We Study Billionaires - The Investor’s Podcast Network - TIP206: Mastermind Discussion 3Q 2018 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey everyone, welcome to today's show. Once a quarter, we get our good friends Toby Carlow and Hari Ramachandra to join us for our quarterly mastermind discussion. If you're not familiar with the format, each person brings one stock pick to the table and they pitch the rest of the group on the idea that the company might be a great investment. After the pitch, the remaining members of the group provide feedback and risk considerations on why the investment might be good or why they might have some concerns.

Starting point is 00:00:28 It's a great opportunity for us to go through our business. our line of thinking and hone our skills at asset valuation. So without further delay, we hope you enjoy our mastermind discussion for the third quarter of 2018. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, welcome to the show. We are always excited to do our mastermind discussions. And for people that have listened to these before. You know the group. But if not, we have Toby Carlow. He's with us from the Acquirer's Fund. And we also have Hari Ramachandra. He works at Salesforce as a senior

Starting point is 00:01:20 director of engineering. Works out in Silicon Valley. He's worked at other companies, call it LinkedIn or whatever. But he's our expert out in the valley and Stig and myself. So without further delay, let's go ahead and kick this thing off. And I believe Stig, you were going to go first with your pick for this quarter. Yes, so my pick for this quarter that is Google, and I'm very excited to hear what you guys have to say before I do my pitch. It's not your typical value pick at all, so I'm really excited. But 80% of the revenue right now comes from digital advertising, and you are probably familiar

Starting point is 00:01:58 with a lot of their products, AdWords, AdSense, Gmail, Google Maps, or whatnot. They have a lot of streams of revenue. and then you have 15% of the revenue comes from. They actually call it other revenue. It's a very original name and then other bets, which is the cloud that they're right now investing heavily in, apps in Google Play, hardware and so on and so forth. Lately, I think a lot of people have noticed that Google has been in the media

Starting point is 00:02:25 about breaking antitrust loss, the fine of $5 billion from the European Union. And just to give you guys in perspective, $5 billion, that comes out of an operating income trading 12 months of 30 billion. So it is significant, even though it's not something, of course, that will have detrimental effect on Google. Just as a fun fact, I can share that the last record of fines given by the European Union that was back 2017, $2.7 billion, and that was also Google. And it's primarily from bundling search engine and Chrome apps into operating system and so on, so forth.

Starting point is 00:03:04 So kind of like a ring from the past with Internet Explorer and Netscape, I guess. But if we look at the main source of revenue, digital advertising, this is a huge industry. We're looking around $250 billion in the market or so. That is out of all global ad spending, which includes radio, television also. But $250 billion, that is only digital advertising where Google is huge. You have the industry that is growing. Last year, it was growing at 21%. So it is rapidly growing.

Starting point is 00:03:38 And Facebook and Google accounted for 90% of that growth. If we look at the mode, and I can already say here, it's very interesting that we have Carter with us here out from the valley because you can probably talk more about the mode than I can. Of course, it's the algorithm and it's the search engine optimization. I think you come up with many different types of mode. So it really depends on where you focus. I like the idea of that the core business that they have right now,

Starting point is 00:04:06 they do not need to reinvent themselves the same way as, say, something like Apple. They're so dependent on their iPhones. I see a lot of moat right now in Google's algorithm and the search engine optimization. They're sitting on 90% of the market share. It's not up for me to say if it's a better algorithm than other search engines. I don't really know if it is, but it is the go-to place. and the platforms where programs are working in. So I know this is a long pitch,

Starting point is 00:04:37 and before I jump into AI and all the other good stuff, I would like to talk about valuation and hope to get some feedback. It's kind of difficult for me valuing a pick like Google. As a value investor, I typically have the idea that let's assume that nothing happens. If nothing happens, what kind of cash flows are coming in and what kind of returns can we get?

Starting point is 00:05:00 That really doesn't make too much sense with Google, or at least if you do that, you'll realize that the valuation right now is supposed to be oil priced. So what I did was I used a two-stage growth model in terms of expecting how much growth can we get over a relatively short period of time and then slowly see a decline after that. So again, it all depends on the assumptions that you put in. But if you assume a 15% growth over the next five years annually, and then actually, actually just cut it off and then have a 3% perpetuity growth after that. Then you will come up with a valuation right now around 7.5% expected return. So I'm very curious to hear from

Starting point is 00:05:43 the group right now what kind of thought you have about having Google. And if I can throw it over to Hari first, I'm very curious to hear for someone who knows Google better than most what you have to say about the evaluation, but also Google in general. Well, thank you, this is a great pick and probably timely from for based on the current events and I think you highlighted some of the key points which are very significant and as you said I guess 85% of Google's revenue is still from advertising so just to put things in context they are still massively dependent on advertising as a form of revenue whether it is search or YouTube or other properties that they have.

Starting point is 00:06:31 However, they have a lot of bets that is going on. So to me, Google represents optionality in the sense that they have self-driving cars. They have their Google platform. And then they have other initiatives that are going on and some of which we don't even know at this point of time. So that's number one. For me, number two, I'm hitting on some of the qualitative aspects here. I guess Toby and Kristen will be better at commenting on the valuation aspects. I'm going to leave it to them.

