We Study Billionaires - The Investor’s Podcast Network - TIP248: Mastermind Discussion 2Q 2019 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we've reassembled our mastermind group to talk about various stock investing ideas. And like previous episodes, each person brings one investment idea and the rest of the group helps identify risks, concerns, or even praise. So without further delay, here's our mastermind discussion for the second quarter of 2019. 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. Hey, everyone. Welcome to the Investors podcast. I'm your host, Preston Pish. I'm accompanied by my co-host,

Starting point is 00:00:49 Stig Broderson, and we've assembled the Mastermind Group, second quarter 2019. Toby, great to have you back. Toby Carlisle, the Acquires Multiple Podcast. We got Hari here. Guys, great to have you. Hey, thanks for having us so long. I love doing this show. We love having you. I volunteered Stee, that he was going to go first. And most of the reason I did this is because I'm really excited about his pick. You know, we always tell each other what we're going to pick so we can kind of do a little bit of research before the show. Each time I kind of look through him like, yeah, that won't make sense. That one makes sense. But this one here that Stig's about the pitch, this is an over-the-counter traded stock. And I'm telling you, this thing is kind of sweet.

Starting point is 00:01:28 So Stig, fire away. I can't wait to hear your pitch. Well, thank you, Preston. You're definitely putting a lot of pressure on me. So how often do I Do I lay up your pick like that, buddy? God, I don't think that you ever done that before, buddy. So I take that as a huge compliment. But you can hear the pits and then you can decide for herself. So my pick is I got games. The stock ticker is I-G-G-G-F.

Starting point is 00:01:53 So you can already tell from the tigger that it's typically not something people trade a lot of. It's a mobile game developer company headquartered in Singapore. The games are somewhat popular across the globe. They have 580 million users, even though you probably. haven't heard about the company, but you might have heard about some of the games. The two most known games are Lodz Mobile and Castle Clash. And the way that they generate revenue is the in-app purchases to enhance the gameplay experience. So you can basically play the game for free, but if you want the fun stuff, you'll have to pay for it. At the time they're recording this podcast episode,

Starting point is 00:02:28 we're doing this June 9th. The enterprise value is about $1.2 billion, and the revenue and cash flows for 2018 or the fiscal year of 2018 were 749 million and 234 million. So already trading and attractive multiples, as you can tell. There are quite a few reasons why it first got on my radar. It has significant financial strength. It's sort of weird for many tech companies. We're not talking about big tech here, but it's for many small tech companies to be so cash rich, having no debt, and actually being very profitable. It's just to mention some of the key metrics I've been looking at, Current, the quick ratios just below three, and the cast and cast equivalents alone are more than 2.4 of total liabilities. Another thing I would like to highlight is the high insider ownership.

Starting point is 00:03:17 So the two co-founders, they're both active in the business today, and today they own a combined 30% stake. Especially for smaller companies that are quickly growing like this one, I really like the high insider ownership and the consecutive and growing dividend. Currently, the yield is 2.6%. The gaming industry in itself, just to give a brief overview, it's huge. It's currently at $134 billion. The biggest players are Tencent, Sony, Apple, and Xbox. There's a lot of networking effects in gaming. It's not like whenever I was a teenager and had time to play a computer. Back in those days, you primarily played single-player games. Today, it's very different. You play usually always multiplayer games. And if your friends are playing, you would typically be playing the same game. game too, even though that most often you would be playing with strangers. Like everything in software, gaming or typically high margins, gross margins around 70% specifically for this company and operating margins around 30. Back in the days, it could actually be slightly higher, but today you have artists, game designers, so many programmers. A computer game today is such a big project that

Starting point is 00:04:30 it definitely cuts into the margins, but the pie, so to speak, is a lot bigger. If we look at the value, of the company. I wanted to be somewhat conservative. It's actually trading at relatively good multiples, as we have briefly mentioned before. We have a TIP multiple, just about five. And the way we calculate the TIP multiple is comparing the operating income with the enterprise value. Whenever you think of the size, so just above one billion in enterprise value, it's around 10, 11, 12 of the cheapest stocks in our screener. Looking at the valuation, I really wanted to be somewhat conservative. I used a 10% probability for a 10% growth, a flat growth I assigned 60%. And a minus 15.

Starting point is 00:05:13 I really wanted to be negative here. A minus 15% growth rate, I assigned that at 30% probability. And if I do that, I come up with an expected return of 14.4%. That was my pitch. So I'm curious to hear it. Actually, I would really like to hear from your president, because you're pretty excited, perhaps even more excited than me. I'm excited.

Starting point is 00:05:32 When you're looking at the growth of this business since inception, it hasn't been anywhere near those growth rates. And I guess this is just the matter of the way that I was calculating the value. I was calculating something not as high as what we've seen in the past because it's been absurd, how much this has been growing. But it was definitely all three bands were kind of in a positive range. And I just came up with a much higher intrinsic value than yours. On top of that, I don't see this company slowing down.

Starting point is 00:06:01 the gaming industry, it seems like they've got kind of their operations. It has the Jim Collins protocol, you know, they've got their due loop of success, and they're just replicating that, and you're looking at their top line, and it is just screaming higher. I don't know. I came up with a much higher intrinsic value than you got, and I know you're trying to be conservative with your numbers, but this thing's explosive as far as I'm concerned. I'm curious what the other guys think when they're looking at it. Are you seeing massive growth here? I mean, it's a little difficult for me because it's a non-US stock and so I'm a little bit out of my depth when I look at it, but I do like the valuation seems unbelievably cheap for something that is growing at this rate.

