We Study Billionaires - The Investor’s Podcast Network - TIP323: Mastermind Discussion 4Q 2020 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. All right. Hey, everyone. Welcome to the Investors podcast today. We bring back our mastermind group with Toby Carlisle and Hari Ramachandra, where we go around the room and we make a pick in the stock market. And we talk about why we think there's value. We help troubleshoot each other's picks.

Starting point is 00:00:20 We poke holes through it. We talk about what we do like about it. And in general, it's just a fun thing that we do every quarter to just, show people what we're thinking about, what we think is valuable in the market, and the thought process and the mechanics behind how we do our analysis. So with that, this is the fourth quarter's mastermind discussion, and let's get started. 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.

Starting point is 00:00:56 Hey, everyone, welcome to the Investors podcast. I'm your host, Preston Pish. And as always, I'm accompanied by my co-host, Stig Broderson. And boy, oh boy, we got Toby Carlisle, Hari Ramachandra here. Guys, welcome back. And what's going on? What's up, fellas? Hey, guys, good to see you.

Starting point is 00:01:24 Just feels like we get crazier and crazier every time we record one of these things. The backdrop. The backdrop is crazy. It just gets crazier and crazier. It's kind of like, when is this going to let loose? I mean, I don't know. Do we have anyone who wants to go first? I'm always happy to go first.

Starting point is 00:01:42 I don't mind. I feel bad pushing to the front of the line, but I'm always having to get it out of the way. No, go. A few weeks ago, we launched a new deep value ETF focused on small and microstocks, and the ticker's deep. And so the pick is one of the holdings in deep. It's called Diamond Hill. The tick is D-H-I-L for the thing that I'm picking. So Diamond Hill is they're a value investor, funnily enough, and this is the very simple overview.

Starting point is 00:02:12 They run about $20 billion, and the economics of an investment manager are quite good. They have very high return in equity. They've sustained it for a long time. They're very good investors. They have long-only funds and long-short funds, and they earn fees on the funds. And basically, they've suffered along with every other value investor out there, both in in the AUM and their performance, but also in the underlying, the company that owns all these businesses and is listed.

Starting point is 00:02:40 So I think it's a phenomenally good business and it's phenomenally well run. It's the sort of thing that I like to find because it's a phenomenal business, very free cash flow generated, very high returns on invested capital, but suffering because it's going through an industry down swing. And that's just that value has sucked for a long time. So value managers have lost some assets. performance doesn't look great, and the equity in the value manager has been punished along with their performance. So I think Diamond Hill, they're very good investors. When value gets a

Starting point is 00:03:15 little bit more of tail when they're going to do very well, they're in no danger of anything happening to them in the interim because they're making so much money, they just don't go free cash flow negative. It's just that kind of business where it's a good business all the way through. So it's really small. It's a $420 million market cap at the most recent close. P is tiny. P is about 12 for something like this, which is a phenomenal business, and it's returned on equity about 30% pretty much the whole way through. They're paying out a special dividend because they've had too much cash on the balance sheet, but they've constantly got a little buyback going on. I think it's one of those things that it's a simple business. It's well executed. It's at the bottom of its business cycle and it's cheap relative to where it is now, it's likely that the fortunes of this business turn around with value. So if you believe in value, you're going to get three ways to win in this. Their AUM is going to grow. Their performance is going to get better. The stock is going to follow along with that. And then, because it's undervalue, the stock's also going to close up. So for me, basically a perfect

Starting point is 00:04:16 opportunity. So Toby, you know where I always go, which is to the top line. And when I'm looking at the company, and this is something I've been doing more recently is when I'm looking at the top line on a company. I'm particularly looking at this, how did they perform in the third quarter and how did they perform in the second quarter? Because I'm looking at that from the previous second and third quarter for these companies just to try to maybe use the numbers as a gauge for COVID. And when I'm looking at where they were at, and I think my numbers are right here, so 31 million here for the third quarter, 28 million for the second quarter, compared to a year before, and they were down 10%, and they were down approximately 10 to 15% for those two

Starting point is 00:05:02 quarters when you compare into the previous year. So it seems like maybe there's some type of COVID thing that's impacting their top line. Do you know what that might be? Yeah, they're an asset manager. So their fees are, they're earned on the assets under management that have. So when their assets under management go backwards, their fees go down. So that's why they were impact. But as I said, the really telling part for this business is not so much what the top line does. It's how their gross margins go through the whole way and their gross margins are fat and they're able to, you know, it's basically, it's a very scalable business. It's all basically income that they can control their costs. They're not going to flip cash flow negative as a result of having a backwards few quarters.

Starting point is 00:05:46 And then, you know, that kind of COVID drop as it goes away, their fortune is going to be tied to their performance and the performance of value. I like this pick in many ways. And I mean, what an interesting way of making a value pick investing in a value investing company. It's a meta, isn't it? Yeah, it is. And so I like a lot of things. You know, whenever you read about them, what they do, whenever you read the shareholder letter from Heather Brilliant, the CEO, a lot of good things.

Starting point is 00:06:13 And she's saying all the right things. And to me, that's good, but it's also a bit of concern. So let me elaborate a bit on that. In the latest annual letter to shareholders, she addressed the issue of passive investing head on. And like she's saying, you know, it's good for investors and, you know, but that's not our game. We're alpha seekers, right? So we want to upperform the market. So let's talk about that. Can they upperform the market? And I think one thing that's really against this business with all the good things that you guys just mentioned, there are a lot of good things, a lot of good tailwinds, but the main

Starting point is 00:06:42 issue is really interest rate the way I see it right now. I mean, back in the day, you know, Buffett and no Buffett is Buffett. He had his 0625 system, you know, hey, just pay me on performance, you know, it's all about performance. Those days are just gone and they're gone for so many reasons. You know, back whenever he was like, yeah, I can always do more than 6%. But guess what? You know, if the risk-free interest rate, the 10-year treasury is 6%, it's a lot more easy to be compensated on performance. So you are in the world right now where I look at the products, you know, I look at the global mutual fund. I look at the all-cap US. I'm looking here at expense ratios of 85 basis points or 87 basis points, respectively. And I'm like, well, if the U.S. is priced as 3%, the world is priced

Starting point is 00:07:26 at less than 5%. I pay a lot of that performance, a lot of that potential alpha. I'm paying a lot of that just front-up in fees. And I'm paying that to someone following a strategy that has just been, you know, punished year over year and with like no sign of any change, right? Because that's not how the world thinks. You know, they're looking at how value has performed and like, hmm, Okay, they're not really giving me any kind of yield and I still pay a percentage. And I mean, this company is not going anywhere. I think in the latest update, they have $22.4 billion on the management. I mean, it's not going to go away, but it is having that value investing mutual fund,

Starting point is 00:08:05 high fee structure, I don't think it's made for the world where now more than half of all AOM that's passive investing. So I kind of feel those headwinds are a bit concerning, but I let me try to be a bit more positive. I like the valuation. That's what I was just going to say, Stig. What do you think of the valuation? I think the valuation is good.

Starting point is 00:08:26 I guess what I would be concerned about is what's going to happen next time whenever the market drops 4%. What really worked out well for all SMEs this time was that the stock market just bounced back. What if it doesn't? It's not only 4% that's just gone. Thinking about how many people are like, I don't know if I even want to be in stocks, but if I am going to be in stocks, it's definitely going to be big tech.

