We Study Billionaires - The Investor’s Podcast Network - TIP356: Investing Mastermind Q2 2021

Starting point is 00:00:00 You're listening to TIP. Once a quarter, I sit down with my friends Toby, Jake and Wes and talk about investing. For today's episode, I asked the investing in Mastermind Group how they think they can best add value to our listeners. Toby wanted the audience to better understand value cycles. Jake shared his thoughts on how to create your own free MBA. And Wes shared his insights on how to optimize your taxes. And me? I've invested in two stocks in 2021.

Starting point is 00:00:28 Serrated growth properties and frankly Covey. Today, I want to talk about Franklin Covey and why I think it's an asymmetric bet with limited downside and a major upside potential. So without further delay, here is our Q2 Investing Mastermind Discussion. You are listening to The Investors Podcast, where we study the financial markets

Starting point is 00:00:53 and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Dick Bruterson, and it is time for the Q2 investing in mastermind meeting. And as you guys know, we have two different groups. We have one with Preston, Hari, and Toby. That was the one we did a few weeks ago. And today we have Wes, Jake. And for some weird reason, Toby has sneaked himself in once again into the group. So it's always great to have the three of you with us here today, guys. So thanks for making the time.

Starting point is 00:01:33 My pleasure, man. Thank you so much for having me again. I'll show up to anything. I'll show Anytime you guys are opening an envelope, I'll be there. Love it. So the outline here is pretty simple. Each of us bring a topic to the group, and then it's up to the other group members to add as much value as we can to the topic as possible, playing devil's advocate if we need to as well.

Starting point is 00:01:54 So, Toby, having said that, let me throw that over to you. Everybody knows I'm a value guy, and it's been a long time in the woods for value guys. Wes and I wrote a book that's nearly 10 years old now, which is crazy, because I don't feel that old, but I don't know if we really would have thought that the next decade would have looked like this, like it has looked. But in any case, I think that there's some good news for value guys, and it looks like maybe September or later last year, value seems to have turned around and value seems to have run pretty hard against the market. But it looks to me

Starting point is 00:02:30 like it's sort of, it's been drifting around for the last month as the, probably the anti-value is like ARC or Tesla or those kind of firms. I'm sorry, I know that, I know that there are lots of people out there who hold them. They're like the biggest things in the market. So it's unavoidable that everybody's got some exposure to it. But from my perspective, they basically trade inverse to value. So where Tesla and ARC have run really hard, VALDI is done really badly. And then as that relationship has turned around, value has started doing really well again. But we're within value, we're always going to talk about the different types of value. Part of the reason I think that it looked so good last year is that the type of things that

Starting point is 00:03:08 had fallen into the bucket were the cruise lines and the airlines, which are asset intensive that weren't earning a lot of money. And so they sort of ran pretty hard. And then, which is not uncommon, which is what you see at the beginning of a recovery, value looks really good. And that's sort of that style of value where it's the stuff that's right on the precipice that really needs the funding, starts running pretty hard. And then as the cycle matures a little bit, you get this transition to higher quality value.

Starting point is 00:03:35 And so higher quality, better balance sheets, companies that are throwing off cash flows rather than burning cash flows. And it's that part of the cycle sort of seems to last the longest. And that can run from early on to right near the very end where it starts looking much more bubbly, I guess. I think it's a funny rotation, this one, because we didn't, even though March 2020 was a big drawdown, I think it was more like a flash crash than. than the old school kind of grinding bear markets that probably we've all seen a few of now,

Starting point is 00:04:06 the 2002 bear market that just went on and on and on and every rally gets sold. And the 2007, 2009 one, I think I went back in Canada at one stage. I think there were 15 rallies over about 20 months that got sold. And it's that it's that 15th rally that really gets sold to a low or low that really breaks the heart. It's not so much the scary drawdown at the start that sort of is the hallmarked. of the bear market. It's that sort of ongoing grind down. We didn't see that this time around. So I don't know if that means that the cycle's ended. I don't know if we're in a new cycle.

Starting point is 00:04:38 I don't know if any of it really matters. I just sort of look at the way that the, not so much the factors, just I look at like a broad range of ETS that track these different strategies. And so what I have observed is that value has been pretty strong from September last year. I think it's still going pretty well at the moment. I think size is the one that I think that probably the academics had written that off it had done so badly. There's no alpha in that strategy. It also ignores size as a factor. And of course, the moment that you say that size starts working again, I think they said the same thing about price to book too and price to book. As Cliff Asness points out, it's the worst value factor out there, which means that when value's

Starting point is 00:05:15 doing really badly, it seems to do pretty well. And it's done pretty well again over the last six months just by the nature of the stuff that fell into that bucket, you know, the heavy, heavy assets without much cash flow coming off them. And then the question. Quality factor is one that I find kind of most interesting that it's down still over like a rolling three year period. It looks really gnarly. So the stuff that's the low quality stuff, which is stuff that's got bad balance sheets and losing money, has done really well. And that's the high quality stuff that's like self-financed, good balance sheets and good businesses throwing of cash flow that's suffered. And it's all sort of down.