Starting point is 00:07:05 The second thing that I feel in the valley or in the tech industry, one metric I look for, which is usually not in their balance sheet, is their ability to attract talent. And in the pecking order of the Silicon Valley, and if you for now ignore some of the really hard startups, just among the bigger companies or even the mid-sized companies, Google is the top contender. I think if an engineer is coming out of Berkeley or MIT,

Starting point is 00:07:40 any other company, except for Facebook, we most likely will choose Google. Stig, I wanted to talk about the valuation part that you were saying, because I like the way that you want about value in it. I'm a fan of this pick. I think that this is a, you know, out of all, the picks that we're going to be talking about on today's show. I think I like this one the best. When we look at how the companies performed over the past 10 years, what I did is I went and looked

Starting point is 00:08:06 at the top line. What was the growth rate of that revenue over the last 10 years? And when you look at that, it's at around a 19% growth rate for the last 10 years annually. So if we start with that as our foundation saying this is what they've done in the past and what they've done in the past is unbelievable. Can they do that moving into the future? So, So if we start with that as our foundation for valuation, if they made 19% annually in their top line and they continue to make 19% in their top line, what kind of valuation comes out starting with that as our baseline? And then we can adjust from there to kind of determine whether we think that that can

Starting point is 00:08:44 be sustained or not sustained. So if we start with that valuation and we say that it's going to continue to grow at 19% for the next 10 years and then after that we'll just use inflation, at the current price you're going to get around a 9% return. So now the question becomes, well, do you think it can keep growing at 19%? And, you know, I don't think that we're going to hit those kind of numbers. I mean, maybe I might be wrong, but I would say maybe 10%, maybe half of what they've done in the past is what maybe they'll do in the coming 10 years.

Starting point is 00:09:16 And so then let's look at what that number kind of produces as far as evaluation goes. And so when we plug in 10% growth into the future for the next 10 years, we're getting more around a 4% return. And, you know, if it's less than that, well, then you're right where the rest of the market's priced at. So I think it's priced better than the market, my personal opinion, because I do, I don't think that 10% for them in the next 10 years is out of the question, especially with where they're at with AI. But I think there's a lot of unknowns and I think it's, you know, those are big numbers to produce in the coming 10 years. 10 years. And I think that no one's going to argue with that. So I agree with everything that Harry said is specifically on the TensorFlow stuff and their cloud computing and the way that they're going to be basically outsourcing resources and also storage on their platform because I think

Starting point is 00:10:05 everyone's going to want access to their open source AI. And I say open source with quotes around it. But I'm a fan. I'm definitely a fan, especially when you look at some of the other stuff that's out there. Yeah, Stig, I agree with you that Google is a phenomenal business. the growth rates in it are just astonishing for how big it is. It's a market caps like 86 billion enterprise values about 770, which means that it's got roughly $100 billion in cash and investment sitting around. The thing that I run into, the problem that I have with it is I think it's expensive. It's that he's like 54.

Starting point is 00:10:43 If I look at the metrics that I like, like an acquires multiple 25 enterprise multiples on like 20. If you look at any of the quality metrics, it scores off the charts and any of those quality metrics. So I think it's one of those companies that it's very hard to lose much money in something like this because you buy it likely is a bigger company 10 years from now. The question is how much bigger over that 10 years and therefore does it justify the price currently? It's not a company that I would invest in because it's just the valuation turns on the growth. And the growth has been extraordinarily high and it has to continue to be extraordinarily high. If it does that, then you get pretty good return, but not a phenomenal return.

Starting point is 00:11:24 Whereas if it disappoints in any of those metrics, then the return is going to be much more subdued. But I don't think it's a stock you lose money. And so I think that the risk reward is interesting. Like the downside is very little. The question that you have is how much money can you make? So, you know, for that reason, it's not a bad pick. I want to talk risks as well, Toby, because what we saw recently with Mark Zuckerberg going up on the hill and testifying in front of Congress, and they were asking their questions, which were absolutely hilarious, you can quickly tell

Starting point is 00:11:55 that there's a major gap in what I would say the majority of Americans or anyone around the world really kind of understand about tech and what Silicon Valley understands about tech. And until that gap gets shored up, I don't necessarily know that you're going to have the regulations kind of take hold, but I think that that day is coming. And I think that what the focus is going to eventually turn to from legislators is a focus on making your data history more accessible and easier for you to adjust. As soon as they get on that narrative, and as soon as they start forcing that into some type of regulation where, let me give you an example, you go on the Facebook and it's required by law that in the navigation bar, there's a button you can click

Starting point is 00:12:48 that goes into your entire history of every single thing that they've collected on you, and that you can go in there and amend and tweak that at ease. And I think that that's where the legislation is going to change is that. It's very easy somehow that the spirit of that is built into the law, that they have to make it very easy for people to go in and amend their history and what's being collected on them. Once that happens, the ad revenues for Google, Facebook, whatever, drastically changes in my personal opinion. Because if I can go in there and see every single piece of

