The Compound and Friends - The Biggest Threat to Apple, Amazon, Microsoft, Facebook and Alphabet with Byrne Hobart (The Diff)

Episode Date: September 4, 2020

Josh's guest on the podcast this week is Byrne Hobart (author of The Diff substack letter, link below) who has just completed a comprehensive series of thought experiments on each of the largest technology stocks. After a conversation with Andrew Walker (Yet Another Value Blogger), Byrne set off to answer the question What could disrupt Amazon, Apple, Microsoft, Google or Facebook enough to knock them off their pedestals? It is historically unlikely that the five largest stocks of 2020 will remain the five largest in ten years' time. So which is most vulnerable? And why? Join Josh and Byrne as they explore the threats to these gigantic companies (and their stock prices).   Make sure to check out Byrne's writing and research at The Diff! https://diff.substack.com/ Subscribe to The Compound Show podcast and be sure to leave a rating and review - they mean a lot! Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey guys, it's downtown. Welcome to the final weekend of summer. It's here. I just wanted to say thank you to everyone who listened to the show last week and offered feedback or shared it with their friends. I can't believe how many people reached out just to tell me they could relate to it

or they were inspired by it. I just can't tell you how much that encouragement means to me. So thank you. I've always thought about the kind of content that I do as something like an agreement between you and I. So whether it's on the blog or it's a TV appearance I'm making or it's a video or it's a podcast episode, I've always said to myself, if the audience is going to exchange some of their time, then I better earn that time if I want them to come back.

This has always been the guiding principle of how I've thought about doing content. And I started the Reform Broker blog in late 2008. So it's almost 12 full years that I'm doing this. So it's almost 12 full years that I'm doing this. And what that means is that I try to deliver something every time I write or I speak that's either going to help you, teach you something you don't already know, inspire you to try something new, inform you of something you may not be aware of, or, and this is not quite a last resort, but it's definitely not the priority, entertain you. And what I've learned is that if I can accomplish all of those things

in one single blog post or in one single podcast episode, then the response is going to be enormous. It's not easy to do. You can't do it every time out. But if I can help you, inspire you, teach you something new and make you laugh or entertain you in some way all at once, and you walk away from whatever content I've delivered saying, I didn't know that before. I enjoyed hearing about it. And I want to hear the next thing Josh has to say on that topic, then it's a big win and it makes you happy and it makes me happy. And those are the types of blog posts or videos or podcast episodes that have gotten the biggest response. I think with my six lessons from Pandemic Summer, which was the episode last week, I was able to do all of those things at once.

And I think that's why it got the response it did. We did some market insights. We did some business lessons. And that's all great. And then what people really seem to respond to and love was the stuff about staying married and how keeping your family together is going to be more important than any asset allocation you could possibly come up with. And I think you guys really liked where I called myself a blonde minotaur. I got like a zillion texts and emails about that one. So maybe that's now a permanent part of my repertoire.

I'll keep coming up with things to make fun of myself about. All right. I wanted to mention one other thing before we get into today's show. And today's show is going to be amazing, by the way. The first thing I want to do is just point out on the YouTube channel this week, my friend JC Peretz of All Star Charts came back. We did another episode of Big Trends Monthly. We look at the monthly candlestick charts that come out on the last night of each month to break down the most important trends in the stock and bond markets. So what does that mean? Candlestick charting, for those who are unfamiliar, basically it plots the highest price of the day, the lowest price of the day, the opening price and the closing price. So on a monthly candlestick, what you're

saying is, let's say we're looking at the S&P. A monthly candlestick chart would show you the highest close for the S&P each month, the lowest close, and then the open and the end. So like where it started the month and where it finished. And candlestick charts on a monthly basis are really fascinating. They tell you a lot about the long-term trends that are in place, some long-term trends that may be on the verge of a reversal. When you look at daily charts and you're a long-term investor, a lot of times you're just wasting your time. They're very noisy. Even weekly charts. I look at individual stocks on weekly charts. But when you're looking at things like interest rates, the bond market, you know, emerging market stocks, the S&P, the small cap 600.

When you're looking at that stuff on a monthly basis, there's a lot of clarity. You clear out a lot of that noise and you can really focus on what the bigger trends are. So that's why we call the show Big Trends Monthly. I like to think of it as technical analysis for fundamental investors. And I think there's a lot in there, no matter where you are or what you're doing. If you're a trader, if you're an investor, if you're an asset manager, if you're an asset allocator or a financial advisor, I think there's a lot of good stuff there. JC just absolutely crushes it every time.