Starting point is 00:06:41 I just wonder why. Do you know, Steve, why has it been depressed? Why is it trading here? It's a good question. And I think there is some skepticism. If you look at some of the risk factors, it's the maturity of the games. It's a very highly concentrated revenue model that they have. So, for instance, Lord's Mobile, the game I talked to about before, that's 80% of the revenue. And Castle Class, that's 14.7%. They really rely heavily on that. There's some maturity to that. I guess with the mode or the lack of mode that you have in the gaming industry, I don't

Starting point is 00:07:11 know how much of that can really be replicated until, oh, this is a talented team. They can create a new blockbuster whenever it comes to computer games. Imagine whenever this becomes outdated in a few years. What happens then? Stick, do you know where do they get the revenue in terms of geographic distribution? That's a good question, Hari. For the year, 46% of the revenue came from Asia, 27% from North America, and 23% from Europe. Okay, so my main concern is if their revenue is coming from China, for example, it's basically

Starting point is 00:07:45 completely uncertain how things would pan out, how they would be treated in China. that might be the reason why their value is where it is today. And that is why we have a Silicon Valley programmer on our show right there. I love it. As a guy who looks at the numbers and gets excited about the numbers, that is such a strong point which you just said that is really worthy of a person's research and it just goes to show you how important it is to fully understand what it is you're buying before you buy. because Hari's point could be very detrimental if you don't understand something like that.

Starting point is 00:08:25 A few other things, I think uncertainty also really plays a big part here. We had many years where we saw the cycles between PC games and console games, like where the action happened. But if you look specifically at our company, I Get Games, all the revenue comes from mobile gaming. And you didn't have that segment not too long ago. That might be another thing that plays into this, like how are the consumer preferences changing, not only whenever it comes to the game itself, but also what type of medium would you

Starting point is 00:08:53 use? I mean, you can develop the best PC game ever, but if everyone is playing on the mobile, what does it really matter? It does take years to develop a game like this, and a lot of things can change. And the other thing is that the networking effect might not promote that much of a moat and the barriers of exit. I mean, yes, the value you get from that game, from all the money you spend on swords and dragons, so what not that you bought. I haven't really played this game. but that is what I imagine. You would of course lose them if you didn't play the game. But you know, you could say the same thing about other games. Relatively terms, these are small games compared to some of the other games that you find out there. So if we are talking about the networking effects,

Starting point is 00:09:31 this might be a small fish. One thing I would actually like to bring into this piece about the valuation. I can easily see why, based on the numbers, you would be more optimistic. It might be an acquisition target. And it's very obvious to mention someone like 10-cent has been buying up a lot of gaming companies. So at the price is training right now with these two blockbuster games, that might be a catalyst for realizing some of that shareholder value. But I'm curious to hear more your thoughts about this pick. I know one thing, you get Tenseat involved,

Starting point is 00:10:00 then all of a sudden your China problem goes away. Good point. Is it a boom-bust cyclical industry? Is it an industry where your fortunes go with the success of your current big game? And do they have that development cycle where they bring out one and then there's a bit of a lull until they have the next version ready and then everybody comes back again because that's always interesting and worthwhile modeling into the valuation? Yeah, it definitely is. So that's also one of the reasons why they might be a bit inflated. The other thing is it's really difficult to predict the success of these games.

Starting point is 00:10:35 You know, it's kind of like whenever you do a movie and perhaps it's even more difficult than whenever you're doing a movie. I mean, that's why Disney keeps on making those adventure movies, right? They have kind of idea of, yes, this is state of revenue. And it's difficult for a company, this size that are so small. They're so reliant on these games. And actually, they do a few different things to extend that cycle. And there are a lot of things that have been popping up with the past few years, the gaming companies in general have been doing.

Starting point is 00:10:59 So you might be familiar with Twitch, which is a streaming platform, where you can actually watch video games like it was a sporting event. They actually have their own Twitch, so to speak. I got games. It's called Pucket Social. That is one way they're doing. and they also have their own tournaments in these games where they award their best players.

Starting point is 00:11:17 So they have all the loyalty programs and they want to extend that cycle, but no, there's really, really good chance it's not going to be there for 10 years. Why would it be, if you look at other computer games? Very, very few have been able to sustain more than three, four, five years, only the very, very best and biggest.

Starting point is 00:11:33 And they are continuously being developed, by the way, even the biggest old games. The last thing I just wanted to mention is that Presta and I write up our analysis of various stock picks, and we do that over our intrinsic value index. We'll make sure to link to that index in the show note. It's completely free. Another thing that's completely free is subscribing to our newsletter.

Starting point is 00:11:53 And what we do is that once a month we take the analysis that be written for the past month. For instance, I got games. And you can subscribe to that or at t-ipemail.com. All right, guys, who wants to go next? I'm happy to give you my pitch, if that's acceptable to everybody. Absolutely. So mine is a short. I run the Acquirous Fund, which is an ETF ticker ZIG. That's 13030 long short. This is one of the shorts in the short portfolio. We're recording this on June

Starting point is 00:12:24 9th, so it's possible that it trades out by the time that this airs. I don't know. I'm just telling everybody, I don't want you to think that I've pitched it as a short so I can then sell it to or buy it back from me or whatever. It's just, I'm just telling you where we are. So the pitch is basically real page. The ticker is RP. It's probably. property leasing software. So it helps you with your accounting and your marketing and some metrics if you have a rental property. It's sort of software as a service. I think it has many of the things that I like to find in a short, even though I think that the business is, it's a real business and it is making money. I just think it's nosebleed expensive. And I think it's going to turn out to be more cyclical than perhaps other software as a service business. I think it's going to go where the rental market. market goes and the rental market is as hot as it has been in a really long period of time. So what are you getting with the real page? The market cap at the moment, it was trading at about 60 bucks, 5963 close on Friday. Market cap is 5.5 billion. Enterprise value is

Starting point is 00:13:27 6 billion, so it's carrying a little bit of debt, about $500 million in net debt from an acquisition that it made. But that's not a great deal of debt. My real issue with this thing is just the valuation. Enterprise value to EBITDA, which is the sort of acquisition metric is at 40 times. And when I run a valuation on this thing, I struggle to get it much above five bucks a share. So it's 60 bucks a share. That's about 90 to 95 percent down to where I think the value is. So I think there's an enormous amount of water in this thing. I don't think that the stock is that ugly. It's just a combination of the debt and constantly issuing stock. So you're being diluted all the time and it's already extremely expensive in a very cyclical.