Starting point is 00:08:48 it's not going to be value investing. And so just keep that in mind whether I'm going to pitch my awful, awful pig. That's a very classical value pig afterwards. So, I mean, just keep that in mind, guys. But that's definitely a concern that I have. But I do buy into some of the good things you're saying there with the margins, Toby, you know,

Starting point is 00:09:08 the biggest expense they have is whenever they do perform well. So you have a heads there. They have no capex, more or less. So it is a great business. And whenever I look here, I could probably find it generous 8 to 10% return again. And that's very depending on do I think value investing takes off if that's what I think. You know, it's much, much higher. If we continue being in this environment we're in now, I can easily see that return go lower simply because there's no takers for

Starting point is 00:09:33 that. Let's talk a little bit about valuation, about how value has performed. So the valuation of this thing is $140 paying a $12 special dividend for stockholders on record November 25. It pays a dollar quarterly dividend as well on top of that. They just throw off so much free cash and it's just the nature of that business. You can't reinvest it. It's going to be a very cash generative business. Whether the cash is reinvested in the business or not is sort of, that's not how they drive their growth.

Starting point is 00:10:00 Their growth is driven by the AOM going up, which is a matter of performance and a matter of, you know, to some extent, marketing. It's a business that I understand fairly well because it's my business as well. So I'm very comfortable with this business and I think that they're doing a very good job. The question that you're talking about is a little bit more macro. what happens if value doesn't start performing again. When I look at value now, so this is the extraordinary thing that's happened. The way that I think about evaluation is you basically get the dividend, you get the yield,

Starting point is 00:10:27 however that's manifest in either stock buybacks or special dividends, and then on top of that you get any underlying growth in the business. And the way that I look at growth is I just look at, what does this thing return on invested capital? How much capital is being reinvested in this business? And then how does the market treat that money that it's reinvested, that incremental growth? So that's how I think about it. When I look across the value portfolios now, and I'm shocked at some of the names that have been squashed down into the small and micro, because I know these names when they were bigger companies. It's just the valuations have fallen so far. They're now regarded as small and micro companies. The portfolio has a greater yield than the S&P 500 index than the Russell 2000 index and the Russell's 3,000 index. The yield in value portfolios is much, much higher. I mean, with a tenure at 80-bips, the yield across some of these portfolios, it's like three to four percent. And then on top of that, the return and invested capital is higher

Starting point is 00:11:21 across the portfolio. They're reinvesting more. The growth rates that manifest out of that are higher too. I just think it's a matter of time now before the rest of the world wakes up to the fact that these portfolios are much better than anything else that's out there, including big tech. And when the performance comes, then the multiple expansion comes to. But without the multiple expansion, this thing, I still think will likely outperform. So, Toby, I'm with Stig on the valuation. I think the valuation is screaming by, right? I'm getting double digit returns based on the earnings that it's kicking off for the money. I think the dividend is massive. It's a 6% based on the current price, right? Well, it's a dollar a quarter. The current price is 140 bucks. They're

Starting point is 00:12:07 paying about a dollar a quarter, but they're also paying the special dividend. So it's 16 bucks on 140. Yeah, that's crazy. And, you know, what's interesting is you're still seeing their book value for the business grow. Payout ratio is like 56% last year. Right. And the business growth is almost independent of that, too, because of the nature of the business. They can scale assets at almost no cost. All they need is a little turnaround in value.

Starting point is 00:12:35 You know what I'm blown away by? I'm looking at our momentum indicator. And this thing's still red. And it's up 70% since March. I look across my portfolio. When I look at Zigg, it scores high and everything except for momentum. When I look at Deep, it scores high and everything except for momentum. This is an interesting pick. The numbers are screaming. There's value here, no doubt. I'm just concerned like Stig is concerned that there is so much momentum and so much more expectation for more printing and more of the same of what we've seen to date, that that's my concern is it almost seems like value investing has been penalized based off of policy. And it seems like the policy is getting ready to be doubled down on, which should, I guess, in the back of my mind is suggesting that values is going to get punished even worse if they continue to do what they've been doing policy-wise.

Starting point is 00:13:27 As an investor, I don't really care so much about what the stock price has been doing because I think about the stock price is just the marginal buyer and seller getting together. And the way I think about return, like the return that I'm going to get is, as I described it before, it's going to be the yield plus whatever underlying growth, plus whatever they, you know, when I say underlying growth, it's going to be whatever yield they pay out plus the return on equity multiplied by the amount of money that they reinvest in that business, multiplied by the way that the market treats that reinvested capital. And so you can look at, it's a very simple calculation to do. I really never care about the actual trajectory of the stock price. I think that

Starting point is 00:14:06 that's something that you just, that's out of your control. The only thing that's in your control is your own analysis of the business. And when I do those things, the returns to value are as good as I've ever seen them. It's a small cap, small and micro. But this is just what's happened in small and micro world. It's all crushed. So one quick question to you here, Toby, about the asset management industry as a whole. That's one thing I can't help but ask. Now we're talking about this pig and we're talking with you. With everything that's been going on, those low yields we have now, I'm looking at some of the old, well-renowned value investing company. It doesn't necessarily have to be value investing, but for the sake of argument, just say it is. And they're all built around

Starting point is 00:14:43 doing close to 1% in fees. And they're not performing. And even if they did perform as the benchmark, you know, it's like 3%. And with all that money just going into passive ETS from Vanguard, seven basis points, is a company like Diamond Hill Investment Group? Are they seeing if they can get the same investors on board or is it just a completely different ballgame who are not so much interested in fees and like perhaps the seller products through banks and and like different type of investors who are just not looking into this whole, hey, why don't we just index? If you looked at the index and you did the same calculation that I did, which was a yield plus a return and invested capital multiplied by, you know, and so on, just the way that I was

Starting point is 00:15:27 describing, what you'd find looking at the index is that the return over the next decade is likely to be between zero and two percent, including dividends. And I think that that means that it's negative on a real basis. So the amount of money that we're going to print over the next decade, probably that's going to dwarf anything that's ever been printed before. And you're going to earn at a big discount to that if you're in the index. So it really doesn't matter if you're paying seven basis points or zero basis points. I don't think you're going to get any return there. In order to get a return, you're going to have to buy things. I mean, this is what the Fed does. They push guys out on a risk spectrum. You're going to be down in small and microcap value

Starting point is 00:16:04 world to get some decent return. And so I don't mind all of that money flooding into the index is because it distorts prices. It distorts valuations. I'm a value guy. That's the best thing in the world that can happen to me. I love that kind of stuff. And you plan on holding it as in the long term. So your opinion is that it's in a, the market's in I eventually realize what the real value is, which we're all looking at this and saying there's value. The numbers are screaming. I don't need the market to recognize the value in these things. Because, I always calculate the return without the market having any multiple. And if I can get a return that's bigger than sitting in a 10 year or whatever the comparable

Starting point is 00:16:44 kind of my other cash alternative is, then when I look at these things, they're like 10 to 15 times the 10 year. The return is enormous. So I'm very comfortable holding these things. Well, Toby, the dividend alone is double the return you get out of the S&P 500 based on its P.E. All right. Let's go to another one.

Starting point is 00:17:03 Harri, do you have anything for Tobis or you want to roll to the next thing? This is way out of my circle of competence. Sounds very interesting. I'm going to go next if you don't mind Stig. Please go ahead. It's not that I have two picks. I just want to emphasize my pick on the first quarter of 2020 was Bitcoin. It was at 8,600 back then.