He's, talk about entertaining. He's hilarious in real life and in his content. I mean, he cracks me up. So it's JC and I, and we do it once a month. And this month's episode, which looks at the August closing candles, went up on Tuesday. So you can check it out at youtube.com slash the compound RWM, and I hope you like it. All right. Today, we have a can't miss discussion about the biggest threats facing the five largest stocks that have come to dominate both the US stock market and

probably your own portfolio. Apple, Microsoft, Alphabet, Facebook, Amazon, each one of them has its own very specific Achilles heel. Each one of them has a very specific risk. And if you go back and study the history of the companies that have become the largest stocks in the US stock market, it is very rare that 10 years later, those companies are still there. Some will be, but some will not be. And so we're going to have a discussion about what the risks are to each of those names. I'll throw in Netflix too. And which risks are most likely to play out and which ones are a little bit more marginal and maybe not so much to worry about. So I think you're going to love it. I have a really great guest. But first,

Duncan, let's hit the intro. Welcome to The Compound Show with downtown Josh Brown. Josh is the CEO of Ritholtz Wealth Management. All opinions expressed by Josh or any podcast guest are solely their own opinions and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast. Hey, guys. My guest today is Bern Hobart, author of The Diff, which is a phenomenal substack letter I've been reading every week, all summer. Bernd just did a multi-part series where he asked the question, which of the largest technology giants is the most disruptible or

vulnerable over the next 10 years? We're going to get into all of it right now. Bernd, thank you so much for being on The Compound Show. Welcome. Yeah, great to be here. All right. Before I get into the FANG stocks and all of your excellent analysis, just give us a quick idea of your background. Yeah, sure. So my background, originally I worked in online marketing, moved to the financial world in 2012, working at a large long short hedge fund. And since then I've been doing research on

buy side and sell side, and then struck out on my own late last year and started writing the diff around that time. And now the diff is most of what I work on. I also do some investing and consulting on the side. So I love reading the diff and it's a sub stack. What made you go with that format versus just a blog with a password or some other version of how people could get your thoughts? Yeah, I like the form factor of email because email, your inbox is supposed to be where all the important messages in your life at least stop by. They may not stay in your inbox very long, but they do get there.

And I try to write for an audience of people who really value their time, who are looking for high value commentary that they can actually use, or they can actually mull and think about. And so the inbox is just the natural place for that. It's something everybody checks multiple times a day. And it also forces you to really step up your game because people are very quick to unsubscribe. They can just stop reading your blog, but they have to actually hit the unsubscribe button if they get tired of your newsletter. Yeah. So I think that's a really good point. It's amazing how important email still is for content. You never would have thought that emailed content would have hung on as long as it has. But even on my blog, the amount of subs

every week, it's like an important metric to see whether or not people want that much information from you. All right, I want to get into what you wrote about. So we live in a moment right now where five stocks make up approximately 25% of the S&P 500. And everyone knows the names, Amazon, Alphabet, Facebook, Apple, Microsoft. Lately, Salesforce gets thrown into the conversation. Zoom, Adobe. So there's a second tier. There's a third tier. But those big stocks look to be invincible right now.

And nobody can really come up with a reason for why they won't continue to be invincible into the end of this year, into next year. And that's despite the fact that they compete with each other on so many fronts, but it almost seems not to matter in the traditional way that we would worry about competition. Revenues are still growing at all these companies. So are profits. Margins seem stable. They're even expanding in some cases. And what I'm describing is not a new phenomenon. It's been going on for a decade, although over the last five years, it seems to have accelerated. Are investors underestimating

the extent to which these companies could actually be very vulnerable in the near future? What's your take on the sentiment around these stocks on Wall Street? You know, it's a funny question because if you look back in history, anytime you look at a list of the largest market cap stocks, at least some of the companies in that category just did not do very well. So if you go back to 2007, 2008, you're looking at Exxon, a lot of big banks had very large market caps. Of course, if you go back to 2000, you see big tech having huge market caps. And in a lot of cases, it wasn't so much that anyone was blind to the risks. It's just that if you own either some of these stocks or if you just own an index fund, you are exposed to these risks. And it's just worth thinking about what is the story that we will tell 10 years from now about how one of these companies looked totally invincible and just did not end up doing as well as investors had anticipated.

I think people are generally aware of the broad categories of risks, but it's also, there's so much focus on just the continued growth, continued margin expansion, that the story that these companies have been telling for years is playing out almost exactly as they said it would. And it's just easy to get lulled into this sense of complacency as you see Netflix continuing to add subs and accelerating, Amazon continuing to add revenue and accelerating, that they seem to be pandemic proof that we go through the largest economic disruption since the 1930s or perhaps even before that, and they all just keep on going. So I thought it's almost a meditative exercise of saying, whenever you invest, you they all just keep on going. So I thought it's almost a meditative

exercise of saying, whenever you invest, you're getting paid to take risks. What are the actual risks that you're taking and how realistic are they? In the last couple of days, how about this for a chain of events? I think GE hit, if not an all-time low, a multi-decade low. It's a $6 stock. multi-decade low. It's a $6 stock. IBM was just leapfrogged in market cap by Zoom. IBM is a 110-year-old company. Zoom is a 10-year-old company. Zoom is now a bigger market cap. And we watched ExxonMobil get kicked out of the Dow 30, maybe for the first time in its existence, or if not, at least in decades. So GE, ExxonMobil, and IBM are three companies that in their heyday seemed invincible. They seemed unassailable. And it's not like I'm talking about 70 years ago. It's really not that long ago that all three were in the top 10 market caps.