Starting point is 00:05:51 It's still down. And it looks to me like, I think that at the point that that starts turning the cycle matures a little bit. and we go back into a value, like a more traditional kind of value quality market. I'm just interested because I know that Wes, I know that he tracks these things. You sort of track the academic factors, Wes, is that fair? Yeah, we track them all, but yeah, I generally focus on the academic backed factors versus a lot more of the practitioner ones. But I think you nailed it.

Starting point is 00:06:20 Momentum sucks, quality sucks, size rocks, value rocks, beta rocks. You got any thesis as to why that's happening? No, I mean, it's just, you know me, man, it's just noise. It's such a short horizon period here. This has happened. It'll happen again. I don't really have great narrative beyond what you just explained there and kind of how assets shifted through the pandemic and anything.

Starting point is 00:06:46 It's just people like junk and cheap junk. But that could also change. You just never know. Jake, I couldn't help but notice that. you are nodding a lot more than I was whenever Toby was presenting his topic. So why don't throw to you and hear your thoughts? I just had a question actually on, did you look at rates, say like 10 year treasury, how that's kind of maybe influenced some of this? Because that's maybe been some of the argument is that rates have kind of ticked up off of still in like incredibly

Starting point is 00:07:16 low on any kind of historically informed basis. But it seemed to kind of correlate a little bit the bottoming of this value. I know Jake pretty well, Stig, these days. So when I see him nodding, that means I understand what you are saying. I have a question about what you are saying. So I don't take that for agreement with what I'm saying. I would say I just happen to have a look at the 10 year this morning, just because I'm sort of interested.

Starting point is 00:07:39 It's funny how when you pull it back on like a 10, when you pull back the 10 year treasury on a 10 year window, it's crazy how flat and squashed down it is. It's just we're right near the bottom of the. of that long, long cycle down. It starts in 82 is the peak and it runs all the way down to today. And then if you zoom right in, it looks like it's run up a lot because it's bottomed at 0.6 or 0.57 or something last year. And now it's sitting about 1.56 or something like that. But it got as as 1.7.3. I think that the narrative that it has some influence on value, I think, is a good one and is probably right. I just think it's really hard to show it in the data, or at least I find

Starting point is 00:08:20 it intuitively appealing. Like a lot of things I find a lot of these things are really intuitive appealing. It's just, I can never show them in the data. So you've got to be wary of that, but it certainly seems like value's done better as the 10 years crept up. The thesis for stuff that I'm trying to buy is always the same. It's cheap and it's got pretty good margins. It's better quality than it kind of looks, even though my definition of quality sort of excludes return and invested capital a little bit because I think it's more mean-reverting. You equally don't want to buy the worst of the high ROS, the worst of the return and invested capital stuff because it's all stuff that's set up to fail. It's like the biotech stocks that they've never got a business. They're just burning cash to try and find a compound that works or any of that sort of stuff that's just created trying to find a business where they're really, it's more speculative. And like those things just, there's no mean for them to return to. So I don't think you ever want to be in the very worst bucket of that stuff. That's the way the portfolio is constructed. They're cheap and they're like good but hidden. And then, you know, what happens after that is sort of an emergent kind of property of them.

Starting point is 00:09:21 And I don't really have any control over that stuff. But I just like looking at the fact is because if my portfolios are doing badly, I want to understand the reasons why they're doing badly. Is it something that I'm doing wrong or is just some broader trend in the market that is sort of, you know, for whatever reason, higher quality, undervalued stuff, just not catching a bid? Because that happens sometimes, particularly in this market where it's still a Wall Street bet, speculative kind of option type market like AMC which is the I think it's taken over as the meme stock from GameStop it's now run up it's like 4x over the last few weeks or something like

Starting point is 00:09:56 that and you know is that because people are heading back to the cinemas I don't think so I think it's because it's it's kind of gone up a bit so it's gone up a lot more and that's there's a lot of that happening in this market it's not and maybe that's maybe that's what always happens in the market but it feels to me like it's still it's still short-term voting machine rather than longer-term weighing machine. Yeah, I heard that AMC was trading it at one time's revenue. Oh, wait, that's five years cumulative revenue. Is that good?