Starting point is 00:17:27 Today it's at 15,260 for a 77% gain over the last 200. If you analyze that, that'd be 131%. I am doubling down on that right now. I think that the next 12 months are going to not just be better, but way better than what we've seen since the previous selection. Back then, I suggested that I was looking for a price of around 20,000 by the end of the year. I think that that's still possible.

Starting point is 00:17:56 I kind of suspect it might be pushing into the first quarter of 21 for that previous all-time high to get hit. it might get there by the end of the year. We'll see what happens. My expectation for the end of 21, or 12 months from now, is I think it's going to be at 100,000, maybe even higher. So I really like this pick. I like the direction this is going. I like where the fundamentals are going. I like the people that are entering the Paul Tudor Jones of the world that are now starting to pile into this, talk about it on CNBC. So I do want to emphasize something that I think is really important. extremely volatile to the point where if you don't have the temperament to own something that's

Starting point is 00:18:38 very volatile, it's probably going to scare the bejesus out of you. So if you do want to take a position in something like this for all the technical reasons, and I'm not going to get into all the technical reasons here unless you guys got questions about something specific, I can talk it. Because I've done plenty of interviews that people can kind of go to if they want to hear my opinions on all the deep reasons why I like this so much. But I would recommend that a person, if they do want to take a position in this, they're worried about the volatility, do it through dollar cost averaging where you say, I'm going to buy a little bit over this period of time, call it three months, and I'm going to buy a little bit each week.

Starting point is 00:19:15 And whatever position size you want to get to, whether it's 1% of your portfolio, 5% of your portfolio, which Fidelity has sent out an email recommending that people have 5% of their portfolio in Bitcoin, surprisingly enough, which I would have never expected something like that from a company like Fidelity. But they're on board. So my whole point in bringing this up is if you do want to take a position, I recommend that you do it through dollar cost averaging, probably over three month period of time to get yourself into the position even though it's super volatile. And yeah, I'm very excited about it. I hope you're right. So don't get me wrong whenever I'm saying this. One of the things that you're so engaging on Twitter is also that you want to hear

Starting point is 00:19:56 like why you are wrong. And so I'm sure you had a lot of people tell you, either wrong. Some of them probably had good points. Some of them didn't have good points. But I don't necessarily know if the mastermind group is the best place for you to get a lot of pushback and sort of like provide the bad case. So I'm going to give you a very ungrateful question. I'm going to ask you, could you tell me what is the best argument why you are wrong on this, call it 7x return that we're going to see within 12 months? Like, there must be a really, really good bad case. And as you know, Preston, we really, really like here on the show to argue from both sides. So please be your own devil's advocate. So the best argument that I've heard of it not being able to do what I'm talking about is if

Starting point is 00:20:42 elected officials become fiscally responsible. Because then the dollar and everything, you know, all these fiat currencies aren't going to be debasing at, you know, breakneck speed. And so there would be no reason to own Bitcoin. So it really comes down to your opinion on what. what you think is going to happen with the alternative, your opportunity costs from a currency standpoint, do you think that governments around the world are going to continue to debase at a breakneck pace? I think that they will. So I'm looking at something that can't be debased and saying that's going to do really well, especially when you look at the market cap. So that would be the counter argument. If you don't buy into this narrative that I buy into, that might be an

Starting point is 00:21:27 issue for you if you own this. That's a very good point. What I'm curious is, why is there a divergence in terms of price increase in gold versus Bitcoin? And the follow up question to that is, is Biden going to be better for Bitcoin than Trump? The reason I'm asking that is usually supporters of Biden are in Silicon Valley, many of them. And they are all huge backers of Bitcoin.

Starting point is 00:21:56 supporters of Trump traditionally have been gold bucks. And when they lose trust in the government, the gold bucks go to gold. When the Silicon Valley folks lose trust in the government, they go to Bitcoin. Now their guy might be in the White House. So will they now go easy on Bitcoin? Or will the gold bucks go more into gold? I look at this question as being really straightforward. So when you look at gold, the market cap on gold, most will argue is around $10 trillion.

Starting point is 00:22:31 When you look at Bitcoin today, it's at around $250 billion. So when you're looking at something that is literally 40 times less in its market cap, but can serve the same purpose. And I would argue even more than what gold can serve simply because you can actually put this on your smartphone and go to a store and spend it. unlike carrying around ounces of gold and making them divisible in order to conduct transaction. So I look at the utility on this as being way, way more superior than gold. Not only that, when you look at gold, you have to conduct a purity test. Like if I deliver a lot of gold to you, you have to somehow determine whether that's actually real or not.

Starting point is 00:23:12 This is really easy. You just run a full node and you can see that it's authentic and it's part of the protocol, right? So when I'm looking at that and accounting for the upside of where this is potentially going, this is like a slam dunk as far as why the upside is there. And it really kind of comes down to market cap and utility. When looking at the Biden portion of your comment, you know, the thing that Biden has said that he's going to do way different than Trump is taxes, specifically capital gains for high net worth people. So when you look at where this is going right now, Bitcoin's treated like anything else

Starting point is 00:23:45 and you have to pay a capital gains for any type of gain that you have on it. So I would argue that if you increase taxes on this, that is very bullish for Bitcoin because people aren't going to want to sell it. They're going to want to hold it longer, which then reduces the supply that's being put on the market for buying, which makes the number go up. So, yeah, I think that that aspect of it is probably how I'm viewing it just from a numbers and mathematical standpoint, I think the higher that they put the taxes on this thing, the less you're going to see people dropping it onto the market.

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Starting point is 00:28:25 That's Shopify. com slash WSB. All right. Back to the show. So the question is also, do you feel, to Preston's argument really, like what's the back is? feel that this time is different? Do you feel that we will go back to a period like we have been where there will be more or less no inflation? Or is what you see now is that here to stay? And I guess that's up to people for themselves to decide. Yeah, well, I think the inflation piece is really

Starting point is 00:28:56 important to talk about because in my opinion, 99% of the people I've ever talked to in finance don't even understand what inflation is. They say the word and there's really no meaning behind it. So whenever I think of inflation, I've got to break it out into monetary inflation. Are we talking about how many more dollars we're adding into the system? Because if we are, the dollar was debased by 20% this year based on printing alone. Now, did we see that show up in the price of oil? Did we see that show up in the price of, you name it, commodity that's measuring this basket that everyone likes to call inflation because it's published by governments?

Starting point is 00:29:31 No, I would tell you that all that printing pretty much went into the capitalization of assets, right? Because, I mean, think about it. Most of it's going straight into QE, which is bidding the bond market. So when you're looking at something that's massive and it's getting printed like that, I would challenge people to, especially when you look at how we're valuing things, right? Because what we're doing is we're valuing things based off of a 10-year, quote-unquote, risk-free rate and a premium above that based on inflation, right? That's how risk-free rates are priced, is they're accounting for, quote-unquote, inflation. I think, that a lot of that is getting mutilated and destroyed in such a way that it's not even

Starting point is 00:30:13 making sense for a lot of economists until they actually take their paradigm and flip it on its head to fully understand what in the world is actually happening. And I think that that also makes it an extremely bullish case because most people don't even know what inflation is. But let's go to the pick. So, Hari, I need your help on this. I'm not an expert on Oracle. Everyone knows what Oracle is. They know it's a business-to-business type company. And so that's why I think we're just not intimately familiar like we are with Apple or Amazon or something like that. Because behind the scenes, when you look at their revenues, 66% of their revenues comes from cloud services and licensing support. Another 19% comes from cloud licenses and on-premise licenses. Only 8% comes from hardware and 7% comes from services.