Starting point is 00:14:11 sector. It's just something that I feel that it could be very weak if we go into some sort of drawdown. And I think it, given that it hasn't done much for about a year, and it looks like it's sort of floating back down again, I don't mind putting this position on. Although I'd caution that I could easily roll out of it in the not too distant future and you might look at the holdings and see that it's not in there. So I'm just telling you that we're always watching the shorts very closely, but that's my view on it right now. 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 somber. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every

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Starting point is 00:18:31 W-S-B. Go to Shopify.com slash W-S-B. That's Shopify.com slash W-S-B. All right. Back to the show. Toby, I'm curious if there's a competitor in this space that would be interested in buying them for a strategic reason, not necessarily because it's a value from, you know, the way we would look at it as investors, but they're looking at it more for a strategic reason

Starting point is 00:18:58 to purchase it and then that could maybe continue to give you a hard time in it. That's always the risk to a short in a really hot sector. But this thing is so expensive for very, very little yield on an acquisition like that. At that kind of price, I mean, really it's a pretty modest software hosted on a website, like for $5.5 billion or $6 billion total in a price value, I feel like I could build that. Give me a billion dollars. I'll build it again. Yeah.

Starting point is 00:19:24 I really like what Toby just said. It's like Buffett's test. Like if you have a company, if I give you, say, a few billion dollars, would you be able to build a similar product. Do they have the brand appeal? I don't think they have any of those. And you don't even need a billion dollar to build this product, frankly. That was the high side.

Starting point is 00:19:43 Everything's expensive in San Francisco these days, Harry. And I think nowadays, things are moving out of San Francisco too because of the same reason. So if somebody builds it somewhere else, probably $50, 60 million or max $100 million, somebody can build this kind of a service. I'm only talking about the product as a technical stack. Of course, they would have to spend a lot of money building the rest of the support system, as you said. But it was founded in 1998, Toby.

Starting point is 00:20:12 It's like really old. I mean, they're like the granddaddy of SaaS companies. Old by Silicon Valley sense. It's something to still have to drink, Harry. Yeah. Yeah. So I think I agree with you. It's like insanely expensive for the niche market they have.

Starting point is 00:20:28 One question I had, though, was, is there? like peripheral, adjacent markets they can expand to? Why are they so expensive? Well, I just think it's software as a service. Anything that's software sold over the internet to address some sort, and you know, and they're generating. They are making money. Like it's, I don't hate the business. I actually think the business is a reasonably good business. It's just that it's not worth $6 billion. It might be worth $500 million. I might buy it at $500 million. But at $6 billion, there's so much water in it. I just think that any kind of, if you got that much water in a really cyclical industry, which property is boom-bust, particularly rental property. And I think that we're much, much closer to a peak

Starting point is 00:21:07 in rental property prices than we are to a bottom. It's kind of interesting looking at the numbers. You know, the coverage ratio is just barely too. And it's really starting to look really, really ugly. And I guess that says something about the management also. And I think that they replaced management not too long ago. So I think that's another factor to include. I would probably like a little more shorting validation from the market. The long-term trend that I'm looking at right now, it's still more bold than it's bare. And I know that you can always make it argue that it's, it is best to shop whenever that day when it's most expensive, but it's really, real difficult for all of us to do that. So how do you look at that tradeoff, Toby, to see more validation

Starting point is 00:21:46 from the shoulders? That's been a big learning process for me as a value investor. To get better at shorting has been that you don't short on valuation. Something that's stupid expensive. I think David Ironhoun has a great line where he says something that's two times overvalued is silly, but it's no more silly at three times overvalued. It's still just silly. And what he's saying is that once it departs from underlying valuation, there's no reason why it can't go 20, 30, 50 times overvalued. So what I look for is the market getting a little tired of the story. And one of the ways that you do that is just by making sure that the stock hasn't done anything for an extended period of time. When I look at Real Page, it's trading where it was about a year ago.

Starting point is 00:22:26 It's been higher and lower in the interim, but it's been more recently a little bit higher, and I think it's coming off again. I think it's one of those things that it's just, it's really just waiting for some event to justify like slipping 30 to 50%. That may make it a better short at that stage, but I think it is a short right now. I'm there with Stig on the validation because I'm, so I pulled up our TIP finance tool and I'm looking at the momentum status for this particular company. And annual volatility on this is around 23%. So as you're watching the price action, just no other metrics other than the stock price. You should typically be able to see that the volatility on that bounce around quite a bit. 23% is a lot of volatility relative to some other company. I mean,

Starting point is 00:23:06 you can get way worse. Trust me, you can go way higher than that. But 23% is a lot. And so when you're looking at the low that this company had, what was it back in December, 17. 42, 43. Yeah, it got down into the low 40s and you're seeing this thing up, where's it at right now, $59 right now. And so you're well within that volatility range and you're in that volatility range going to the upside. So our tool, our momentum tool has this still in the green status. I would argue that you're not seeing a statistical change outside of its normal operating volatility to demonstrate that you have seen that transition point where maybe it's time to really plow into it. But you got to make these.