And I'm not going to say they're totally irrelevant, but their stocks are. market caps. And I'm not going to say they're totally irrelevant, but their stocks are. So which of today's gigantic tech monopolies do we think most resemble something, a situation like a GE, for example, or could, I guess is the way to phrase it. Yeah. So every company, the more successful it is, the more unique the story is. And sometimes you can find patterns, but they're not exactly going to repeat. Like with GE and with IBM, part of what went wrong with these companies was that they had a model that worked extremely well. They have these trusted brand names, exceptional management teams, and they basically tapped out their core market.

So they could either take a risk with something totally new, or they could lever up with what they're already doing. And because they were such effective operators, levering up was for a long time exactly the right choice. And that's both levering up in the literal sense of we're going to sell more bonds, buy back more stock, and levering up in the operational sense of we're willing to have high fixed costs to continue serving the existing client base that we have. And we're willing to operate on this really working capital light kind of model or a model where we're assuming perfect execution because we can actually do perfect execution. So in those cases, they just got hyper-optimized for a business environment that then shifted

and they weren't able to adapt to that shift. When I look at the companies today that face the broadest kinds of risks, the two that stood out as being companies that could potentially face just enormous catastrophic risks were one, Netflix, two, Amazon, and for totally different reasons. And I should caveat this with the fact that I'm an Amazon shareholder. So it's always a real nightmare to go through a company that represents some of your net worth and ask, why will I look really stupid in a couple of years for having made this decision? Well, I think that's, so I think that's actually the right way to go about being an investor is again, we're all assuming risk. So I own Amazon too. By the way, everyone in America owns it.

It's like one of the biggest weightings in the Q is the S&P 500. It's in almost every actively managed fund. So let's start with this baseline that at its current size, a trillion whatever, everyone has exposure to Amazon. Okay. That's right. Unless you went out of your way to short it. Okay. All right. So now let's start with Netflix though.

What's the reason behind – I think everyone knows that Disney Plus is formidable and the other content producers to varying levels of success and commitment. They're all going to follow in Netflix's footsteps and try to do the same kind of thing. Or is it deeper than that, the risk that Netflix shareholders face? Yeah, I think it's an extension of that risk, where if you look at how other companies use streaming video, they're not using it as a core product that they want to sell for the most part. They're using it as part of a bundle. And it's often a part of a bundle that makes the overall bundle a lot stickier, keeps people engaged. And that means that the focus is on monetizing other parts of that bundle. So if there's cross-subsidization going on where Amazon wants you to watch streaming video through Amazon Prime so that you'll order more stuff using Amazon Prime,

then Amazon can afford to lose a lot of money on the video side on its own in order to keep more people logging into the site. So what do you want? You want Netflix to buy a supermarket? So that's, yeah, I was thinking about what could they do? Like, could they buy, they compete with Disney by buying a theme park? Maybe. Like they, the Disney model is just amazing. Like Disney, it reminds me of the meatpacking industry where they realized that the way to get the right, the way to get maximum margins is use every single part of every animal and just sell everything you can. So there was a deal in the 60s where the Wilson Meatpacking Company got bought, and then it got spun out into three different tracking stocks. You had the actual

meatpacking business, and then you had the sporting goods business. So literal pigskins turned into figurative pigskins. And then there was a pharma business because before it became easy to desynthesize some drugs, you could actually get things like insulin from taking a bunch of pig pancreases, crushing them, spinning them around in a centrifuge for a long time, and then skimming off the insulin. So- Hold on. Wilson's Sporting Goods is an offshoot of sausages and bacon? Yeah. Pig skins. It's true. So I learned something new from you every, every time I talk to you or read from you, it was an awesome deal because it was an early tracking stock deal. Investors nicknamed the stock. So you had meatball, um, golf ball,

you had goofball, um, karma was the big growth story, but, um, it was the, the business only worked if they sold all of those products and got some kind of profit from each other. So it would be a break even or money losing business doing just one of those things. You have to do all of them. And that's how Disney thinks about a lot of their IP is that if we were, if Disney's just making movies and putting them in theaters, okay, right now there's no business, but you know, over the long run, it's, it's an okay business, but pretty lumpy. Whereas theme parks business is a really good business. Streaming business increasingly looks like a really good business.