Starting point is 00:31:03 So, I mean, this is all about their intellectual property for software and on-site labor, it appears. Looking at their numbers from 2019 to 2020, their numbers are slightly down. And I want to start off by saying that I'm bringing this pickup because it is showing up in our value filter, not at the top of our value filter, but it's demonstrating that it is kicking off a decent amount of profit. And the momentum on this is good. When you look at the long term of this thing, clear back to the 2000s, this thing has just really had a very steady climb just year after year. When you look at their margin in a per share kind of way, it's very high, double digits. When I'm doing an intrinsic value assessment and doing it in a conservative way, I'm getting in excess of like six or seven percent on an annualized basis for the company. So not nearly as good as what Toby had, but decent numbers.

Starting point is 00:32:03 I really like the network effect and the fact that they're in this technology space, because that really kind of seems to be where all this printing is manifesting itself is in anything with a network effect that's tech-related. So I'm looking at it from that vantage point, but I'm kind of curious to hear your thoughts out in the valley of what people think of Oracle. from evaluation perspective, I do agree with you that this is not something that is on the radar of many growth investors, at least. My opinion about Oracle is that just to give some context, their main strength is their relational

Starting point is 00:32:42 database. This is like how IBM had their mainframes. What mainframes was basically, they were system of records. for many companies. So it was really really at the core of many businesses that it's really hard to replace. I have been in many companies, I'm not going to name them. I think you can guess where we had attempted to replace Oracle and these were companies with good technical talent.

Starting point is 00:33:14 It was a Herculean task. Really, really tough, took many, many years. In fact, Amazon has their own database. in AWS. And only last year is when they were able to get out of Oracle and even then they had a lot of trouble doing so. So it's not easy for people to get rid of Oracle database. So having said that, the challenge I see with Oracle is the same as IBM.

Starting point is 00:33:46 They have a cash cow which is deeply entrenched in some of the existing businesses. but they are not able to innovate like Microsoft and get good at other stuff that is relevant today for most companies and businesses. And that has shown up in the way they have failed to capture the cloud and how they were slow. In fact, I put IBM and Oracle in the same bucket. They both are old, soggy companies which none of the brand new top. talent or not even talk. If you can't get into any of the companies, you'll probably join Oracle or IBM.

Starting point is 00:34:30 If you are from Oracle and IBM, I mean, I'm talking today. I mean, 10 years back, 15 years back, 20 years back, really good engineers used to go to Oracle. So I'm not saying people in Oracle now are bad, or bad engineers. It is just that today, if you ask a new college grad, Oracle will probably not be in their list at all.

Starting point is 00:34:53 So I'm worried about that is number one. Number two, they made a couple of investments which were like buying Sun really didn't pan out. And in your numbers, you just said like 7% of their revenue comes from hardware. Basically that's all Sun. And Sun was already like, you know,

Starting point is 00:35:10 their hardware business was not great. Java was not making money. So it was not really apparent why they bought Sun Microsystem and whether it really panned out. them. So it's like how IBM made some acquisitions that really didn't pan out well for them. So I just put them both in the same bucket. So in the short term, yes, they are a cash call. In the long term, I would be worried about their ability to execute. And also we have to keep in mind, Larry Ellison, the founder and CEO, he's gradually disengaging because of age and his tenure there.

Starting point is 00:35:44 And I believe Mark Hurd was one of the CEOs who passed away. So they have leadership issues as well going forward. So when I look at their ability to attract talent, when I look at their product portfolio, which apart from RDBMS, that is the database, they don't have much to show. And when I look at the competition, they're slowly waiting away at the fringes,

Starting point is 00:36:06 and this is exactly what happened to IBM, basically. Because their ERP solutions is not best of the breed. A lot of companies like Workday, Salesforce, and other service now, Amazon, on AW with their AWO's offering and Microsoft, of course, they're all eating away Oracle's lunch on the fringes but getting to their core. And especially the new companies are not going to Oracle for a database as well, because most of them will build the software on the cloud and Oracle is nowhere in the cloud. I like how you're comparing it to IBM. The only thing that I

Starting point is 00:36:41 would push back on with that comparison is when you do look at the top line between IBM and Oracle, IBM's top line is withering away. It's getting eroded. When you look at Oracle, it appears that it's been holding steady. I mean, just as an example, in 2011, their top line was $35 billion. Today it's $39 billion. And when you look at the trend through those last 10 years, it's just been this really slow, gradual climb up.

Starting point is 00:37:11 It hasn't, it's not very volatile when you look at their top line. And it goes to this network effect that I think that we're both agreeing they have. So that would be the only thing that I'd push back on. This is not a sexy pick. This is not an exciting pick. I get the same impression as you that they're just riding this IP that they have, this digital, intangible IP. And I just don't see a lot of creativity of like how they're going to take their company to the next level or how they're going to take market share from anybody else. And the valuation isn't great, but it's not terrible. It's a lot better than you'd see in the S&P 500, so I think it's going to do fine. But it's not something that I'm real excited

Starting point is 00:37:52 about. I don't own it. I'm just pitching it to kind of see what your thoughts would be. In the short term, next five years, I wouldn't be worried about Oracle. They're not going to go anywhere. I'm thinking longer term. If I want to want it for the long haul, they will have their motorated over a period of time. I think it's an interesting pig, also because we spoke with Evan the CEO of NetSuite here on the podcast. If this pick, and I think they're up like 30% organically, NetSuite, if this was NetSuite in itself, like you would just see that rocket fuel growth

Starting point is 00:38:25 that you see with cloud computing right now. And then you see Oracle. And, well, it's not, you know, let's call it flat or slightly positive. It's not what you would expect with a cloud computing company. The margins are great, but it's one of those where you're like, it generates a lot of cash. you'd probably much rather hold it than cash. It's just one of those where I'm like, being in that middle range, if you can call Oracle with

Starting point is 00:38:49 that, you know, with the huge market cap, if you can call a company with $170 billion, like a middle-sized company, it's not. But, you know, if we compare it to like the huge clock computing companies, those who actually do have markets as to top three, who would that be? You know, that's Amazon, Microsoft and Google. Can they even compete in that space? And I guess so to send it back to you, Harri, and you talked about a bit about, you know, big tech and eating their lunch.

Starting point is 00:39:09 like this relationship thing that obviously has a lot of stickiness to it and won't go anywhere anytime soon. With all the investments that are going into cloud computing right now, why won't they take on that as the next thing for those big three in tech? Why would that still be with Oracle? I'm not completely sure understand that. That's a very good point. I think one of the difficulties in removing the database from any application or workflows for companies is that they have to refactor or re-implement most of their software to adjust to that.

Starting point is 00:39:45 So even, for example, somebody is going from their on-prem to cloud, they would still prefer to keep their database the same. They don't want to change too many things at the same time. So they might move to say AWS, but they will say, I still need Oracle database. I'll be on AWS or I'll be on Azure. but I will keep my database as Oracle because that's how my system has been working for many, many years. I just don't want to change immediately. But over a period of time, they might change for some of their non-critical flows.