Starting point is 00:23:49 Sometimes when you make these calls on a short to get all of the juice to be squeezed, you've got to make the bold call at the top where you're not seeing that evidence yet. I wouldn't say that this is necessarily the top. Just on the price section, I'd say the 52 week highs is 10% higher. So it's a 66 buck. 50 day moving average is below. It's below it's 50 day. And it's 200 days 57. So, you know, none of that really factors into what I'm doing. I'm just looking where it was about a year ago. And I don't think you want to be trying to short these things at their 52 weeks. highs. That's not something that I would try to do because 52-week highs typically lead to more highs and 52-week lows typically lead to more lows just statistically. If anything, it's coming off from where it was, it's not charging ahead. All right. I guess we'll move on to our next pick. Hari, do you want to go or do you want me to fire away? Sure, I can go next. Today, my pick is Slack, Inc. It is not at public, but they have filed for their S-1. So I've been watching

Starting point is 00:24:49 and following this company for a while now, to give you a brief history about this company and the founders. One of the interesting thing about this company is unlike many of the famous Silicon Valley companies, it is not founded by few students in their dorm. Its founders are really experienced entrepreneurs. Stuart, who's one of the founders, was actually at Flickr. He founded Flickr. So Stuart Butterfield is who I'm talking about. So he's pretty famous in the valley. He sold Flickr to Yahoo, I believe too early, because he got probably 25, 30 million for Flickr. That's check change for such a great service. And of course, Yahoo promptly kind of shouted it in the shelf.

Starting point is 00:25:32 It didn't go anywhere. He left Yahoo in 2009. The way Flickr started was he wanted to build a gaming company. And then it didn't pan out, but one of the features in the game was sharing pictures. And that's how Flickr came into existence. And back in 2009, all the founders of Flickr who were at Yahoo left again, they thought, okay, this time we have money, we have experience, let's build a gaming company again. And of course, the technology has moved forward and they started building the gaming company again. But around 2012, 2013, they realized that it's still not there where they could really gather more momentum.

Starting point is 00:26:12 They had built an internal messaging communication system while they were working on. this company and they felt that was something that they thought was groundbreaking. And that's how Slack was born. So Slack has been a phenomenal growth story ever since 2014. In the rest, one, they published data starting 2017. So they had a $105 million in revenue in 2017. Today, they're around $400 million in revenue. They have around 600,000 paid customers spread across 115 countries. 36% of their revenue is from international. They have around

Starting point is 00:26:52 500,000 pre-customers. The way they calculate customers is if a organization has three or more users using Slack, they call them as an organization. They have 10 million users today and there are some interesting

Starting point is 00:27:08 data that they provide in terms of their engagement. Most of their users spend around 90 minutes per day on Slack. One of the interesting thing about Slack is they entered into a crowded market. Obviously, Microsoft is the big elephant in the room when it comes to productivity and communications. Google also has entered with Google Suite and Amazon has also launched its own product in the same area called Amazon Chime. So what makes Slack special is they entered a market

Starting point is 00:27:41 where all this big guys had a lot of sales force on their side, and it was really hard for them to muzzle through that and get into the C-suite in front of the CIOs and sell their product. So instead, they took a different route. The founders came from consumer internet. They started marketing more through word of mouth, how you would do a flicker, for example. There is a term called shadow IT in the industry,

Starting point is 00:28:09 wherein if you're in a big company, your IT organization dictates what you can use. Most of the engineers and employees are best because that's not what they like. And then Slack offered this freemium model where if you are a manager within a group, you can say, okay, let me try out Slack for 20, 30 employees that I have, and then I start using it, and slowly it spreads within the organization. And then from bottoms up, the pressure builds up. And then the VP just says, okay, let me just sponsor it for my org.

Starting point is 00:28:42 I don't care about what the entire IT for the entire org says. And then finally, enough organizations within a company start using it and then the IT buckles. And that's what I have seen it happen in company after company. I have a story where there is a Fortune 100 company in Sinicol Valley. I cannot name that company. But one of the guys who works for the IT team there, the IT had a policy that they can't use Slack, or any other tools, only whatever that was dictated by the IT. But under their nose, the same organization, smaller teams were using Slack because they felt

Starting point is 00:29:18 slack was so good. So I think the strength of this company is the product itself. And Stuart Butterfield, the founder, talks about it quite a bit. The vision of the company is to make work pleasant and working lives more simpler and productive for people in the enterprise. and their value proposition has changed over a period of time. It started with communication, but it has spread to integration with other applications. I know folks in engineering who now use Slack to bring up services on the cloud.

Starting point is 00:29:52 Salesforce used to track their leads through integration with Salesforce. So they have partnership with Salesforce, Workday, Google. So you can pretty much do everything through Slack. and the way I see them as the V-Chat of enterprise users. They are becoming one interface that most users are used to. They integrate with all other applications. A lot of these SaaS application are still quite shoddy, actually, in terms of user experience. So Slack kind of smoothens it out.

Starting point is 00:30:23 That's kind of the pitch. I also will talk about what are some of the drawbacks and challenges, but I think Prist and Stig have questions, so I'll be happy to answer. Harry, I really like your peg. I just do want to emphasize what you also said there in the beginning that we really can't compare it to a price. So we know it's a great company, but we don't know if it's a good investment because we don't know what we're paying for it just yet. TAP is using Slack. It is absolutely amazing. We're actually free users. And the very first thing whenever we do, when we onboard a new member is to give them a Slack account. It is sort of difficult to explain why it's

Starting point is 00:30:57 better than your other communication channels unless you try it out. The way that Slack is just organized, the way you communicate with each other is just so much better than email and the other chat functions that you have out there, at least so far. I do want to say that as much as I love Slack, I'm as a user considering moving away from Slack. And we actually talked about that for quite a few months now. One of the reasons is that we're using so many different apps already that it's really nice to have just one. You mentioned G Suite before. As an example, Google talked about how the new Google Hangout, which is sort of the equivalent to Slack, how they would be upgraded in October. And apparently it's going to look exactly like Slack, because