Starting point is 00:10:24 Yeah. Inax just like to ask Toby, like, okay, betting out a sample next year, do you think value's going to keep beating momentum, crazy names? Or what are you thinking? I think it's impossible to know, but I just think that it's, the only thing that I've observed in the market is once the trends get going, they just sort of seem to go on for a long time. So I would have said that momentum or that the expensive stuff probably had an unusually long run.

Starting point is 00:10:50 And now that there has been some turn, probably value just keeps on going for a while. Because I think as it works, more people are attracted to it and more people move away from the arcs and the Teslers. Just because it's, you know, they're down. They look like they're going to keep them going down. I think that that's how trends happen in the market. I mean, I don't know much about momentum. So you'll have to, you can probably fill me in a little bit more there about why momentum works. but it just feels to me like, oh, it seems to me that when the trends get going,

Starting point is 00:11:16 they do keep on going. We're sort of in a little value trend at the moment that the 12-month figures will be coming up in only three months. And then if the year looks good, then maybe more people invest in it. There's a lot of narrative around value working at the moment. It's in Bloomberg and on CNBC pretty regularly. Yeah, I agree. You're spot on.

Starting point is 00:11:34 All right. So moving on to the next topic, and this is a hard one because West wanted to talk about taxes. So because of that, I think Jake should have the next go. Save the worst for last, Dick. I appreciate it. I actually think Wes has got a great topic. All right.

Starting point is 00:11:52 Take it away, Jake. Okay, well, I thought it would be helpful, especially for younger investors who are being drawn into this market right now to find a touchstone that they can that will help them guide them through potentially a difficult period. I think the message that they might need to hear is that like it's not this easy normally to do this well. And when it starts going poorly, I'm sure, Wes, you can probably speak to this from your military experience of like you plan for all the ways that things can go wrong and you have a mitigation plan for it before you're in the middle of the firefight, right? Yeah, of course. They call SOP, standard operating procedures.

Starting point is 00:12:33 So if you right now are waiting until to figure out what your plan will be when the proverbial S. hits the fan, that it's kind of too late. Like, you should be thinking about it now. And what I am going to put forth is a little bit of a little curriculum that you might do that would help get you grounded to be ready for when maybe things get difficult. And it's going to be very, very Buffett-centric. And this is not because, well, one, it's because he's been so generous with sharing all the things that he's learned over the years.

Starting point is 00:13:04 Two, he's been incredibly successful. And then three, which I think Toby could speak to, I'm just not sure there's anyone else who's done it better. It's historical, his output and what he's been able to create. Yeah, I agree. 100%. The first part, step one of this curriculum is to pick up the essays of Warren Buffett, which is someone, a professor took all of his writings and organized it by topic. And then you can just go and read through that and get the original source material. And this is a good lesson for anything, actually, that you're researching is the closer you can get to the source material, the less interpretation bias there is of filtering it through someone else's mind. So going to the root source as often as you can is usually a good idea.

Starting point is 00:13:49 So this is a good way of getting the best nuggets that Buffett's ever written in one 250 pages-ish, tremendous read. So start there, and that'll provide a good context. Now, after you've done that, to really get to a deep level of understanding of business, Adam Mead had this book that came out only a few months ago that's called the the complete financial history of Berkshire Hathaway. And he walks through all of the deals every single year. What did the financials look like? What company did they buy? What was Berkshire trading at? How did the insurance perform? How did each of the subsidiaries perform? And you walk through year by year and you just get to see this story unfolding, this masterpiece that Buffett's been painting for 50 plus years. So the first, part of the book is about actually pre-Buffet and the textile industry. And so you get through that kind of quickly. And then you start to get into Buffett and him making deals. And where it really gets fun, and this is where it is going to provide the most value, is that starting in 1994, the annual meetings are recorded and available to either watch on YouTube or you can listen to

Starting point is 00:14:57 them on a podcast. So what I would do then is get up to 1994 in the book. That'll give you a very nice intro into sort of how things have been built so far. And then, you know, read 1994 section in the book and then watch the 1994 video. So Adam gives you all the numbers. He gives you all of the background that you would need. And then Warren and Charlie come in and they give you all the color about that year. And then go and do 1995 together. And then 96. And you can work your way all the way up until this last year. And it's just an incredible opportunity to learn directly from one of the absolute masters and you're as close to his feet as you can get to learn. If you do that, boy, you'll be a hell of an investor. And I think you'll save yourself potentially a lot of heartache if you're serious