Starting point is 00:13:22 data that company X is collecting on me and I can delete it, you know, with one click, boy, the whole game changes and the money that these companies are making are going to be drastic. The problem that I think you got right now is an education problem from legislators. They know there's a problem. And I think most people don't like not being able to control that. I think if you interviewed 100 people and asked them, do you wish you could control the data that's being collected on you with a couple clicks? Everyone, every single person is going to say yes. But what the problem is, is you don't have legislators that can basically orate that or basically say that that's what the issue is, is the control of the history of data. Instead, they're asking silly questions like, you know, are you collecting on my text messages and not really talking about what the fundamental problem is?

Starting point is 00:14:13 And the fundamental problem is that people don't have control of the data that's being collected on them from a historical context. And as soon as they figure that out, I think it's going to be a bad thing for Silicon Valley. I've got a question for you. In that sort of scenario, would you rather be Google or would you rather be Facebook? I think both of them are going to be punished extremely hard on this. But to answer your question, if I had the pick, I would probably say Google. I don't think that people realize how much data Google collects on them. Whereas you sort of feel like you've shared a lot with Facebook,

Starting point is 00:14:46 which is why there's a lot of enmity towards Facebook at the moment. And I think that's even shown up in some, like their daily average use has dropped pretty significantly over the last, probably 10%. This and to your point, I completely agree with you. To your point, how often are you on Facebook and whatever number you come up with? How often are you using a web browser? Okay.

Starting point is 00:15:09 And what's going through the web browser? I mean, I'll even take it a step further. I've got Google routers at my house. And it doesn't take a genius to figure out real fast who's collecting more information on you. And you can, if you log into the Google page and you can see, you know, it tracks your cell phone. So it can see everywhere you've been for years and years and years. That's pretty scary. Yeah.

Starting point is 00:15:31 No, I mean, I think that that's really, when you get to the crux of the issue, as soon as legislators figure out that what I just described is the issue, the question then becomes, okay, well, they were. making this much money per person when they had full open access to pretty much anything that they wanted and people couldn't delete anything. But if that would change and you got, let's just say 10 or 30% of the population literally wipes their entire history clean, and we're making a very strong assumption that something like that would ever exist. But if it would exist, what happens to their numbers? Oh, man, I think it's going to be brutal. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending. three days in Oslo at the height of the summer. You've got long days of daylight, incredible food,

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Starting point is 00:20:15 All right. Back to the show. Yeah. So I completely agree with your concerns about the valuation. I mean, it is hard to bring a growth pick or whatever you want to call Google into a group of value investors. I guess. And so I completely agree with you guys.

Starting point is 00:20:35 It looks really, really hard. Whether or not you would use my 15% for five years or Preston's 10% for 10 years, I think it's really, really difficult. I like Preston's approach about saying, what's the top line, which is basically also what I did, and I subtracted some. I mean, it's not really a scientific art whenever it comes to predicting crazy growth rates. Because, I mean, you have to come up with something and argue for. why you think it should be 15 times five or 10 times 10, whatever you want to come up with. I think

Starting point is 00:21:06 whenever it comes to Google, I think one thing that is unknown, and I know that I am talking like a growth investor right now and not as the value investor I would like to be, I think the future of AI, I think is going to be very interesting. I think that Google right now is probably best positioned. And again, I'm not the right person to ask. It's probably better to talk to Hari and someone who knows what they're talking about. What I know with the little knowledge I have about Google, you know, with Tendaflow and for them more or less being the standard, if I look at the numbers and the dollar value of the acquisitions and AI, I mean, Google or, you know, they're buying up more AI property than anyone else combined, which is in itself like pretty crazy whenever you think about it. So to me, it looks, I think that. pot looks appealing. I think in terms of digital advertising, I don't think that we will see a dramatic slowdown, even though, of course, a recession wouldn't be too good. There's a lot of room to grow for digital advertising right now, and it's hard for me to see that Google and Facebook won't continue to be the emergence of the winner. I also do want to say if we look at the valuation

Starting point is 00:22:16 right now, and if we look at, you know, compared to the past 13 years, I like to look at the EV to the EB. It's not too different from whenever Toby's talking about the quest multiple. We have a median of 18 and it's slightly above right now. In his historical perspective, it's not good. And the last thing I just want to say before I throw over to the group is, you have just full disclosure, I am long, Google. I bought here some time ago, not a decade ago like I should, but I am actually right now considering whether or not I should add more to that position at the price level as it is. Again, I am almost blinded by how great company. company of this, and I'm probably too optimistic with the growth rates.