Starting point is 00:31:39 the features in itself are not as complicated. It would see for me as a non-programmer to do with just a new way of organizing communication. I guess my concern is I really can't see why it wouldn't be possible for Hangout to do that. And the networking effect, you talk about tell million users. That's not a lot. If you compare that to Microsoft, you compare that to Google, and you have everything combined anyway, especially whenever you compare it to the pricing. It's definitely right. You know, it's not just about communication. That's really where they started. Now they are more trying to compete with the other tech giants by offering different features like CloudSpace. One example, Slag is $6.67 per premium user, and you would get 10 gigs

Starting point is 00:32:18 if you did that. For Google, for $6.6, you get 30 gigs. And if you pay $12 for a so-called, premium account, you get unlimited storage. That's just one of those where I'm like, if one of the others fix the communication part, which I think and I hope they will, you get all the other bells and whistles that are much more developed with, for instance, Microsoft and Google. I guess that's some of the concerns I would have as an investor in Slack as much as I love the product. And yes, I do probably spend 90 minutes on it every single day. So I'm really happy you. You mentioned that too. I don't feel too weird about doing that. So, Hari, my only comment really kind of hits at what Stig opened up with, which is the valuation. So this thing can be the best tool on the

Starting point is 00:32:57 planet Earth. But if we don't know the price that you're going to have to pay in order to participate in whatever earnings they produce, that's going to be the big question for me. And then the other big question for me is going to be how much more market share do we think Slack can take globally or whatever regions they have a dominant presence? How much more of that market share can they take when I'm doing my math and trying to figure out what I think it's worth. So those two factors for me are going to be more important than, I don't want to say more important, but I would say just as important as the quality of the product, which is what we've really kind of been addressing throughout the entire conversation. So without knowing that,

Starting point is 00:33:34 I can't really say whether it's a buy or not, but I will be watching very closely as they do IPO and become a publicly traded business. Yeah, those are really good points and questions, TIG and Kristen. And the reason I brought this up is exactly this, because I wanted to get a feel of as a business model and as a company, how viable they are, in terms of long term, is it something that is sustainable? And, Kristen, you brought up a very good point in terms of, okay, Microsoft and Google. Just to give a comparison, compared to Slack, which has 600,000 paid customer, Microsoft has 28 million businesses paid customers. And their monthly active users are like 165 million monthly active users.

Starting point is 00:34:17 And it's not that they're not growing. Back in November 2015, Microsoft had only 60 million monthly active users. So Microsoft Teams pretty much has replicated everything Slack does. The only difference is that it doesn't integrate very well with third parties as much as it integrates with their own ecosystem. And Google also, as you stick pointed out, is coming up. They have five million customers, paid customers for their Google suite. What Slack is facing is an uphill battle in terms of gaining those customers.

Starting point is 00:34:51 I guess the small and medium businesses, they have won so far because you are not tied to Google Suite or Microsoft. Interesting, you would bring that up. And I think that as a business owner, I don't really care. It just has to be easy. So let me give you one example. As a free user of Slack, I can't have calls with more than one person at a time. So we would use Skype for that. Whenever we're outlining tasks, we're doing that in Google Sheet.

Starting point is 00:35:18 So that would be Google. And then we would have the communication over Slack. I mean, to me, that's not super efficient. Why wouldn't it just go to one place if I have one place that sells all that? And by the way, for storage, we would use Dropbox. If all of that can be, you know, fixed, I have no sense of loyalty to Slack. I love the program. I love the features.

Starting point is 00:35:35 I don't have any brand loyalty. I think as a business owner, you really focus on your product. You focus on a lot of different things. The tools you're using to get to that point is not really. really important. You just want that to be as easy as possible. You don't spend time. You don't want to have too many costs involved with that, whether it's time or actually dollars flowing out of your business. I've been using Slack for a few years in my business. I love the product. It's really, really hard to describe to someone what it is. It's like chat relay, the old internet chat relay, internet relay chat,

Starting point is 00:36:04 IRC, but it does integrate with everything really well. It's hard to describe. And it is really addictive. And they've got that really clever thing where they make you pay for your history. It gives you some limited history. Is it a year or four months or something like that? And if you want to see something that you tweeted as someone a year ago, you've got to pay for that, which we have ended up doing. I think it's an absolute killer business with that viral mode where it comes in down the bottom and just takes over the host organism. Like, that's an incredible business. The only question is what they're going to try and sell it for. And I know when it lists, it's going to be absolutely nosebleed expensive. So I'm probably not going to buy it in the listing,

Starting point is 00:36:36 but hopefully it gets beaten up at some stage because I think it's a great business. And it's going get taken out by Google or someone at some stage because Google doesn't have anything. I hope that Google builds something similar because I use all of the Google spreadsheets and Gmail and all that stuff. But I think it's a great pick. Just it's going to be a question of the value. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and and customer trust together on one AI-powered platform.

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Starting point is 00:40:28 My pick today is Auburn National Bank Corps. I apologize up front for all the Alabama fans out there that I'm going to be talking about Auburn here. But this bank came up on our filter. So Stig and I built this TIP finance tool. We have a filter on there. We got a momentum tool. We got all sorts of stuff. But this one came up very high whenever I was looking at smaller businesses, small cap businesses. I kind of wanted to talk about this one more because on the show, we very rarely talk about small cap businesses, businesses that are under $100 million for their size. And so for this one here, it is small. It is really small. And a lot of the times whenever you're buying a small cap business, you get into liquidity concerns. You get into liquidity issues with being able to with the price action. The price action is usually really choppy. It kind of doesn't seem to make a lot of sense because you're dealing with such a small business. With this one here, the top line, the sales for the business for last year, 2018, was $29 million. So very, very small. I see.