And because they have all these different ways to monetize the same IP, they can actually afford to take some cinematic risks. They don't really do it, but they can afford to. They can afford to invest a lot in making these characters ubiquitous, knowing that they're going to get years and decades of revenue out of each new character they create. So Netflix has to bet the other way, or they don't have to, but they are. Netflix just has to say the content is enough and the track that we're on, we want one out of every six people on earth to be a Netflix subscriber because they're willing to pay for our content. And that's our business.

because they're willing to pay for our content. And that's our business. And we're not trying to profit off these characters or whatever, or IP in other ways. And that's where you think the peril lies. Yeah, the peril, yeah, it's basically, you have a lot of really well-managed companies that are competing with Netflix, but they don't have to make a profit

selling the same core product Netflix does. And Netflix does have to make a profit selling that product. So that's a tough position to be in. Like if you are competing with Jeff Bezos and his cost of capital and his ability to cross-subsidize and his benchmark for a good streaming business doesn't necessarily have positive profit margins, then that's really tough. Now, Netflix has done an incredible job. Like all the management teams of all of these companies are just exceptional. So it's tough to bet against them. But if you're just fried. What are you going to do for the rest

of your evening? They want to win that moment. They want you to just automatically choose Netflix. And so anything that is an automatic thing to do after you're done working is implicitly a Netflix competitor. So if you look at something like Fortnite, Fortnite is something people do when they're done with work, done with school. And it's a habit. It's than that yeah my kid my kid did fortnight instead of school this year that also works yeah he did a he did a semester abroad in uh fortnight land so i i all right so they right so they're not just competing with other streaming video they're competing with anything that's capturing people's time and attention um but but there's a lot of that to go around. So that hasn't stopped media companies before.

Let's pivot over to Amazon, which was the last one in the series that you've done or at least the last one that I read. And what you're basically saying with Amazon is that at a certain point, it's either going to be mandated or they're going to decide to have spinoffs and let some of these businesses stand on their own. And you mentioned specifically the e-commerce operation and then the cloud business being separate. And I forget what you said would represent the third business. But then your point is these are very competitive people. They're Amazonians. And they may start off as like in a relationship with these other subsidiaries where they do business with each other. But then at some point, Amazon Grocery is going to say, why are we paying Amazon Shipping and Logistics so much money to deliver these groceries? I bet we can get a better deal with Instacart. So that's a really interesting way to think about Amazon. Take us through that example. Yeah. So that was, in my view,

the funniest one to think about was how would Amazon get killed? Because at one level, the big threat to Amazon is antitrust. But if you try to calculate how big a share of retail Amazon is, it's just not big in terms of retail. If you try to calculate as a share of e-commerce, it is big, but there are plenty of companies that are growing fast there too. So part of the risk is this more abstract risk of current antitrust law doesn't really say that what Amazon is doing is wrong. You have to go way back and think about the early thinking on antitrust where it's not about consumer harm. It's actually more of this broad question of concentration of power. So for Amazon to get an actual antitrust trouble, we need a new theory

of antitrust, or at least to resurrect and contemporize some older theories. And so we really don't know which way that'll go. The normal way to critique a company on antitrust grounds is they bought up all their competitors. And when there was nobody else in the market, they tripled their prices. But with Amazon, it's more like they bought up some of their competitors, they killed the rest, and they also cut prices 20% and they gave you same day shipping. So it's tough to say there's any- Well, Bern, if you're a small seller on Amazon's site, you're a third-party seller, you're not saying antitrust. You're saying racketeering. You're basically saying I had the number one iPhone cover, and it did so well that Amazon noticed, and now they're making an alternate version.

They're priced $3 below me and I'm done. That's not even antitrust. That's a whole other category of harm. The thing is there aren't a lot of those people. There are a lot of consumers. So if there's no outcry from sellers, it's hard for a politician to want to take up the mantle of, I'm going to be the idiot that goes charging at Jeff Bezos and all that that entails. Yeah, exactly. That you have the absence of consumer harm. And in fact, you can even take the edgy argument of Amazon is eliminating the harms of these third-party sellers who have their own tiny monopoly on a particular design of iPhone case. That Amazon clones it, now it's a commodity instead of a monopoly. And that benefit mostly occurs to consumers. Now that's, that is really a logical stretch, but I think the general

point stands that Amazon does face this breakup risk. We don't know what form it'll take because we don't, we have to, someone has to invent a new legal justification. And there are a lot of people thinking very seriously about what that justification would be. There's almost, it's almost like we have this emotional sense of Amazon is way too powerful. There's got to be a law against this. And then we're going to have to find what that law could conceivably be. And Amazon's option here is the defensive one of saying, we're just, we know that people are uncomfortable with this huge aggregation of power, and we're going to start spinning

stuff off. They already try to operate in this really decentralized way where the internal pieces of Amazon do business with each other. So AWS is not quite a third-party company because Amazon is still a very important tenant of AWS, but AWS does operate as this somewhat independent entity and they are managed relatively independently. So the high-level companies allocating capital did figure out strategy.