Starting point is 00:22:55 I wanted to throw one thing out there, Stig. So we were following this ticker AIEQ, which is this artificial intelligence ETF, Berkeley PhDs are the guys that have stood this thing up. This thing scouring the entire web. And its number one pick out of its entire portfolio of every single stock on the market is Google. And I mean, I'm not, there's no analysis to that as far as value. valuation, growth, whatever, but I can tell you that this bot that's using machine learning has selected Google as its number one pick. I also want to say that the risk that I highlighted

Starting point is 00:23:32 with respect to the legislators and stuff like that, I don't see that happening anytime soon. I really don't. I think that, you know, although we talk about it, could it happen? Yeah, I mean, it might be years out there. But from what I'm seeing and what I saw on that last thing with Mark being on the Hill testifying, I mean, they're nowhere close to Stan and sometimes. type of policy up or anything that's going to limit this? You know, Harry, I would really like to ask you about this AI piece. I mean, I know it's always horrible to say this time is different. I think we tried that so many times in financial markets and we are usually always wrong.

Starting point is 00:24:07 It is, however, astonishing to see what Google can achieve with only 89,000 employees. It's incredible, like kind of growth rates they have, considering the size. It shouldn't be able to produce so much revenue and produce so much profit with the amount of people they have, will AI completely wash out the conventional metrics in many ways with an exponential growth, even for something as big as Google, in your opinion, Harry? One of the things I find very troubling is the way AI is being used as a buzzword for everything nowadays. And that's the risk. And IBM Watson is famous for just slapping AI on everything they do. It's actually an automated checklist for the most part.

Starting point is 00:24:50 So I think that's where we have to be careful in buying into the hype for Google actually is more relevant in search and YouTube, which we don't seem to notice. In fact, their AI and machine learning sense are from their search background because they perfected it with their search engine. The way they can predict what you want to type and all that stuff. stuff. And we should not also forget YouTube. I think what I've heard is YouTube's mission is to take over your living room. I feel among all the companies, Google has the most hold. I think Stig, sorry, Kristen kind of gave a very nice overview of how his life is now being captured by Google. I think Google is in our living room with Google Home. And then we have YouTube on your TVs. Android TV, with Android, as well as Google Search, and with the self-driving car, I think you will be pretty much leaving a Google life. Okay, guys, thank you so much for the feedback. Let's move on to the next pick, and that would be Hari.

Starting point is 00:26:02 You're up, man. Okay. Continuing on the same theme, I thought it would be timely and interesting to bring up Facebook. The reason I want to bring up Facebook is it has been in a lot of news for not really good reasons. Due to their recent guidance and quarterly results, their stock had taken a beating.

Starting point is 00:26:25 Now it's kind of recovered a little bit. But at the same time, I want to just cover some of their key aspects and then I'll come to the risks later and I wanted to get your opinion on the pick. An average user of Facebook spends around 41 minutes every day on Facebook and around 25 minutes on Instagram. So pretty much one hour on Facebook

Starting point is 00:26:45 properties. Across the North America, they have like 72% of the population on Facebook, Asia where they're growing really fast, they have 17% of the population. This is minus China. And Europe, they have around 41%. At the same time, Instagram is also going very fast. And Instagram now has 800 plus million members and close to a billion. So they're, they're growing very fast over there as well. So that makes it very interesting. So now getting to their business. I think it is fair to say that there are one trick pony even today. All their revenue comes from advertising. And in terms of Facebook's revenue, they were growing at a pretty hefty rate so far, still they announced the recent changes in terms of what they're doing

Starting point is 00:27:40 and based on GDPR and other compliance issues. They said, that they might slow down in terms of their revenue and in terms of their margin. In fact, in the latest quarter, the second quarter of 2018, the revenue was 13 billion, which was an increase of 42% year over year. But even without regulation risk, it is fair to say that at some point, the law of big numbers will catch up with them

Starting point is 00:28:10 so they cannot keep going at these rates forever. Kind of what I would like to highlight here is that even if we consider that their margins are going to go down, their operating margin today is around 49%. I mean, that is unheard of. I think to give you some context, if you look at the margins of an average SNP 500, or a medium, the margin is around 19%. considering that you're not going to capitalize their R&D and content, which I think you should. And if you do that, their margin will come up to 57%.

Starting point is 00:28:51 We can assume that their margins will go down because of all the changes. Systems and Toby, you guys are much more the right people to talk about valuation than me. So what I wanted to make the case for Facebook, on the tenant that when there is a lot of bad news, there might be value. that would like to know your opinion. You know, Hardy, I think it's a very interesting pick and there might be value. Because you have to like factor in a ton of growth. But I do want to say that right now,

Starting point is 00:29:24 you can look over the past eight years really since the time that they went public. The lowest the EB-2-Aid has been, that was 18.4. And right now it's 20. And the median is 41. So, I mean, in historical perspective, it is interesting.

Starting point is 00:29:39 then you can always argue is it just chronically overvalued because then you can use these numbers or really anything. But it is interesting. But to get a decent return, I mean, we have the same problems that we have whenever we talk about Google. Like you have to factor in some very generous double-digit growth rates. You know, you have to come up with a short run, call it five, seven years, whatever, like on something like 15, 20 percent annually or something like that. And I'm not saying it's not possible. You know, the way that Facebook has grown the revenue, I think it's been so impressive. One, a worry I do have before throw to the guys in terms of talk more evaluation.