Starting point is 00:40:19 And that's how it starts. Once a customer gets confidence that some of their non-critical flows can go through non-Oracle stuff, they can replace some of their critical flows as well. So that might be the reason why a lot of companies. phase challenges and migrating away from Morocco. When you look at their margin, this has to be one of the fattest margins of a company for this size on the planet. I mean, their margin is 25% after tax.

Starting point is 00:40:51 After they pay their tax, they're banging out 25% margins. That is insane. They're popular for being extortionists. Because they know they have a captive cutoffer. Tomi, what are your thoughts? I'm just kind of fascinated listening to Harri's discussion because I think, I guess, when I look at these big legacy tech companies, that is the concern. That's always the concern that the reason that they're cheap.

Starting point is 00:41:20 And there's a few of them around at the moment, Cisco, eBay, slightly different, to solve consumers rather than businesses. But there are quite a few of these olderline tech companies that have got to that mature stage that are ignored completely by the tech investors. That does make me a little bit concerned when I look at something like this. What does this look like over five or ten years? This competitors compete for those big fat margins

Starting point is 00:41:43 and people who are trying to escape when you've got that prisoner's dilemma-type relationship with your customer where you're gouging them every single time they're looking for an opportunity to get away. I just wonder what that does. Harri, you had mentioned that AWS had gotten away from them in the last year. When I'm looking at the numbers from 2019 into 2020, it seems like there might have been a little bit of an impact, but not nearly the impact of an Amazon AWS stepping away. So did they only break themselves a little bit or do you have more details on that?

Starting point is 00:42:16 I don't have all the details, but what I meant by AWS or Amazon stepping away from that rather than AWS, because AWS doesn't really control what their customers will be using. They give them all choices. So Starbucks on AWS, for example, they can still go ahead and use Oracle. So it wouldn't be a big impact because my understanding is it's just Amazon related. So it must be just one customer. All right, guys. So before we started recording, it was just Preston, me talking for a few minutes before we dialed in Harry and Toby. And Preston's comment was, you have a very bold pick. And when Preston is saying bold, it sometimes means bold, most often it means stupid.

Starting point is 00:43:04 You know, he's just a very polite person. So just keep that in mind as we go into this pick. My pick is Foot Locker, the stock ticker is FL. And I usually pitch one or two things here. You know, either it's a stock pick with promising growth prospects that are just not having like high current earnings, at least compared to the price. And I previously pitched Google, Spotify and Alabama here on the Mastermind Group. And the three of them have worked out pretty well and its positions that are still hold. And then I also pitched stocks that are cash flowing really well, but the prospects are just very modest.

Starting point is 00:43:41 And examples would include AT&T in Allstate, companies with a very narrow mode, just like Foot Locker. We're riding 2020 and trading at a low price to free cash flow is just not in fashion anymore. The promise of earnings in the distant future is really all what this game is about, so it seems. So I really can't help myself, but I am still going to pick one of those ugly picks. And you can already criticize me for all the same things that I criticized Toby Ford before with like value underperforming and all the horrible things by value. But, you know, I am a slow learner. I have been keeping up with a few tech stocks, but at the end of the day, I like these

Starting point is 00:44:21 ugly but cash flowing stocks. like Footlogger. So most of you out there probably already know the company. With 3,100 stores in 27 countries, it's a well-known brand. And they're selling primarily footwear, but they also have in parallel to all minor lines. Most of the stores are owned by Footlog themselves. 139 of them are franchise businesses. The vast majority of products is from Nike. Actually, up to 70% of revenue comes from selling Nike. So I can all. already sense to someone saying, what about Amazon? At least that's, you know, we've been talking here about GameStop before, Beth Bad, Beyond. It very, very often comes back to Amazon.

Starting point is 00:45:05 So I thought long and hard about Amazon before I'm making this patch. And at first glance, it definitely seems like just another retailer that's going to be crushed by Amazon, right? And well, Amazon show is a competitor with close to half of all market share and e-commerce there in the States. It seems like company like say Nike would go to and then stop working with Footlogger. But I would argue that it's not as dangerous as it may seem. Actually, Nike started working with Amazon because of this reason back in 2017. And after facing all types of problems, they actually stopped working with them in 2019. And the reason for that is actually pretty simple. Amazon's platforms, with all the great things that they can do, also have some issues,

Starting point is 00:45:48 not just copycats and fake reviews, but Amazon is not good at building communities. It's not good at building brand loyalty for the seller, especially not if that seller is a company like Nike. So I'm not supposed to pitch Nike. So please forgive me for talking about it, but it is after all 70% of the revenue. So it's really important to understand that company to understand Food Locker. and I think you should see foot locker to some extent as an extension for many footwear companies. Because whenever you enter a footlogger, it's not a great experience. And I hope I don't offend anyone whenever I say that. In many ways, it feels like it's a supermarket for shoes.

Starting point is 00:46:29 And that's great. And that's also the advantage for a footlogger. It's a much more approachable showroom and distribution system for another target group that primarily would shop in Nike's own stores. And so, and you can even say that for, you know, the second most important partner that Footlogger have, that would be Adidas and then followed by a new balance and under Armour. You can really say that. And it's very much integrated.

Starting point is 00:46:52 So just one anecdotal example, you know, Footlogger is integrated into the Nike app. You know, so if you have your Nike Plus Logger program, you would get the benefits. You can even access and pick up your shoes in the closest Footlogger store. So it's very much an extension of that. All of that being said, Footlogger clearly has a very remote. I think that's quite obvious. But I also think there are a few things that's a bit different to understand for something like footwear.

Starting point is 00:47:20 And it's just controlled in a different way than, say, mass apparel. It's not as fragmented, and the competitive situation is actually more fierce. It's just constructed in a different way. You have a few huge producers, and the price competition is not the same thing. Because the pricing of Sniggers is very similar across many different distribution channels. It's tightly controlled by these massive companies. like Nike. And Footlogger is the biggest independent sneaker sell in the US. And so whenever we think of size, we typically think, well, that means they have a lot of pricing power. You know, they can go in like Walmart

Starting point is 00:47:54 and go in and negotiate with the supplier. Well, they can't do that with a company like Nike. But what is in that deal, just using that as an example, but it's prevalent in that industry is that you would not compete on the price. You would have a, you have a store like foodlogger that would target mid and low income families, not so much the fatal margins that Nike can do in their own stores. And a company like FootLock will get the preferred treatment that they would get their own collections and they would get just after Nike. So if you're going to Dix or a finish line that's not being acquired by JD Sports, you won't get the same thing. So that mode, if you like, comes from collection itself and where to go. So whenever I look at some of the

Starting point is 00:48:36 evaluation, I try to justify this narrow mode that I've tried to try to. to like, I don't try to excuse in so many ways. By saying that this is a company that's probably not going to grow a lot. It hasn't in the past. It has also not taken the same beating as you see many other retailers have lately. Whenever you look at the bottom line and even the profits, it haven't been shrinking. It's been a bit of a pain here during the pandemic, even though Trent Trayn is still going to be a profitable year.