It launches these things, and then they run as their own businesses. So it wouldn't be trivial. It's never trivial to spin off a giant company from another giant company, but the cost of that spinoff is a lot smaller than the cost of, say, Facebook trying to undo the WhatsApp and Instagram integrations and spin those off. Well, let's look at the eBay spinoff of PayPal. So that was at gunpoint, right? You had hedge fund managers, activist hedge fund managers come in, file 13Ds, and basically demand that PayPal is where all the value creation is happening.

The marketplace business is mature and boring. That's why the stock's not getting a growth multiple. They spin off PayPal. I think Andreessen fought it. I think he was a board member at eBay that was against it. But it ends up happening. PayPal is one of the biggest value creation stories on the NASDAQ in the last 10 years. Just this remarkable growth in market cap, profits, revenue gains. They absolutely crushed it. And you could probably make the argument that if it were still a part of eBay, they would not have been able to be as aggressive as they were with capital expenditures, R&D, marketing. So that kind of needed to happen for PayPal to become what it is now, which I think is $100 billion plus

standalone company. So that's an example of that kind of thing going right. If Amazon Web Services became a standalone company tomorrow and kept its relationship with the other internal units at Amazon so that Whole Foods website, for example, would be hosted at AWS, I don't think shareholders would lose. So we talk about break up a company. It's not necessarily a punishment. Yeah. Every morning I check the journal and just wait to see the story of Amazon announces preemptive spinoff of AWS and maybe some other stuff. They could do it. They're probably waiting for the right moment.

It's kind of, it's like the HQ2 thing. They love making these really big, splashy decisions that just reset the terms on which these things are evaluated. So HQ2, first they say, we're not just going to discreetly talk to mayors and governors and ask what tax breaks we get. No, it's an open auction process. Everyone can participate. And then they get to the end of it and they say, oh, we can't pick a winner. We're picking two. And that didn't quite work out for them, but they do like to just totally reset the rules of the game. And I think

doing a preemptive- So they could do that anytime with something like this, you're saying? Right. Now you look at counter examples of that. You look at, let's say John D. Rockefeller, Standard Oil. He spent maybe a quarter of his life fighting against breaking up the company. He's almost on his deathbed by the time they do it. It's, I guess the 1920 or something like that. That's where we get Chevron, Texaco, Mobil. These are basically Standard Oil of New Jersey, Standard Oil of New York, Standard Oil of California become all these giant oil companies. Shareholders did unbelievably well. The Baby Bells, AT&T, I think there were five of them or six of them. And then one of them became SBC and actually bought AT&T decades later.

But shareholders did really well. So when we hear in the press, such and such companies will be broken up, a lot of that is almost more like the risk is to the ego of the founder or of the CEO than it really is to the shareholders. That's not really a risk to the shareholders. What is a risk to the shareholders in these FANG names, I think, the shareholders. What is a risk to the shareholders in these FAANG names, I think, is innovation risk or just consumers finding something they prefer to do more. And so that's why I want to go on Facebook. So we love Instagram. And for 10 years, it's been one of the stickiest social media platforms and shows absolutely no sign of people falling out of love with it. To me, that's a bigger risk in the case of Facebook.

Not that they're forced to spin it off, but that people just stop liking it. What's your take, though? Facebook, the core big blue app, has done a pretty good job of just turning itself into this incredibly boring utility. And the way I thought about it in my Facebook piece was, you can say Facebook, a kid in high school doesn't want to join Facebook because that's where their parents are. That's where their grandparents are. It's a boring old people site.

But kids were willing to talk on the phone when mom and grandma also use the phone. So the more you make it just this completely generic utility that has no connotation whatsoever, the more you can get away with being uncool. So Facebook's job in part is to have totally post-cool assets like the Facebook app, and then to continually stay ahead of trends in how young people behave and try to spot them, try to clone new use cases. So they did a really good job of cloning a lot of core Snap features. And they obviously did a really good job of cloning a lot of core snap features. And they

obviously did a really good job of acquiring Instagram once they realized it could be big. And basically, they knew it and Instagram's VCs knew it and nobody else understood how big Instagram could be. So they've done a good job on that. Where I saw the risk on Facebook was, I think of it as super linear risk tailing, which is that Facebook has to do moderation in proportion to the number of people on the site, because more people means more crazy people, more evil people, et cetera. But also, the more people are on the site and the more time they spend on Facebook's various apps, the more they have an incentive to misbehave on Facebook and the more newsworthy

it is. So that's why the risk is it's a function of not just number of users, but actually the number of users squared. So the bigger Facebook is, the more important it is, therefore the more newsworthy any given abuse is and the more people there are to abuse it. So the way they have to deal with that is continue to invest just vast amounts of money

and time and technical energy in moderation. And they have done that. Like the line that Zuckerberg used in a company meeting a while ago was that I think it was last year, Facebook spends more money on moderation alone than Twitter collects in revenue. So they've done it.

