general administrative expenses and then return some or generate some overall profitability for the investors or for the total company. But excluding general and administrative from a restaurant-level margin makes sense as a step

in the process of figuring out what they're doing. But excluding the restaurant-level cost of using the machines is just harder to stomach because it's a core recurring operating expense for them, and one that's only going to become increasingly important for everyone, really, as the world moves towards automation in different ways. The other one that might raise some questions for investors is that they also add back in the pre-opening costs. When a company is in growth mode, they're trying to open more restaurants, one could say that maybe this isn't a one-time expense for these restaurant margins. Another good lens there of, how do we associate when companies tell us that something

is one-time or ask us to ignore it? It's a good, broad conversation. We don't necessarily have to take their word for it. If it truly is one-time, that's fine. But I think Sweet green is a good example where look pre-opening expenses they're saying they're in growth mode and maybe they should be in growth mode but if that's the case then that's going to be a recurring expense for you know the long foreseeable future if i can add one more thing in there as they continue to grow just a caution i have with sweet green is you're assuming and this is one where i think we can kind of learn from what happened to whole foods a couple years ago like their first locations did amazingly well and their margins and their growth and their comparable store growth

the metric that Costco succeeds on are really great. But at one point, you know, I think they just ran out of those ideal locations and they started putting stores arguably maybe too close to stores. Here in Austin, Texas, we have a little bit of that with Whole Foods. Or they just had to go to like less optimal locations. I'm not saying they're bad locations, but they're not as good as the initial ones. So you have that challenge to operating profitability as you keep growing, which is that if you put your, you know, make up a number here, if your first 400 locations are like the best ones where the brand resonates. Let me bring back in the conversation about, you know, that with, with valuation, the brand resonates, you've got the ability to have a good

margins. You can kind of get all those other things working for you, but it's likely that you're going to potentially run out of them at some point. And if you run out of them, you are going to have to expect that you could have lower margin on a per restaurant basis as per unit basis going forward. So, you know, location choice is one. I want to go back to our conversation about keggers where I don't want to just assume that because they had profitability at this amount at their optimal locations, that as you move out and add more locations, that profitability will be maintained. As we wrap up with this conversation, we like looking at the top line revenue and expenses, but those aren't the only factors

for determining earnings quality. And some folks, including myself, I've been guilty of just checking out that free cash flow line. Sometimes this can work and sometimes it can't. So first, let's talk about the times that this can work yeah one i would say and i'm a big part of this in class all the time like it's not it's not a earnings versus cash flow argument you don't have to choose a side i think sometimes we do that and we make a mistake it's use both and so the the but orient ourselves with the idea of like i should expect them to work together now they won't be the same either in like a bookkeeping transactional sense or even for an annual year don't expect them to be the same but i would say over time you should expect like it's

it's a red flag. If your earnings are moving in one direction and your free cash flow are moving a different direction for a repeated period of time, not for one year or whatever else, but figure out what that's, what's going on there. They should be, you know, they should trend together. If you have increased your, what's your primary driver of free cash flows back to the beginning, it's your ability to generate revenue greater than your expenses over time at any moment in time. No, there's going to be exceptions to that, but you want them to work together. So it's a, yeah, look at both, look at the how and the why of revenue, look at the how and why in the free cash flows. And if you have profitability and no free cash flows, I'm

worried about that. And if you have free cash flows and no profitability, I'm also worried about that. So that's kind of the first way of looking at it. It's like, just use them together. There's no side we have to take here. Multiple financial statements, multiple financial metrics for a reason. I don't, I don't ever want to make a decision where I'm ignoring information that's out there. Do you have ideas about topics for our next full school session? We want to know. You can always reach us at podcastsatfool.com, but we're also getting more active on Motley Fool member boards. Ricky's got a thread on community.fool.com, where he's chatting with listeners and sourcing

ideas about guests and topics for future classroom episodes. So head on over and let us know what you want to know. Community.fool.com. I'll leave a link in the show notes. See you there. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. so don't buy or sell stocks based solely on what you hear.

I'm Mary Long. Thanks for listening. We'll see you tomorrow.