Starting point is 00:49:04 But it still sustains their top line and they're still making a very decent profit. I find a double-digit return for a company like Footlogger. If I just say flat growth, I come up with 12.5%. I think you definitely can make the argument that it can be hard enough in itself, especially over the coming year. But that is my pitch for the boldest of value investing picks right now. So if I had to throw it back to you, whenever I'm pitching these stocks, you know,

Starting point is 00:49:32 and I don't want to put worth in your mouth, but it often comes down to Preston saying, dude, we're in a new world. Stop doing that. And Toby, who's like, you know, I really like the valuation, the cash lows on that one. So I'm very curious to see, like, how this discussion is going to go. Yeah, so that's roughly where I was going to go. It looks, I just had to look at the shares out.

Starting point is 00:49:53 They've been pretty good buying back stock. And as a result, the revenue per share has grown pretty well for, like, the last decade, which I was kind of surprised by. It's remarkably consistent. I guess they're engineering some of that growth through buybacks. It's a surprisingly good business on its financials, given what we know about it. It's retail.

Starting point is 00:50:17 It's typically in malls. It's got a 70% customer or 70% supplier in Nike. Sometimes I get a little bit concerned with something like this. What if their interests become adverse to Nike's? What happens then? Does Nike need them? Great question. I would argue that Nike needs them.

Starting point is 00:50:35 because they can do what they can't. It would be really bad for their brand if they started talking the same people. But there are a lot of people who are buying Nike products who just do not feel good about going into a Nike store. And I think it's quite evident whenever you walk past the Nike store and then another place in the mall you have Foot Locker.

Starting point is 00:50:56 I wouldn't call Nike stores intimidating at all. That's not what I'm saying. But how do you like to shop? And for most people who are not only brand conscious but also price conscious, you would go to Foot Locker instead of Nike. So instead of rebranding and having like a more approachable Nike products, I would say they would need a company like Foot Locker to do that for them. So to me it seems like a win-win to do that.

Starting point is 00:51:19 But you all right, this is narrow mode. They can't just flip the Swiss and say, you know what? We're going to do like 70% Adidas instead. I mean, that's just not how the business works, unfortunately. 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 customer trust together on one AI-powered platform.

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Starting point is 00:55:13 I mean, the March event, the whole COVID thing, that quarter was disastrous for them. they were literally down 50%. But this past quarter that they just closed out was right back to where they had been historically for the last 10 years. So that tells me that there is some type of customer. I don't get it. Like, I personally don't get the whole sneaker thing. I know there's a lot of men that go out there and like, this is like their thing is

Starting point is 00:55:39 they collect shoes similar to, you know, like my wife does. And they're into it, right? I don't understand it. But I think that there is a fairly large market of guys that like to go to these foot locker shoe stores and try on these new Air Jordans or whatever. And based on the numbers, it doesn't seem to be getting impaired in any type of way, which to me just does not make sense. I would suspect that because the traffic at the mall, the foot traffic at the mall is down significantly, that businesses like this would be suffering. But the numbers are telling me that that is not true. That is false.

Starting point is 00:56:21 When I look at the valuation on it, I mean, come on, it's price to perform. There's no doubt about it. It's packing in a lot of profit for the price you pay. The margins are marginal. They're at 6% after tax. So I don't think that the margin is anything that's that exciting. But I do think that the market has penalized the price significantly. And that's where the value is as you're getting it because the rest of the market

Starting point is 00:56:46 has, I think, had the same opinion that I'm having at a superficial level without doing the deeper dive into the financials. They're just saying, well, the traffic in the malls down, so why in the world would you ever own this? It's just, I'm sure when people heard you pitch it Foot Locker, they were just like, are you even serious right now? Because intuitively, it just doesn't seem like it'd be doing well. But I'm telling you, look at the top line of this company, and the top line is rock steady. So I do find it an interesting pick. I don't like it long term. I'm like, is this something that I think is going to do well 10, 15 years from now? I don't know. I'm not so convinced, but over the next three years, do I think the price could come back because it's just so

Starting point is 00:57:25 cheap and for the profit that they're kicking off? Sure. I don't own it. I don't think that the momentum on it's that great. But it's a surprising one to me. I think, you know how I would describe this? If somebody's listening to this and they're in like grad school or they're, you know, getting an MBA or a finance degree, I would tell you, this is a really interesting. to look into and to study from the financial statements because you can see how well this company is being managed. You can see, and my first point there about the CEO, the CEO has been there for a long time. He was the CEO from 2012 and has just basically climbed up the ladder. He's now the CEO. He's been there for a long time. I think that this guy really has a good understanding of

Starting point is 00:58:08 just business. So those are my thoughts. Well, I think you put it extremely well, Preston, And I definitely have the same concerns as you. And the reason why I do consider it is, you know, because of the same reasons as Toby talked about, you know, the financial just rock solid. We have a quick ratio even close to one here during the pandemic. So they don't even need to sell shoes. They're still cash neutral. And obviously, they will sell footwear.

Starting point is 00:58:32 That's not what I'm saying at all. But it's rock solid. It had more than a billion dollars in cash. You know, it won't be the first one to go. And so to me, the reason why I found it so interesting was looking from the sideline, everything that was happening on Nike and like the try-it-out Amazon. It just didn't work. Nike's not going back and trying out Amazon anytime soon.

Starting point is 00:58:49 What's going to happen in 10, 15 years, like you mentioned, Preston? I don't know. Will we see some major disruption here? Probably. Can I make my money back before then? I think you can. I think that Toby has said this quite a few times for some of the ugliest pick that I've had here.

Starting point is 00:59:03 And I had a lot of really, really ugly picks. Buy a basket. You know, there are a lot of these stocks out there who, I think in my cap is around $4 billion, you know, not major companies. generating a ton of cash. We previously talked about GameStop and thank God only I was stupid enough to invest in that and we talked about Beth Bamion. We talked about a lot of different companies. Companies that are cash flowing but just facing a lot of headwinds, sometimes you see like crazy source in the stock price because of an Elliott management or someone like that would go in

Starting point is 00:59:36 and take an activist position. That might be an approach for you. I think the volatility for a stock like this can be a bit brutal. And also, I think it's important to say whenever you do your intrinsic value assessment that they're not going to be a huge growth potential for something like that. You know, whenever you read through the strategy, like how they want to grow, you know, they talk about they want to target Asia and how they're opening stores up and now have a distribution center in Singapore. They talk about the new loyalty programs, pushing for women's shoes. I think all of that sounds good. I think in reality it's like corporate cliche for we're supposed to say that we're growing. I think a lot of that would be really

Starting point is 01:00:14 difficult. And for also having been in Asia and know the brand of Footlogger, and I'm sure they can rebrand and hopefully they can. A brand like Footlocker is not going to be attractive almost any part in Asia, if you ask me. So unless they're really, really good in terms of rebranding that. All right, guys, that was my pick. Any other comments? Great. Horry, I think you're up next. It's been almost a year since I had pitched Reliance Industries. And at that time, I didn't have all the information, but I did know that they had put in a lot of investment and effort into building out geo, which has now become India's largest carrier for cell phones. And that's all I had that they were putting in effort. So, but however, the major issue then, I think Toby had pointed that out, it was their debt.

Starting point is 01:01:13 So one of the major concern we had then was their close to 20 or more than 20 billion in debt, billion dollars because their cash go is their oil business and they were transitioning into being a technology business and geo was their technology arm and they were neck deep in debt. because they had to build out those infrastructure. So what Gio has done is, geo has the cheapest data on as a wireless carrier in the world today. And it also has an optical fiber across the country, even like B-Tons, not just the major cities, but also the smaller cities.