Starting point is 00:30:17 One worry I have is what is the backup plan, do they need a backup plan? 98.5% of revenue comes to digital advertising. Then they have 1.5% from other bets, which is primarily the payment processing system. But guys, Preston and Toby, what are your thoughts on the valuation? I think this is a very similar situation to Google in that the business is spectacular. The balance sheet is pristine. Market caps $520 billion. Enterprise values 480.

Starting point is 00:30:47 So it's sort of net cash and investments. P is 27 high, which is about half what Google is. So it's interesting. If you put Facebook on the same P.E. as Google, it becomes another trillion dollar company. I've spoken to Hary about this offline before because it's something that I, I have observed for a while too that if you look at, as opposed to sort of the late 1990s.com boom, where things were just crazy overvalued without sort of any underlying business, the fang stocks now aren't sort of crazy overvalued if you believe that the historical growth rates persist.

Starting point is 00:31:23 So Facebook's been growing at 40% plus for five years. You know, that's on the top line. Ibit die growth is like 60% plus. EPS is explosive. of like 186% compound over five years, kind of an amazing number. If you assume all of that holds, then it's probably half price.

Starting point is 00:31:42 If you assume that it slows down or it runs into some headwinds, then it's probably expensive. But I get to the same point that I did with Google. I don't think there's very much downside, and it's probably a much bigger company in 10 years than it is today. The question is just, you know, how much bigger does it continue to grow?

Starting point is 00:31:56 And therefore, is the valuation justified? For me, it's my bias is always to be more wary of growth rates, but that hasn't been a great strategy for the last five years aside. I think that you know you got a winner when people hate your platform and then they go on your platform to talk about how much they hate your platform. And Hari, what I really captured from everything that you said was everyone's mad, everyone wants this to be fixed, everyone wants their privacy to be protected. Facebook's going through some really rough times from a PR standpoint, but the numbers are

Starting point is 00:32:29 telling us a different story. That's what I got out of what you said. And I think you're kind of right. I think the numbers are pretty much saying that everyone's still using the platform and they're not as upset as what they're basically with the media is making it sound like. I did the same thing as you, Toby. I went back and looked at the top line growth and I got, you know, a very high number, like way higher than Googles.

Starting point is 00:32:52 And that's something else. You know, I mean, to have 40, almost 50% growth rate on your top line for the time that's been a publicly traded company is pretty insane. You're getting a much higher growth rate and you're paying a much lower multiple. So I think Facebook and Google probably Facebook is much, much cheaper than Google at the moment. Yeah. And from the numbers, you know, from the valuation standpoint, I completely agree with you. Because whenever I go and I drop the growth rate down into the coming 10 years at 10 percent, I mean, I'm coming up with a 5.5% percent return on the free cash flow of the business.

Starting point is 00:33:29 So, I mean, it's a hard one. I personally can't stand Facebook. I just freaking despise. No, I really do. I despise Facebook. I just think that it's the ultimate time trap. And I think that one of their challenges is there was some study I read. This was a while ago that when people go on and they use Facebook, they feel worse about themselves after they're done using the platform. And I think that when you look at why was Mark Zuckerberg testifying in front of Congress versus Larry Page and Sergei Bryn and some of these other folks, like, why Mark?

Starting point is 00:34:04 And I really think it comes down to this idea that most people can't stand Facebook. Like deep down inside, they hate it. It probably makes them feel like they're back in high school again or whatever, and they just can't stand the platform. Where Google, it's like, I think most people, if you ask a person, how does Google make money? And they'd be like, oh, advertising because people just know that it's advertising. But at the end of the day, Google is so much slyer at what they're doing.

Starting point is 00:34:30 and so much further under the radar at what they're doing that it's like, you know, I don't mind Google. I like Google because the little bit that they, I mean, think about it. If I go onto a search engine, I'm trying to find something and Google gives me the first result and I don't have to search around for it. I like that. It's not like I feel like, you know, some person that I met 10 years ago is bugging me with messages on Facebook. You know, like that's annoying. People don't like that. I don't know.

Starting point is 00:34:58 I think that that's their challenge moving forward is how they manage this from a social standpoint and from a psychological standpoint with their users and like, you know, from a regulation standpoint, who's going to come down on them? But from the numbers standpoint, I'm with you, Hari. I think that the numbers look pretty good. I just, I don't own this. I don't want to own it for some reason. Maybe these are all my biases coming out during the show is probably more of what it is, but I mean, those are some of my thoughts. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:38:39 and expenses. This and other information can be found in the income funds prospectus at Fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Toby, let's hear your pick. I've got the highest tech pick for the day. I think it's Pilgrim's Pride, PPC, which is like a chicken butcher distributor. As you can imagine, it's not as exciting as Facebook or Google and they don't make as much money. Chicken production, basically very fragmented industry, very cyclical.