The Facebook we see with all the problems it has is actually this incredible success story. It's just getting 2 billion plus people to behave and be on their best behavior all the time is actually a really, really difficult task, especially like you can do it at a, at a nation level, you can do it somewhat because you have these norms that correlate across the country. But when Facebook has to operate in Saudi Arabia and in the Netherlands and in India and in Japan, like there are all these different cultural norms they have to balance against.

There are things that are totally okay in one country that you absolutely have to censor in another country. Like they've been dealing with this in Thailand right now because it's illegal to criticize the King. In the U S we're, we're pretty okay with criticizing monarchs. We're certainly okay with criticizing our head of state, but well,

for now we are. Yeah. Give it time. We'll see. But they have all these different standards they have to conform to. And then they get the PR blowback from they banned speech in Thailand, unacceptable in Thailand. So now everyone in the US and Western Europe says you're censoring people for criticizing a king. And we think it's totally laudable to criticize a king. So they just have this ongoing moderation problem that scales faster than the size of their business. Some parts of it they can solve.

They've gotten really good at detecting all kinds of speech that they don't like and that most of their users don't like. And they put up pretty good reports on this. So basically, every kind of speech that they discourage, other than bullying, they detect like 90% of the time algorithmically before anyone sees it. Bullying, I guess it's harder to detect because there's, that's more situational, more passive aggressive or something. But for everything else, you know, if you, if you put ISIS propaganda on Facebook I don't know if you've tried this, but I have not, your friends will not see it. Facebook will detect it first and they'll take it down. Yeah. Because I don't, but I don't think any of that is profitable. Like bullying and terrorist propaganda is not going to lead to profits for Facebook. So it makes sense that they're vigilant where where that runs into trouble is political

content is probably the most engaging content there is on Facebook. And they are highly incentivized to not remove that stuff even when it's on the line. In fact, especially when it's right on that line because that's when people are the most engaged with it. So I think that there's a big difference between, hey, we cleaned up our platform. No, no, no. You got rid of the guys saying here's how you make a bomb. make a bomb. What you haven't done is getting rid of the people that are organizing counter protests and trying to send people with guns to go up against college students. You're not doing anything there because it's in your best interest not to. I think that's the most legit

criticism of Facebook's moderation. So what they will say is political content is highly, highly engaging at the time and totally exhausting. Everyone gets sick of it really fast. So they're not trying to optimize their metrics for what can we show you that makes you click and type really angrily in all caps to all of your friends and tell them all they're idiots. What they're selecting for is five years from now, are you still using Facebook? So they actually tamped down on just pure political news a couple of years ago. And they said, this is actually going to hurt our usage. People will spend less time on Facebook now, but they're less likely to delete it in frustration in the next year.

And they do think about that long-term compounding effect because the network effects, network effect businesses are wonderful when they're growing. They are a nightmare when they're shrinking because that same network math plays just as strongly in the opposite direction. So if more of your friends are leaving Facebook, you have less of a reason to log in. And now you're one of the friends leaving Facebook. I want to go to Alphabet because Sundar Pichai probably looks at the

problems that Zuckerberg has and says, thank God, I don't have that issue. It's like Google tried to get into social networking, I guess, 10 years ago, and it failed miserably. It's probably the best thing that ever happened to the company in the intermediate to long term. So they have their own issues, though. For me, I always was worried. I'm a shareholder in Alphabet. I always was worried that the big risks there were out-of-control spending on moonshots, none of which actually become anything. I'm not saying that will be the case, but that would be a risk. And then the other one is that what if we stop looking

at our screens? What if all of a sudden we do all of our searches via voice, talking to Siri or talking to Alexa? Where does Google fit in if that's the direction the world ends up going? So what are your thoughts on the risk to Alphabet and Google? Yeah, I used to worry more about the moonshots, but I honestly think that EarthGuard has totally cleaned things up there where they're breaking out the spending. They're basically saying the moonshots are sort of your tax for owning some Google. So just like if you pay taxes to the federal government, some of it goes to R&D, some of it goes to weird studies and you don't understand what they're for, but you can't really do anything about it. And the overall package you

get is fine. So you're going to continue spending. You basically have no choice with the US government. You have basically no choice with Google. So I think that problem is more under control than it was. You're absolutely right that the problem of being disintermediated is a huge one for Google. They can worry about voice. But that's been a risk that people pointed to for a long time. And it hasn't played out because the risk 10 years ago, you could say the risk was apps, that people aren't going to Google best restaurants in New York. They're going to open Yelp and look it up there and get better results.