Starting point is 00:15:46 about this. Now, if you just kind of want to make quick money and then also, you know, recognize that it can go away quickly, then, you know, that's a different game, different conversation. But if you're serious and you actually want to be an investor, I'm not sure. sure that there would be a better way to spend your time. Yeah, I endorse that one. That sounds like an amazing. I'd love to spend the time doing it myself. I've got that book. I interviewed Adam on my podcast. He's a good, he's a good, dude. Fascinating book. Well, imagine how much work it was to write that, too. I mean, he brought so much information together from so many places and then distilled it. I mean, just a tremendous effort. I applaud him for doing that for us. I would have loved to

Starting point is 00:16:21 have that book exists, but it would have been impossibly painful to do it yourself. I think I said exactly the same thing to him. I was like, I'm so glad you did it because it's one of those books that somebody needed to go and do, but it's just so much effort every time you think about it, you just walk away for a little. Yeah. You know, I'm a foundationally, a Warren Buffett fan. How do the heck do you get people to stick to the program, though?

Starting point is 00:16:45 Because a lot of times their advice is so intuitive and it makes all the sense in the world, and they are right, but people repeatedly just don't do it. So you got any insights or what to read there for the advanced NBA? It goes back to the bigger part of this game, which is controlling your own mind. And, you know, what do you feed your mind? What are the environments that you create for your mind to operate in, both from a biochemical level to the input of the stimuli that you give your brain? All of those things should probably be thoughtfully controlled for.

Starting point is 00:17:21 And what it does is it helps you to, you know, it's like if you don't want to be a gambler, like don't go sit in the casino and stand next to the slot machine, right? Because you're like, oh, maybe I should put a quarter in, maybe not. Like, just don't go into the casino and just keep yourself away from it. And then you don't have to have as much willpower. So on top of that, I would say that there's probably the argument to be made that you may be wired a certain way that allows you to do it easier. And I'm referencing some like the, the, marshmallow studies. Like, you know, some people are just able to not eat the marshmallow right away. They can wait for the second one or to get two later. And then, you know, William Green's new book, he was talking, interviewing Munger and talking about how, gosh, how do you handle all of this quotational stress in the middle of a crash? And Munger says, like, I don't even feel anything. It's not that I control it. It's, I literally don't even feel it. So there's nothing for me to control. So, and that's probably a wiring thing as well. So we have our genes, but then we also have our our input to our genes that we give through environmental control. Do what you can on the environmental

Starting point is 00:18:25 side and hope for the best for yourself with your genes. If you're trying to lose weight at the same time, you're trying to do well in the stock market. You're like burning up some of your willpower on not eating stuff and exercising or whatever. And so you don't have as much for the other stuff. For me, all of those research, all that research shows that basically if you're using willpower, you're setting yourself up to fail. You have to like put the bumpers down when you go to the bowling alley and just bowl with the bumpers down. So you make a, like you said, take the quotations off your computer, make it hard to pull up your daily, your numbers. Don't track it, tick by tick. All that sort of stuff, I think, is really the only way you can do it unless you're built like

Starting point is 00:19:05 monger is. And to go back to that, going to the source material, Jim Channos has this idea of what he calls the information onion. And so at the core of the onion, where there's the most truth is the actual SEC filings, right? This is what the company has to tell you. And then the next layer out from that is the company's presentations and the annual report that they write that, and that's sort of the things they want to tell you. Maybe it's a little bit further from the truth, not in a lie necessarily, but just a rosier version of it. And then you move out towards cell-side research, which is going to be what someone else wants you to think. And then finally, you get out into the cacophony of Twitter or Wall Street bets. And that's just the pure rumor mill where

Starting point is 00:19:50 who knows how far from the truth that actually is. So controlling where you spend your time and what part of the onion you're eating. And I think it makes a huge difference too in the quality of the information that you are filtering through your brain. Another approach that I've seen people use effectively, it's kind of like an inversion of what you said, which is an out monger, is just setting up a gambling bucket on purpose. It's like you do your 10% adventure bucket or whatever, and you just go crazy with no willpower. But then it kind of causes you to lose focus on the 90%

Starting point is 00:20:26 that is doing the old school stuff. That's maybe another technique. Portfolio cheat day. Yeah, yeah, but it's permanent cheat. You just get to blow it out the door. It's your just be bad and crazy bucket. To Toby's point, maybe you exhaust that system one problem out on the money that doesn't matter and then hopefully you could prevent yourself from touching the rational bucket. I don't know.