Starting point is 01:01:56 They're basically becoming pretty much a monopoly in India. Now, last six months, they're having, significant developments where Facebook paid them close to 9 or 10 billion. I forget like 7 billion, I guess, 7 billion for a close to 9% stake in geo business. Then Google came in, they paid another for Colcom and their list goes on and on. And many

Starting point is 01:02:25 Silicon Valley venture partners also invested. Within a year, they have raised $22 billion or more. and just to give you a context, the entire VC funding in India in 2019 was 10 billion. This one company raised $22 billion for their, and they gave away 22 or 24% of their stake in geo, their technology arm. They're now making a phone, the cheapest smartphone is what they're calling it, with the help of Google. And they are entering into a partnership with Facebook where they're going to. to use WhatsApp and make it into like VChat for India. That's another.

Starting point is 01:03:08 And through that, they want to compete with Amazon because they already have a retail arm, reliance retail. And they are taking a different approach than Amazon, but essentially trying to compete with Amazon or online retail. I thought I read something this week that showed that this was happening over in India where they were incorporating Wii chat with payment mechanisms so that you were going to be able to pay by phone through the Wii chat app. Is this the same deal that you're talking about, Hari? WhatsApp.

Starting point is 01:03:38 I mean, no, Vechat is banned in India. That's what I meant to say, WhatsApp. Yes, that's the deal. So Facebook and Relance, I've entered a deal. Facebook, I believe, has been trying to turn WhatsApp into VChat, monetize it. I don't think they have succeeded well that much in U.S. But in India, WhatsApp is really, really popular. and online payments are also very popular.

Starting point is 01:04:06 And then that's the deal that Reliance and Facebook entered. So just one last thing I'll say, and then we can talk about your question, Kristen, is as of last month, Reliance became zero debt. They announced that they cleared their $20 plus billion in debt. So that's why I want to bring it back in. It sounds to me like they're going to achieve a major network effect over there. Yeah.

Starting point is 01:04:30 And also I think in India, there is a lot of regulatory hurdles. I mean, building out wireless towers, laying out all the fire optic cables, requires a lot of permissions and regulatory approvals and stuff like that. And the way I think about it is, Facebook, Google, instead of they navigating all the regulatory hurdles, they're paying a toll to Mukay Shamban, who's the CEO of Relance, to do that job. for them anyway. And they're going to be partnering with him. And it's a huge network effect that way. And you were saying that you only have the ticker on the Indian exchange. Is there any way to get access to this on a U.S.-based exchange that you know of? Yeah, the ticker symbol is RLNIY.

Starting point is 01:05:21 Yeah, I just want to add one note here that last year when I talked about this pick, I had a hunch that trying to transform their business from being a oil and gas company to being a high-tech company. But over the year, what has given me more confidence is their execution and their ability to attract capital. And their ambition also has grown. A lot of analysts in India are now talking about they being the Alibaba of India. and that's a long pending and awaited event to happen in India where as the Indian market is going, as the economy is now reaching $3 trillion and projected to grow to $5 trillion, it really needs banks and technology companies that can scale and support that kind of an economy

Starting point is 01:06:14 and reliance is well positioned. And the past year of track record and their overall CAGRR for the, the past 10 years has been up north of 20%. They have been without the support of all these investments, they have been growing quite fast in terms of their top line. They're expensive, they're not cheap, but I believe that most market participants still don't appreciate the transformation that is happening and the opportunity and the market size they have,

Starting point is 01:06:47 the total adversarial market they have, they are pretty much like a combination, combination of Verizon, Amazon, and you add in Facebook, like WhatsApp, basically, or reach out. So there are a combination of these three areas, online retail, social networking, and the infrastructure or wireless carrier. So that's what makes it interesting because there can be a lot of network effects. They are the toll. They control a lot of traffic that can get into these destinations, and they can leverage those relationships they have. Hardy, whenever I look at the company and whenever you do explain with all networking effects, as you mentioned, you think of, could this be the next Alibaba, just a lot cheaper?

Starting point is 01:07:36 And you definitely see some moves there on the top line, even though you don't see the same consistency. And I can't help but think how much of this is what Alibaba did. I mean, China had the infrastructure. I'm not necessarily talking about. roads here, even though that also plays a role, but like the digital infrastructure to make those moves. Is India ready for a company like Lions to make the same moves? That's a good question. What I see in India is, I think, somewhat similar to what China was in the 80s or the early 90s. So it's really hard for somebody to imagine that an Alibaba like company can exist in India now.

Starting point is 01:08:20 And that's also the risk because it might not pan out. And that's the reason I wanted to bring it up back because one year back I was less confident, but I just had an hunch. One year since I pitched this, I see those things pan out. For example, Indians are leapfrogging landline. Everybody has a cell phone now. The penetration is humongous to the point where every street vendor has multiple smart phones. Everybody is using QR codes, which for folks in US, when you go and buy vegetables,

Starting point is 01:08:56 you buy from a street vendor in India. And like US, so grassy sale all happen on the street. Earlier I had to pay cash. Now I had to just flash my phone, can that QR code on his cart, and that's it. I don't have to use cash at all. And COVID has accelerated that. When I was in India for sometime now recently. Amazon and Flipcard, everybody uses it. Now Reliance is coming into that market as well. So the infrastructure is much better than it was. We use, like my friends and relatives back in India, use Reliance for their cell phone as well as internet. They're, if not better, at least same as US. So people are migrating to geo really fast. So these are all like based on my personal experience also. They are anecdotal, obviously. Those things give me confidence that the next five

Starting point is 01:09:51 years, their growth will accelerate. All right, guys, that's all we have for this mastermind. I love doing these, by the way. I'm going to throw it over to Toby. Toby, if people want to learn more about you, give them a hand off. I've got a website, Acquireasmultable.com, which has got all the books and links through to a screener that's got some of the stock picks that I discussed. The Two funds that I manage are the Acquirous Fund, Z-I-G. It's long, short, deep value in the US, and the new one is Deep, which is D-E-E-E-P. It's a small and micro-same process as the other stuff. And I have my own podcast, too, or I talk to various folks about value investing.

Starting point is 01:10:32 It's called The Acquiris Podcasts on all good podcast platforms. Thanks. Ari? You can find me on my blog, bitsbusiness.com, or talk to me on Twitter at Harry Rama. Guys, we can't thank you enough for always making time for us and the community to come on the show. I love being here. Thanks for having me. Yeah, same here. Thank you, guys. All right, so as we're letting Tobin Horry go, let's play a question from the audience.

Starting point is 01:11:01 And this question comes from Daniel. Hi, Preston and Stig. Love the podcast. When valuing companies, you often talk about the internal rate of return. I was wondering how you decide upon the expected growth rate of the company's cash flows over the next few years and also how you decide on the discount rate to use. Thanks. So Daniel, the discount rate and the eternal rate of attorney is sort of two sides of the same coin. And you can even bring the growth assumption into that.

Starting point is 01:11:36 But I'll get to it here shortly. So let's just take the example of footlogger that I pitched here in the episode. The stock today is trading at $36. If you discount the future cash flows back to what the stock price is today, you will have your internal rate of return. So if the stock price is high, say $50, the internal rate of return will be correspondingly lower, meaning your potential return will be lower. It's the same thing.