And Google found ways to monetize mobile search. And it turns out that mobile search is more data rich. And since it's a smaller screen, you can have more ads on the screen. So there are a lot of ways that that did not end up playing out. Voice search is, it's a little bit tricky to advertise in voice search. You basically, you can monetize voice search if you're monetizing the actual action. And that means going down the sales funnel. So instead of saying, I'm pointing, Google's job is to get paid to point you to a brochure.

The brochure convinces you to buy the product. Google just has to get paid for that page view. Now Google has to actually get paid for the transaction. And that's where the risk is, is that Google hates things that don't scale. It's a company that was founded by computer science grad students that hires lots of really smart programmers. They love automating things. They want to build something that can scale any product they want to build.

They want to be able to scale it to a billion users and not have to worry about it breaking. And they really don't want to have a number that people can call to talk to a human being about how the product works. Like anything, even you have that at Google scale, you have just an unusable product. So they hate anything where you have to come up with a specific model for a given industry and you have to make deals with individual providers in order to monetize. You can look at their vertical search as an example of that. They've done a good job with hotels, a decent job with flights. They tried to do a credit card comparison service. So if you typed credit card into Google or mortgage refinancing into Google, they would show you actual refinancing options. And then they basically gave up. They just didn't want to make all the deals with all the deal-making with companies or with the consumer.

I think probably if Google Insurance just popped up on their homepage, I think probably a million people would buy an insurance policy in the first hour. But then what? Then you're competing with insurance companies. I don't know that they want to they want to go that route um let's talk about apple to me if you ask me which one is the most invincible of of the five it's either amazon or apple and maybe that's just recency bias and i'm just saying that now because that's how it seems right now. I don't see another device maker being able to touch Apple technologically. I know everyone's always like, no, Samsung's better. No, it's not.

Okay, sure. And then on the services side, they just make everything so seamlessly interconnected. It's hard to picture somebody buying an Apple phone, but leaving the Apple slash iTunes ecosystem. Why would anyone try to do that? So to me, if you ask me, gun to your head, which one of these is still a trillion dollar stock in 10 years, I really have to say it's Amazon or Apple. Where do you stand on that? Yeah. Apple is incredibly impressive. Everything they've executed, they've executed extraordinarily well. And one of the things that they did incredibly well was handle the succession problem of you're founded by this eccentric genius. He got a little less eccentric, but remained a genius for his entire tenure there. And then you have to hand this company on to somebody else. Do you try to find the next Steve Jobs? And the answer was no. You actually try to find someone who is really good at managing a complicated supply chain. And then you have this whole cohort of industrial designers and product designers who just continue to have that spirit of perfectionism. So it's been astounding that that has lasted for so long. They've been able to- Steve Jobs died. They were $150 billion market cap or $200 billion and now $2 trillion-ish?

Yeah. Right. So I wouldn't go so far as to say that Tim Cook created $2 trillion in market cap, but I don't think he's completely riding on the coattails of someone who's been dead now for almost a decade. I think the truth is somewhere in the middle. Yeah. I think the character of the problems Apple had to solve were very different in

2011 than they were when, when Apple acquired next and got Steve jobs back that in 97. Yeah. Right. Yeah. So, so now a lot of the problem, it seemed to be just this optimization problem. Okay. We know how to make iPhones. We know how to improve iPhones and we just need to keep doing keep doing that and keep making our gross margins look a little bit

better every quarter. But it turns out they were actually able to launch new product categories. And then the services business, as you said, just became a huge moneymaker for them. I see some risk in the services business just because there is so much outrage from developers on the fact that Apple's take rates are generally 30%. Sometimes there's a special deal and you don't have a lot of information on what those deals are.

And then, so a lot of people, they want to get around it. Wait, let's hear your explanation of that. So Fortnite basically got into a very public fight with Apple because every time you buy something in Fortnite on the app, you got to pay Apple a 30% commit. Every Fortnite user who bought something from Epic Games, 30% of that money would go to Apple. And Fortnite said, I don't understand. Why does Amazon have a special deal with their app in the Apple store, but we don't? And that, I think, a levy broke, so to speak. I think a lot of

companies came out and said, yeah, what's up with these special deals? So are you saying that you think Apple's 30% take rate in the app store could be vulnerable? Yeah, I think we should not treat that as set in stone. And I think if you're just thinking about what will happen to the stock, I think that if they had to budge on that 30% take rate, that it would do some serious damage to their multiple just because we don't know how the take rate would sort out. It's clear that the App Store does add a lot of value and in some cases, most of the value for some of the apps, especially casual games with in-app purchases. If you're in that business, you're in that business because of Apple. And Google does the same thing. They have the same take rate.