Starting point is 00:39:14 So if beef gets too cheap, then that hurts chicken prices. It's not a great industry. It's not when you buy as a compound. Pugram's pride has been hurt because the not really sure what's going to happen with the tariffs. This is something that can get hurt because it distributes internationally. So the reason, though, that you might want to own it is I think it's very, very cheap. So market cap is about $4.4 billion. Enterprise value is $6.4, which means that it's got some debt on its balance sheet.

Starting point is 00:39:43 But you get it on a P of a little bit over seven, and the acquirist multiple on it is a little bit under seven as well. It's fine on all of the health metrics that I look at. Petroski's about four, so not great. Altman Z score, which looks at financial distress is safe, which, you know, given its debt load, it's something that I wanted to look at, finish M score. So this looks at whether they're manipulating the earnings or not. This is sort of on the fringe at negative 1.5, negative 2.2 is the cutoff there. It has a pretty reasonable return on invested capital around 20%. if I do a reverse DCF on it, you're sort of assuming a negative growth rate of about 1% at the current price. And I think that you're already compensated at this price for all the risk that's in this stock.

Starting point is 00:40:35 So in December it was trading at $37, currently trading at $17.70. So it's off about 50%. So it's got about 100% head rem. I think DCF valuation, it's been growing pretty consistently over the last five or so years, about 5 or 6%. So if you assume roughly 5% growth, I get to about $2730 for this stock. So I think plenty of margin of safety where it trades now. Not a great business, as I said, because it's very cyclical. But I assume that the tariff situation will sort of scare markets for a while.

Starting point is 00:41:08 But when that goes away, it'll sort of be roughly back where it was. So I think $2730 is a reasonable estimate for this stock. Toby, let's talk your position on the whole tariff thing, because I think that that's a really important part to understand this company. How do you see a lot of that playing out or kind of how are you positioning yourself with respect to the risk of it? I don't know how it plays out. It's one of those things that, you know, I'm just trying to take advantage of the situation as it presents itself now. I think a lot of these stocks are priced as if the worst news is the tariffs come in and these things are targeted.

Starting point is 00:41:42 I think that that's the time to buy when you have that uncertainty. Once the uncertainty's gone, you know, I think this is going to be trading at a higher level. I mean, from the numbers standpoint, I'm assuming Stig, you got very good numbers on this as well. I got great numbers on this. Yeah, I have something like 9% even without growth. I always love whenever Toby is on pitching something because it's always cheap. And I like that to what you said before, Toby. Yeah, we're probably not looking at a lot of moat here.

Starting point is 00:42:11 It is a pure play on chicken, which can be quite vulnerable. It goes a little under the radar because of the environment issue. compared to beef. But of course, you have the animal welfare thing. You do see a shift as little as it is whenever it comes to that. You know, there were a few things that I found really interesting about this company. First of all, that they have like this major shareholder of 78%. And I also think a diligent shareholder, the way that the debt is financed is payable after 2025. I can't just, whenever I look at the landscape of companies, I can't really fathom why so many are doing short-term loans right now, whenever they can secure something more, I wouldn't say for free, but take a lot

Starting point is 00:42:53 of the risk off. So I really, I really like that. It is creeping up because of the acquisition they did last year. They do have a bad history of too much debt whenever, well, actually they went bankrupt in 2008, but it's a very different company now. If some of you were to look at the company and like, this is not good whenever there's a recession. It's really because of something else and it's been restructured since. I think the main concern I have is the fear of overproduction And you also hit on that, Tobin in terms of the technicality of the business. It really looks like we're evaluating something on the very low multiple, something that is probably a, call it leveraged earnings, whatever you want to call it.

Starting point is 00:43:33 It seems like we're at the top, not just in general market, but really like in the chicken business. What are your thoughts on that? Is that something you fear in sense that it is already very, very cheap so you can't withstand some adversity or some headwinds? Chicken prices are pretty beaten up at the moment relative to the last three years, and it's sort of below its five-year range. The stock is about where it was about five years ago, but it's considerably bigger stock than it was then. I think that people continue to eat chicken into the future.

Starting point is 00:44:05 I don't see chicken consumption going away. How much that benefits Pilgrim Sprite, I don't know, but it's not a bad business. They've got pretty good scale, pretty good efficiency. They're one of the big ones around Sanderson Farms, speaking the other one, industrious, but Choco is a Mexican one, Tyson, Ferds. They're acquisitive. So once a year they do an acquisition, which is the reason for some of the debt. So I think that these guys have done a pretty good job of the last period of time

Starting point is 00:44:29 sort of working through what is a tough industry. And I think if there's some weakness in the industry, it's to their benefit. You know, Toby, that's where I was going to come at this, where you guys were saying there's not much of a moat. Is the moat just purely the market share that they already possessed. So I'm looking at the last 12 months, they've done $11 billion in sales, which I think is quite a bit. I'm kind of curious what that market size is and what some of their competitors are. It's a sort of business that you're really only competing on price. I don't think anybody walks into, you know, they sell through supermarket chains and restaurants and other places

Starting point is 00:45:01 like that. You're basically competing on price. So the only way you expand market share really is is you buy competitors or you lower your prices. But, you know, the prices are pretty low at the moment. All right. Well, I guess I'm the last one to go here. And the reason I'm the last one that goes, because about 10 minutes before we started recording, I said, I've got to change my pick. I'm changing it to this.