Starting point is 00:41:36 Toby laughing. Twenty-nine million dollars. The bottom line, the profit on the business was $9 million. So when you look at the profit margin here, we're talking, I'm like a 30% profit margin on this business. It's massive. I want to say the S&P 500, correct me if I'm wrong, guys, if you know the number better than I do, but I would say the S&P 500 is probably around a 12% margin on average. And that's very high compared to historical standards. 12% is the highest the margins we've seen in the market for decades. So for this company to have a 30% margin is extremely high, in my opinion. From a financial standpoint, it has a lot of stability. When you look at the top line growth over the last 10 years, it has been just really steady. It's not bouncing all

Starting point is 00:42:22 over the place. It just kind of just keeps getting better each year. The profit that the company produces just keeps on getting a little bit better each year. I will say recently in the summer of 2018, the price on the stock got up to $53.85. And let me just tell you the ticker here, because I failed to do that. The ticker is A-U-B-N. That's A-U-B-N. But anyway, so back in the summer, July time frame of 2018, the price got up to almost $54 a share. Then by the Christmas Eve crash there that we had in 2018, the price got down to $28. And today it sits at 33, as we're talking about it. So pretty big price drop in the last year on this company. And so what I find interesting is you got a company that's trading for $33.79. And the profit per share, when we look at that,

Starting point is 00:43:16 our profit per share is right around $2.50. So you're buying something for $30. You're getting $2.50 of earnings out of it. And those earnings are pretty consistent each year. So really boring mortgage bank that's lending money so people can buy homes. and some small business loans here in the local Alabama area, but very consistent and stable numbers and huge margin. And whenever I do my intrinsic value based on the current price, I'm getting a pretty strong return in excess of 15%. From a momentum standpoint, so back to our TIP finance tool, we have a momentum tool there that also represents whether it's in a green or a red status for long-term momentum trends. And this is in a green status as of right now.

Starting point is 00:44:00 In general, I liked it. I think it's nice, small, boring, big margins, and I think it has a great intrinsic value. So I'm kind of curious to hear what you guys think. Can you just talk a little bit about how you get to the intrinsic value number? Sorry, Preston. Yeah, no sweat. For me, what I do is I look at whatever I think the free cash flow on the business is, whatever I think a sustainable free cash flow will be into the future. I'm kind of making an estimate for the growth rate. For this company, I put in what would be a conservative growth rate of around 5% from where it's at right now. Based on that growth rate and based on the market price, I come up with an intrinsic value. I basically do an IRR calculation and I'm getting in excess of 15%. So what do you

Starting point is 00:44:42 get that, Toby? Yeah. You're looking at me like I've got something run out of my ears, so I want to hear what you got here, Toby. Yeah, you know, banks can be a difficult beast to value. The leverage in them, you know, makes them, they can be, they can be slippery. So if they get some impairments to their underlying loan book, then that often takes a big bite out of their equity. At a very high level, let me just that I really like financials. I think financials are really, really cheap. I think banks are really, really cheap. This is a very steady growler. I think that Preston's absolutely right about that. It looks really good over the last 10 years. And the stock price is crazy. It just dribbles up all the time pretty consistently. It tried to go to the moon late last year, but then what are we calling

Starting point is 00:45:23 that the Q4 massacre, the Christmas massacre? I think this is probably going to work out. I struggle a little bit with the valuation. Like I get, you have to realize I'm a super conservative deep value guy. So like I think I'm getting 27. If I plug in a growth rate of 5%, EPS 252, terminal growth, I don't know, I'm going to stick in four there. Maybe I'm applying too high a discount rate. I'm applying 12%.

Starting point is 00:45:47 What are you discounting at these days? What's appropriate in this market? I think that what you're saying is as far as 12% sounds appropriate. If this is about the mid range of where I would put the value, so I'd put the value somewhere between 30 and 40. It's just hard for me to kind of get my arms around this one. So I should probably be making less noise and being more quiet. But that's not the function of a podcast. No, no. I want you to pick it apart, man. It's like it is a very safe stock. I don't think it's got plenty of cash, really nicely growing.

Starting point is 00:46:16 It's hard to see how you get the explosive upside, but I don't think you're going to lose money on it either. So that's my two cents. I definitely don't think you're going to have an explosive upside. I think what you're going to have is something that is priced at a very reasonable. rate that has a very consistent track record of just growing itself steadily. It pays a decent dividend. It's definitely not a gaming company from Singapore by any shape of the imagination. No, and that's probably a good thing. Whenever I look at it, I really like the numbers, stable numbers, profitable company. If I look at how it's meant, it's somewhat conservative, which I also like for a bank, especially at this point in the cycle. They have maintained a relatively low

Starting point is 00:46:58 loan to totally deposit. So right now it's around 60%. It seems like the new normal is closer to to 80 for banks like this. I do want to say that as good as the numbers look like, and I'm sure that I don't see you lose a lot of money on this. As you also mentioned, it might not see an explosive upside. But I think a more like general trend in banking, now that it seems like everything is being more and more commoditized. Like the advantage of being the local bank today is probably not as much is it were before. More and more is moving online, especially with the younger generation. Being the top of mind for locals are not as important, it seems, as it were in the past. I kind of see some advantage going over to the bigger banks, not just because they're systemic

Starting point is 00:47:41 in itself, but also because that the digital products that they are offering the way banking is today probably will be developed better by the bigger banks, better offers, and more functionality for you as a user. I don't know if you become a customer here. for this company, Preston, but is that a concern in itself? That's definitely some concerns I've seen with smaller banks with, you know, I'm doing more international transfers. There's just some limitations to if you have more advanced businesses as a business person, I guess, for some of the smaller banks. I think that what you're talking about, Stig is all really, really good highlights for risks. I guess if I was going to flip it on its head and try to argue the opposite side of it,