Starting point is 01:12:02 That makes sense because if you think about it, an expensive stock today will then yield a lower return because you're paying more for the same amount of discounted cash flow. and if the stock price then dropped to $20 today, well, then your return and rate return would be higher because now you're paying a lower price for the same amount of discounted cash flow in the future. So the question for you as an investor to ask yourself is, am I happy with the expected return for that stock compared to the risk? You can't put the same number on risk, so we have to make a qualitatively evaluation of that.

Starting point is 01:12:36 How risky is it? And the other thing to consider is, do I really think. that Footlogger will continue to have a flat growth. So when you ask about how we decide what the expected growth rate is, it's a tricky question. Preston might be more or less concerned if Nike should stop working with Footlogger anytime soon compared to my assessment. And depending on those assumptions, we'll come up with different growth rates. So you have to make the decision that of all the stocks that you know how to value,

Starting point is 01:13:03 or what we call our circle accountants, which internal rate of return is highest, meaning where's your expected return the highest. And when you do that, always consider how conservative you should be in your assumptions. You might have learned to use a high discount rate if it's a more risky investment. That's true. The other side of that which mathematically is the same to your question about discount rate and return rate of turn is if it's a risky investment, you can similarly be more conservative in your growth assumptions or use a lower starting point for normalized cash flow. You'll end up with the same result. I hope this was helpful. Daniel. And before I throw it over to Preston, make sure to subscribe to TIP email that comes out

Starting point is 01:13:44 once a month. And I can even say that in 2021, it'll come out once a week. And we graph the free cash flows and discount them back for stock picks that we found interesting. And I think that might compliment the answer that I had right here. Sometimes whenever you see something being grabbed out, it might be slightly more intuitive to look at. I also want to say if you don't want a free newsletter in your inbox, which is completely understandable, you can just go into the Investorspodcast.com, and you can find all of our intrinsic value assessments for free just right there on the front page. So, Daniel, I really like this question.

Starting point is 01:14:18 And the reason I like this question is because it really gets to the essence of what we talk about on the show all the time when we're doing these calculations. And for somebody who's not intimately familiar with the equations that govern these valuations, it might sound really confusing. It might just sound like a bunch of gobbly gooks. So let me just try to explain this in the sims. simplest way that I can. When you're doing these calculations to determine the value of a company, it really comes down to three main variables. Three. The first main variable is trying to figure out

Starting point is 01:14:50 what the future free cash flows look like. So if the company's making, and I'm just going to use really small numbers, so it's simple to understand. Let's just say that a company has $10 of free cash flows. Profit. They're able to retain that. They don't have to spend it on anything. It's all the money that they retain after they pay all their expenses. So Stig and I are trying to make an estimate of what those future free cash flows look like. If they made $10 today, are they going to make $11 next year, $12 the year after that, $13 the year after that, whatever that number is, we're trying to estimate what it's going to be, and we're trying to do it in a conservative manner. So the root of your question was the growth rate, right? So how much are those free cash flows growing?

Starting point is 01:15:35 when we look at how the free cash flows have grown in the past, that can kind of give you a trajectory or an idea of where they could potentially go in the future, but it doesn't mean that they are going to go there in the future. So it's really important that as you're making trend lines of saying, well, the last 10 years, it's kind of grown by about the free cash flows have grown by about 5% a year or whatever it might be. You can project that out and say that I think that the company's going to continue to do that. Now, if you say something like that and you project those out, you need to go into the qualitative analysis of are they remaining competitive? Who are their competitors?

Starting point is 01:16:12 What does their top line look like? Is it descending? All those kind of things are where you're going to go in and dig to try to understand whether those projections that you're making for the future free cash flows should be growing, should be flat, or maybe even descending, depending on what the company is and what it's doing. So when we were looking at the one that Stig was talking about with Foot Locker, For me, I just, I didn't really grow the free cash flows at all.

Starting point is 01:16:38 I just kind of kept them constant across the board because I just didn't really have a good feeling of saying that they could grow from here. Now, that's the first variable is that estimate of the future free cash flows. The second variable, and this is the one I really like to talk about, is the price. So when you go to grad school, they always want you to solve for this variable. And for me, it's a little frustrating to solve for this variable because it's a given. You know, as a person with an undergrad in engineering, the first thing you do when you're solving a problem is you say, well, what's my givens and what's my unknowns? And when you're dealing with publicly traded companies like Foot Locker, for example, you know the price today. So if I want to take a position in Foot Locker, I know exactly what I can buy it for.

Starting point is 01:17:30 it's right there. It's published for me. So I treat that as a given. Why would I solve for something that I know what it is and I know what it's going to cost me in order to buy? So that's where I get a little frustrated with academia is because they're always making you solve for the given. And it just doesn't make any sense to me. So that's the second variable is the price. The third variable is the discount rate. And we talk about the discount rate a lot. And so when you have these future free cash flows, everyone, everyone has probably heard at some point in time, $10 next year is not the same as $10 today. And what we really mean by that is you have to take future money and you have to discount it back into today's value. And when you do that, you have to choose a rate. And so if you use a really high rate, If I take $10 next year and I discount it back to today's value with a 30% discount rate, what it's going to do is it's going to push the value today into a much smaller number. If I use 1%, let's say I discount $10 from the future into today, it's going to make the valuation of that way higher.

Starting point is 01:18:48 So what we do when we're doing an IRR, an internal rate of return, is we're actually solving for that discount rate. Okay? So we're saying this is what we think the future free cash flows look like. We're making an estimate of that. We're saying this is the price. We know what it is. Tell me what that discount rate is.

Starting point is 01:19:08 And when we look at that and we say, hey, the discount rate is 7%. What we're really telling ourselves is if those future free cash flows that we estimated are correct and they actually become that and I can buy it at this price that I know it is published today, my expectation is that I can get a 7% return by buying it if all, if those future free cash flows keep happening. That's how we're doing our evaluation. So it's those three critical elements. And so when we do a discount cash flow, or when we do an IRA on a company and it's coming out with a 15% IRA, that's telling me that there's a lot of value to potentially be captured in a company. If my estimate of my future

Starting point is 01:19:55 free cash flows are correct. So if I'm doing a really conservative estimate with those future free cashless, and it's coming back with a really high discount rate, that tells me there's something there. There's something to dig into. And so on our TIP finance tool, which we're going to give you free access to for asking this awesome question, we do all of this, we make this all automated for you. We make this way simple so that you can just look at a chart of the previous free cash flows, you can just kind of draw it out graphically of what you think the future free cash flows might look like and what that growth rate might look like. And then it'll calculate that IRA. It'll say it's a 12% or it's a 7% or whatever it might be. And for me, you know,

Starting point is 01:20:40 prior to us building this tool, which I use all the time, I would have to go in there in Excel and try to calculate all this stuff. And it was very time consuming. And then you'd have to plot it, plot out the previous free cash flows to see what you think maybe the trajectory in the future is and all that kind of stuff. So it's really helpful. Stig and I are definitely eating our own cooking here with the TIP finance tool. And we're excited to be able to give this to you for free for asking this awesome question. So Daniel, thank you so much. And hey, anybody else out there? You want to get your question played on the show? Go to AsktheInvesters.com. There's a little button there you can click. You can record your question. It's super easy. If it gets played

Starting point is 01:21:19 on the show, you can get access to TIP finance just like Daniel. All right, guys, Preston, I really hope you enjoyed this episode of The Investors Podcast. We will see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network.

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