Starting point is 00:45:22 And I gave these guys no time to prep so they could pepper me with any kind of questions. So I'm just going to, I'm going to lead with that. And the company that I selected was H&R Block. The ticker is H.R.B. This is not nearly as sexy as some of the other picks. I mean, it's probably about as sexy as the chickens we were just talking about. But as far as Google and Facebook, it's definitely not there. When you look at this company just to kind of give you a little bit of an overview, their top line is about $3.1 billion per year on their revenues. Their free cash flow hovers around. I mean, it's a little lumpy, but it's not really growing and it's not contracting. In fact, 2018 was some of the best free cash flow that they've had in the last 10 years. And it was at $750.5.5.000. $51 million for the year. So I look at this company really not taking more market share.

Starting point is 00:46:16 I don't see them really losing any market share. I think that their competitive advantage is in the fact that when people go on to do their taxes, their tax information from the previous year is loaded into the cloud on their system. You know how to use their software. It auto flows all your information over to the coming year. And so if you use H&R block this year, you're very likely to use it again in the coming year because it's just ease of use. So I think that there's a competitive advantage there for anybody that it was in this space to begin with. I think it's very difficult for newcomers to come into this

Starting point is 00:46:49 space and kind of take market share. I like that. From the numbers standpoint, I am pretty much keeping the growth really flat, maybe around a 2%, 3% growth just to keep up with inflation. And I also accounted for in my model about a 20% chance that you'd see a negative 5% growth going into the future. And with those numbers and the price that the stock is currently trading at, it's trading around $25, $26 right now. I'm coming up with a 14% return. And I'm looking at this, just like if it was a fixed income bond is how I'm really kind of valuing the business. I think it's just going to continue to be pretty consistent moving into the future. And I feel like that's a pretty large yield considering where the rest of the market's at today.

Starting point is 00:47:33 So I'm curious to hear everyone's thoughts, now that you guys had 10 seconds to hear my pitch and to prepare for this. Let me hear what you got. Toby. I like this pick for a few reasons. It's cheap on acquires multiple bases, 6.9 times. When I look at the balance sheet and the ratios that it all looks really safe, like if I just go through Petroski 6, Altman, which is the financial distress says it's very safe, Benish, which looks for manipulation says it's not a manipulator. The market caps 5.3 billion enterprise values about the same. He's about nine, which is probably too cheap for something like this. If I look on a reverse DCF, it's assuming you get a fair value for around 33 bucks

Starting point is 00:48:13 when it's trading about 25 growth rate assumed very, very modest, where it's been growing pretty rapidly, 7.8% over the last five years on a revenue basis, 7% on an EBITDA basis. So I think it's a good combination of it's a pretty good business at a pretty low valuation. I guess the qualitative questions are, does the IRS ever get its house in order and send out those much simplified forms, which means that people don't have to do anything, they just sign off? Or do the scrapers that the kids like to use, like mint, or when I say the kids, I use it to, you know, mint or there's things that track your, you know, the way I do my taxes, I use, it's an Intuit product which just collects all of my data through the year. and I have a little app on my phone that I kind of direct to business expenses and so on. And then that pre-populates the tax that I then give to my account at the end of the year. So there's a sort of intermediary step in between these guys, or do these guys work with an intermediary to kind of, that's not an issue for them, sort of questions for you, Preston?

Starting point is 00:49:15 I think most of their customers, and I could be wrong about this, but I think most of their customers are people who get a W-2 at the end of the year. No really other investments. You know, they're intimidated by the IRS form. And so they log on to this thing and it's literally a click-through screen that they input the numbers right off their W-2 and it just walks them through every step to make sure that they have like that sense of fear removed that they're going to get audited. I mean, all those kind of concerns when, I mean, those people are the ones that are not going to be getting audited because the money's already been taken out of their W-2. But I think it's a sense of not knowing what you're doing and kind of using their software. That's my impression. I could be dead wrong about that. And I don't know what market share of their revenue is that person that I just described.

Starting point is 00:50:01 But I just think that there's a very large mode around the fact that they have the history in the cloud of everyone's previous returns and all their information. It's a funny stock that hasn't gone anywhere for a really long. It's trading roughly where 10 years ago I was trading at 25 bucks. And here it is it basically 25 bucks, but it's cheap. Yeah. So is it the fear of the IRS doing that? So what's keeping the price down? And here's, and I want a caveat with what Toby just said because I completely agree with

Starting point is 00:50:30 them. But when you look at the payout ratio, the payout ratio on this company right now is 80%. So whatever they're bringing in on earnings, they're paying 80% of that out to people in a dividend, which I think is great. So if the price doesn't move, so what? You're making decent return on the dividend. I don't know. I think that, you know, you get some of these companies that just continually,

Starting point is 00:50:53 trade at kind of a lower multiple relative to everything else. I think maybe the reason you might see it trading at a lower multiple simply because there's no growth whatsoever. I think everyone's growth hungry these days. So, and they're always growth hungry. What am I saying? You know what is funny? The growth isn't that bad. It's growing faster than GDP. Growth rate for the last five years is about 7.8 percent last 10 years is about 2%. That's a revenue line. Which is a bit lower. But the EPS has been 10 years at 5.7%. That's pretty good. Pretty, pretty good.