Starting point is 00:48:20 I would probably say, this company's so small that maybe they're competitive advantages that they're so small and they're doing loans. They're then they're working a deal. They're then selling off the loan to the big banks after the deal's been done. And it's just, I think they can get away with being so efficient and so small that maybe it's kind of staying that way is their competitive advantage. I don't know. I have no idea. That's me just trying to argue the opposite side of what you said. Harri. This is just a follow-up question to what Steve just said. Considering big bank versus small banks, I was just looking at Wells Fargo in terms of their P.E. ratio, it's a better P.E. ratio than Auburn. And their growth rate is similar in terms of revenue

Starting point is 00:49:03 growth. I'm just looking at the numbers superficially. My question was like, if I had to pick between Wells Fargo and Arbor, like, what's the difference? Why would I pick this bank versus say Wells Fargo at this point, price point, considering the price point? Well, the thing that really got my attention is the margin. So for a company to be banging out a 30% margin, like, that's, that's absolutely incredible. And I said this when I started, I really wanted to talk about this more because it was a small cap company and it had some, what I thought, really decent, stable numbers that were giving you returns above 10%, you know, anything above 10%, I think is worthy of discussion at this point. I say 10% now because Toby kind of came up with his valuation. I had my evaluation and you're

Starting point is 00:49:44 never going to have anything that's kind of the same number because a lot of it has to do with how we're projecting what that future might look like. But I haven't run the numbers on, you said Bank of America. Is that right, Harry? Wells Fargo. So I haven't run the numbers on Wells Fargo to do the comparison. I know on our filter tool, I'm not seeing Wells Fargo kind of at the top where this one kind of came up at the top for a small cap business. So I'd have to dig in there and kind of do that analysis to do the comparison. But I think it's a very valid question. And if the if the intrinsic value, would be similar as far as the return. I think you'd be crazy to own the small cap if you had a

Starting point is 00:50:19 large cap that was giving you a similar return. So I think that that's an important consideration. And so then you'd have to make the determination on how much more yield is the pick worth in order to be in a small cap versus a large cap. One thing that I would add that to your side of the argument, Preston, I had look at their insider trades. And I've just about never seen something like this. They are almost all always buying. I look back over 10 years. Like, Most of the time directors get options and they just punt the shares all day long. But these guys are actually buying what's in there.

Starting point is 00:50:50 So that's about the strongest argument you can get for this being undervalued if the insiders are putting their money where their mouth is. Yeah. All right. Well, I don't have anything else on it. I would encourage people go on Twitter, hit us up on all four of these picks. Let us know what you think. We're trying to figure it out just like everybody else. And if you have a little tidbit that you think could help other people out, we'll retweet it, we'll share it and we'll talk about it.

Starting point is 00:51:13 go on our forum. We can continue the conversation there on the Investors Podcast Forum. We've got a ton of people in there chatting about different picks. Toby, Pari, thank you so much for coming on the show every quarter. I know that you guys are very, very busy people. It just means so much to Stig and I and also our audience that you guys always make time to come on here and have such great conversations. Toby has an incredible ETF that he just recently launched. He also has a podcast. Toby, talk about that and then we'll throw it over to Hari to talk about bits business. Yeah, thanks so much. The ETF that I just launched is the Acquirers ETF.

Starting point is 00:51:49 The ticker is ZIG. It's 1 3030 long, short, deep value ETF. We buy really strong companies on the long side, and we short the junkie cyclicals on the top side. You can check out my podcast, which is Acquirist podcast. It's on my website Acquirers Multiple, where we just interview value investors and find out more about their strategy for the most part. I'm on Twitter too at Greenbacked. It's a funny spelling, but G-R-E-E-N-B-A-C-K-D.

Starting point is 00:52:17 All right, Hari, talk to us about BitsBusiness real fast so people can learn more about you there. I have a blog, BitsBusiness.com, where I share my learnings, what's going on in the valley. And I would love to engage in conversations and get feedback. So connect to me at Bitsbisiness.com. Gentlemen, always a pleasure. Thank you so much. We really enjoyed it. Thanks so much for having us. Yeah, same here. Thank you. So this point in time in the show, we're going to play a question from the audience, and this question comes from Amid. Hi, Preston and Stig. I'm Amit from the UK. I started to learn about investing in October 2017 and have been listening to your show since then.

Starting point is 00:52:57 TIP has played an integral role in this journey. You two are one of the best teachers I've ever had. I'm very grateful to you. So thank you. My question is in form of a request. Can you each share with us a mistake you? made in the past two or three years regarding an investment. How did you feel when you realize it was a mistake? How did you correct this mistake? What steps, if any, did you take not to repeat this mistake in the future? I would love to know your process. Love you guys. All the power to you. Bye. Oh boy, I made so many mistakes. I're not really sure where to start. So let me start my response with the framework of my mistake. So as you might remember, we had Bill Miller on show on episode 247. And one of the key takeaways was as a stock investor, we need to distinguish

Starting point is 00:53:48 between cyclical trends and secular trends. For instance, secular trends, one example that comes to mind is the auto industry. That has historically been a good example. We always seen cycles in the industry depending on where we are in the economic cycle. Basically, in good times, we simply buy more cars and in bad times we don't. Or at least we would buy different cars. Secular, on the other hand, means that things have fundamentally changed. So what we see for cars now, for instance, is the trend into self-driving cars. This is not a trend that will change anytime soon. This is a fundamental shift. So if you keep looking back on how companies have made money in the past and assume they will continue linearly and think that self-driving cars will have no impact on revenue generation