So in some ways, that part of the business is fine and that is a big moneymaker for them. It's other categories of apps where the service existed and people were subscribed to it for a long time. Now it's available as an app and Apple is saying you have to let users buy a subscription and you have to give us 30% of what they pay for it. And there are all of these rules on can you say or not say that there's another option. Like if you try to buy a Kindle

book in the Amazon app, it's very opaque as to what you have to do. And what you have to do is open the same page in a browser instead, and you can make a purchase. I've always been hoping for litigation here because I want to know how passive aggressive the emails between Amazon and Apple were when they arranged how much we're going to break. You want discovery? Yeah. Yeah. I'm really excited for that as soon as that happens. So, Bernd, let me ask you a question. When you think about 10 years ago, Apple was selling at 10 times earnings.

I think if you backed out the amount of cash on its balance sheet, it was like eight times earnings. It was one of the cheapest large cap stocks in the entire market. And the only people who would touch it were value investors like David Einhorn and Carl Icahn. Fast forward, 10 years have elapsed, or maybe it's nine years. And in 2020, Apple is no longer 10 times earnings. It's 40 times earnings, 39 times trailing 12-month earnings. And that's with a 12%, give or take, revenue growth rate. So nothing to write home about. It's already so big, it's hard to grow much faster. So where does that quadrupling in the price earnings multiple in 10 years come from? Is that solely based on the app store having become the most important payment gateway on the planet, basically? Can you attribute most of it to that? I would say the app store is definitely

the best payment gateway to own, for sure, just as an asset. But what I would say is that there are two explanations there. There's the business explanation you touched on and then the pure financial explanation. So the business explanation is everything you said, that they have this, they've locked down this market, that everyone, the apps are always significantly cheaper than the phone. So you already have this sunk cost. If you want to get the most out of your phone, you pay a little bit extra every so often and you get these apps and that money accrues to Apple, very valuable for them. But the other piece of this puzzle is that as interest rates have dropped, any long duration stream of cash flows gets much more valuable and much more interesting.

And if it's a long, long duration stream of cash flows, that's fairly operationally predictable, then it gets really interesting. And if it's a long, long duration stream of cash flows, that's fairly operationally predictable, then it gets really interesting. And so if you start to think of the phone as not the product, but as this upfront payment that then creates several years of payments for different services, and Apple keeps getting a cut of those, then risks like the lengthening of the phone purchase cycle, those become less of a risk. They're more of something that means now your long duration asset is giving you software revenue for three to five years instead of one to two years. So you put a pretty high multiple on that and then the net present value of those phones sold actually goes up. And I think that's part of the shift was that if you looked at Apple

in 2010, 2011, you could say this is a hardware company, that's a of the shift was that if you looked at Apple in, in 20, 2010, 2011, you could say, this is a hardware company. That's a really tough business, right? It's consumer electronics,

historically a shitty business. Yeah. Yeah. And you could see all this competition. You could say, Google has an OS that's free and they want every, every smartphone company to be selling phones that run that OS. So there were all of these risks and a lot of those risks didn't play out. And then just what financial markets look for now has changed.

They look less for pure growth and more for just a long period where you can expect to get fairly consistent returns. Three words. Annual recurring revenue, I think, are like the three most important words on the street. And they just like this idea, this idea of subscriptions and Apple essentially can sell everything as a subscription now with the exception of in-game purchases or in-app purchases. So I think that that's, I think that's the big mindset shift and every technology company that figured out how to become an ARR business has seen a big updrift in its multiple. Yeah. In fact, you could say that since Salesforce was the company that

finally convinced investors that ARR is not this big vanity metric, it's actually the core metric. Maybe Salesforce is actually responsible for creating more market value growth for Apple than for Salesforce itself. Just by getting people to look at the cashflow streams and say, okay, Benny, I'm talking through the math here. I understand how this works now. So I'm going to pay for that. By the way, Salesforce now added to the Dow Jones.

So how's that for coming full circle? Bern, I want to thank you so much for being on the Compound show. Where do you want people to find and discover your stuff? It's called the diff. That's right. Where do they go? What's the URL? diff.substack.com. Okay. diff.substack.com. All right. Go there, read his stuff. You're going to want to become a subscriber. It's always excellent. When we look back and we see one of these companies start to

crumble, you'll come back and take a victory lap on if it's the right reason. That sounds like a great idea. All right. Awesome. I love it. All right. Thanks so much, Bern. Thanks for listening. Check us out at thecompoundnews.com for daily investing and market insights.

You can watch all of our videos at youtube.com slash thecompoundrwm. Talk to you next week.