Starting point is 00:51:27 Yeah, I don't know. I liked it. I liked how ordinary it was and how kind of it's under the radar. And I think the numbers look good. But anyone else, Stig? I know you had maybe five seconds to repair because whenever I started talking to you, when I first turned on Skype, you didn't even know that I'd changed my pick. No.

Starting point is 00:51:43 I mean, I guess my excuse will be that I didn't have too much time to come up with being like a really negative person. on this pack. I mean, the numbers are absolutely amazing. I mean, especially in this market, I don't see a ton of red flags. We actually wrote an article on intrinsic value index not too long ago with Christoph, who we were collaborating with. And it was about tax TAX, that was the Tigger, which is a very similar company. And so in general, within the industry, I don't know how much it applied to specific with the services of HRB, but you see more and more automation. which is also one of the reasons that

Starting point is 00:52:23 HRB are closing down 400 locations. You see a lot of the need for, and this is just like a general thing about the industry, at less need for like speaking to the customer, the person one-on-one, and a lot more can now be done with computers and different systems than this that's really like taking the customer.

Starting point is 00:52:42 Now, so I don't think I would include a lot of growth. I don't think that was what you did, Preston. And the thing is, you know, even if you see like a small decline, it's still a very, very decent pick. I mean, it sounds crazy after talking about, you know, Facebook and Google, where we're like trying to pump up like 15% annually or 20% annually. And now we're talking about, well, if it's only soccer did less year by year, it's still, you know, it's still okay, which is a very different discussion to have. But I think it's a very decent value pick to have, especially if you're income investor. They've been buying back

Starting point is 00:53:18 stock too pretty consistently. So in 20 years ago they had 400 million shares on issue and now they've got a little bit over 200. They've roughly halved the shares outstanding over close to 20 years. So they're doing the right thing. The only issue is that the managers don't own any stock. Yeah. Yeah, that's

Starting point is 00:53:34 kind of telling, isn't it? And also Preston talk about turbotax in Q and what are some of the risks is intubot or turbotak cannibalizing a lot of H&R block customers. Is there still more room for turbotax to cause damage.

Starting point is 00:53:52 And another perspective is I know Intuit is right here in the Silicon Valley, they're doing a lot of work to revamp their technical stack, their technology. They're infusing a lot of new methods and methodologies. And I can see that they're reinvesting in their technology, in their platform. And their payout ratio is like 30% compared to the 80% to say. So that means that they will keep investing. investing more than H&R Block. So my personal opinion is Intuit is a great company.

Starting point is 00:54:24 I think that they're much more developmental. They're coming up with a lot more products. They're in a lot of other areas than H&R Block. But from a pure numbers standpoint, by saying that Intuit is taking some of the turbotax or whatever, you know, I know turbotax is one of their divisions and one of their products. But to say that that stealing market share from H&R Block, I just don't see it. From a number standpoint, looking at the top line, I don't see it. So if they haven't done it in the past five years, I guess my impression is they're not going

Starting point is 00:54:54 to do it in the coming five years because I don't think too much from a technological standpoint has really changed in the past five years. But I think the reason I bring it up, I want people to go out there and check it out. Like I said, the ticker is HRB. Look at some of the numbers. Dig into it a little bit. Tell us on Twitter if you think we're totally missing something. We always appreciate that.

Starting point is 00:55:13 All right. So we really, really enjoy these conversations. Toby, thanks for coming on the show. Give people a quick handoff to where they can find out more about you. My website is Acquireasmultable.com. That's got a free screener that shows the 30 cheapest in the top thousand stocks. And PPC, which was my stock pick, came from that screener. I'm on Twitter at Greenback, G-R-E-N-B-A-C-K-D. And I talk to people and interact. about stocks and things on Twitter. And finally, my current book is the Acquirers Multiple. That's available through Amazon. And if you log in there, you'll see that I've got also quantitative value, which talks about some of the metrics that I discussed today. Thanks, guys.

Starting point is 00:55:58 And Hari, give everyone a handoff where they can learn more about you as well. Yeah, my usual place where I hang out my blog, bitsbusiness.com, share your comments and give me your feedback. Thank you. Well, we really appreciate you guys joining us. If people are listening to this and you guys want to just a quick link to that stuff that they mentioned, it'll be in our show notes. And we just always enjoy doing this.

Starting point is 00:56:22 So thanks for joining us, guys. All right, guys. That was all that Preston and I had for this week's episode of The Investors Podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to the Investorspodcast.com. To get your questions played on the show, go to Ask the Investors and win a free subscription to any of our courses on TIP Academy.

Starting point is 00:56:47 This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or rebroadcasting.

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