Starting point is 00:54:33 in the future, well, then you're likely hit for trouble. That's also why you see some of the car companies right now trading for very low multiples and why more innovative car manufacturers who are leading a self-driving and electric car movement are trading at really high multiples. Across the board, there is a really good reason for that. So when you ask me about some of the many mistakes that I made, the difference between the cyclical and the secular trends is definitely something that I missed in the past. So specifically for me, it was a mistake that I made investing in Beth Bathbeth Beyond. So if you consider my mistake in a company like Beth Bath Beyond. And I guess you could say that for many other retailers. This was a stock that

Starting point is 00:55:13 I bought for $21 and then sold it at 15 before I realized my mistake. And this was in the bull market keep in mind, so it is quite an accomplishment performing so badly. But I completely missed the mark. As a value investor, I'm trained to think that small companies grow more than larger companies. And while that is still solid advice, this seems to be a secular trend whenever it comes to retail companies. Because like with so many other goods and services, they're just sold so much more efficiently by machine learning and optimized websites. The small companies are not catching up with Amazon. Amazon is just getting bigger. And the bigger they get, the better they become, because they have more and more data. That's the very hard of machine learning. So the $12 billion top line of

Starting point is 00:56:00 Bethbath beyond that I was looking at, it actually showed that it had a harder time growing than the $250 billion top line of Amazon. Even if you only look at the retail division of Amazon, Beth Bath Beyond simply didn't have what it took to grow retail and compete with Amazon even though you might think that a $12 billion base would be easier. It's really not. Of course, there are limitations to how much Amazon can grow,

Starting point is 00:56:25 but what I failed to understand was that the consumer preference of shopping and the value at of breaking mortar has changed more than I expected. This is not a cyclical trend. This is a secular trend, meaning it's not going back to the way it was before. Of course, as a stock investor, you know that there's typically a good reason why stocks are trading at a 52-week low, and you know that the stock is worth less than what's before very often. But you have to estimate what you think the new lower true value of the stock is, and then compared to the stock price. So even though I was very aware of the impact of Amazon on a company like Beth Bath Beyond, and I knew that it wasn't worth as much as in the past, I underestimated how quickly it lost value,

Starting point is 00:57:08 much more than the already depressed stock price of $21 that I bought it at. So whenever you ask about the process for mistakes, one process I personally apply is the two-year rule. This is a rule that I learned from Guy Speer, and that is if you buy into a stock that you think is undervalue and where value in itself would be the catalyst that you're looking for, if the stock hasn't moved for two years, I need a really, really good reason to hold on to that stock because more likely than not, I'm just wrong in my analysis. And there's a reason why the market has not rewarded that stock. But thank you for the question I mean. I think it was a great question. I think it's very important that we are very open and we learn from our mistakes.

Starting point is 00:57:50 All right. So I guess it's my turn now. So I think one of the biggest mistakes I made three years ago compared to my approach today would revolve around the lack of momentum that was integrated into my approach. I know I've talked about this a lot lately, but it's just kind of such a drastic change to the way I was doing business. I can honestly say that if it weren't for our guests like Wes Gray, Toby Carlisle, Patrick O'Shaugh, Patrick O'Shaughnessy, his father, James O'Shaughnessy, I would have never even began to think about momentum being a type of approach that would augment the way I invested seriously. I have just enormous respect for those four guys and the amount of research that they do for the way that they invest. And I just realized that, hey, there must be

Starting point is 00:58:36 something to this and I dug into it. And I quickly determined and understood that there's a lot to what they were doing. So after doing some research and studying the methodology, I slowly started incorporating momentum into my style. Since doing that, I don't feel like I have my temperament tested nearly as much. This is one of the things that when you go to a Berkshire shareholders meeting, Buffett and Munger always talk about this idea of temperament. They'll say we were great stock investors because we had the temperament for it. And what they're really saying is they had the stomach for it. They were able to put on a position. It would move against them and it wouldn't cause them to sell the position where many, many people can't say that and they actually do the opposite of buying

Starting point is 00:59:24 low and selling high. Instead, what they do is they buy kind of high or what they thought was low only to have their temperament tested and then they sell even lower. And so that's why I really like momentum and that's why it's become an integral part in the way that I invest now versus a few years back is because it's just helped me manage my temperament by not putting on a value pick too soon. In fact, I can identify a whole handful of value picks quite easily at any given point in time, depending on where we're at anywhere in the cycle. I feel like I can list out a whole bunch of value picks at any time. I think the hard part is finding a value pick that won't make you second guess yourself

Starting point is 01:00:06 in five months or a year. That's because many value-based picks continue to get punished by the market because of psychology, not necessarily because of fundamentals. And so by wrapping momentum for me into my approach, it's helped me not jump on the value-based picks too soon, but to continue to monitor them and then enter them at what I think is a better time and not have to sit through some of that difficult period where I'm having my temperament tested. So I would say that that's the biggest thing that I've learned in the last three years.

Starting point is 01:00:39 So, Amet, we loved your question. We have an online course called our intrinsic value course that we're going to give you completely for free. Additionally, we have a filtering and momentum tool, which we call TIP Finance, and it does all this hard work that I just described for you by calculating whether something has a positive or negative momentum trend, and it also does the deep value filtering that I talked about. We're going to give you a year-long subscription to TIP finance completely for free. leave us a question at asktheinvestors.com. That's ask theinvestors.com. If you're interested in these tools, simply go to our website, the investors podcast.com. And you can see right there in our top level navigation, there's links to TIP finance and also the TIP Academy where you'd find the intrinsic value course. All right, guys. That was all that Preston and I had for this week's

Starting point is 01:01:26 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 TheInvesterspodcast.com. To get your questions played on the show, go to AskTheInvesters.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network.

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We Study Billionaires - The Investor’s Podcast Network - TIP248: Mastermind Discussion 2Q 2019 (Business Podcast)

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