Starting point is 00:20:52 I've seen people use that approach and I've also seen people go the other way where they just won't gamble on anything. They just won't bet on basketball, won't bet on horse racing, won't play poker just because they're like, if I do it once, then it kind of, it breaks the, you know, I've got this personal like code where I don't gamble and that includes like on all other stuff and in the stock market. So when I invest in the stock market, it's like, it's a different system that I'm engaging. But I've seen both. That's where I am. I'm fully abstinent on any negative expected outcome bet. Do you do it because when you walk into the casino, it's just not fun? Like, it's not fun because you know that you're just giving away money.

Starting point is 00:21:30 There's like one bet that's like a fair bet in the casino, right? No, it's fun. That's not the issue. It's that, you know, you just don't go there. It's easier for me to abstain. to moderate. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating

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Starting point is 00:25:46 That's Shopify. com slash WSb. All right. Back to the show. So, can I ask you, Jake, how did you experience March 2020? Like having that mindset, and just for people like, March 2020, what's going on? We had a coronavirus, and for whatever reason, the market went up, but actually it went down first. So that's what we're talking about right now.

Starting point is 00:26:10 So we had Morgan Housel on the show here not too long ago, and he was talking about how being a stock investor is like being a pilot. You know, it's like 99% boredom and 1% sheer terror. Terror. That's how it is. And so that's really whenever you need to show your abilities. Is that that 1%, I guess Chalamong would also say that you had to sit on your ass or sit in your hands or whatever he's saying for the other 9%, which is actually also pretty challenging. But for that 1% of the time, Jake, did you consult your Warren Buffett books, videos, whatnot,

Starting point is 00:26:41 or were you so primed that you were just sitting there and like, this two shall pass? Was that what you're telling yourself? There's the bubble ultimatum, which is you can either look like a fool before the bubble pops or after it. And I had chosen at that point to look like a fool before. And I had a lot of cash coming into 2020, not because I knew there was a global pandemic on the horizon, but just because I, one, I just couldn't find a ton of things to put to work that felt like not making that negative expected bet in the casino. So I was overweight quite a bit of cash.

Starting point is 00:27:17 And so coming in, I was like a kid in a candy store in March of 2020. It was amazing. Like all these businesses that I've been following for a long time and wanting to own but just not at these prices became available. I bought a lot of things. Now, I didn't buy enough because I had in my head this model that, you know, I think Toby even just mentioned early on, was it typically when the bull market's over, you're probably looking at an 18 month sort of average soul grinding down every day type of outcome. And so I was prepared for that battle, which I knew was coming, maybe. I'd actually hopefully. So my whole plan, you know,

Starting point is 00:27:54 going back to the military thing that Wes was talking about, having that standard operating procedure, my plan set ahead of time before there was any pandemic was, I'm going to execute a lot of good buys over the course as we grind our way lower. Not a few perfect buys at the bottom. I'm just going to carpet bomb prices that I liked for companies that I'd been following for a long time. And I got to execute a fair number of carpet bombs and picked up some things, but I didn't get as much deployed as I would have liked. And then obviously it was just as totally, Toby likes to say it was like a golf ball off the cart path that just rocketed higher. And so the things we bought obviously did really well, I would have probably been rather down 50% instead of up whatever we

Starting point is 00:28:36 were because I would have meant I could have put more money to work at better prices. But you play the game and the cards that fall and you can't lament that, you know, that didn't go exactly the way that you wanted and then you get ready for the next thing. So it was not difficult for me. I was ready for it and I was happy that it came. But again, I mean, that's, That's because I had a plan already in place, ready to execute off the shelf. And I wasn't trying to come up with a plan on the fly. I will admit that it was really sweaty for me. And I'll just say that because I have quantitative, systematic kind of proclivities,

Starting point is 00:29:11 I'm forced to behave the right way through that process, even if I probably didn't feel like it at the time. So I don't have Jake's sort of level of zen. So I just have to do an end run around myself where I just sort of make it work anyway. So even though I was panicking and sweating, it did kind of work out because it was forced on me. Or I forced it on myself beforehand knowing that I'd be sweaty in the moment. Wes, I think you previously told me that I couldn't call you a quant. But with that being said, for you to have a very quantitative approach, and you previously talked to us here on the show about

Starting point is 00:29:44 something like momentum. It works because it works. Obviously, there's a lot of factors why it does work. But you're very much looking at the data and not necessarily doing a fundamental analysis. for you to find alpha? I've kind of reached a Zen. I want to say I'm like Charlie Munger, but it just doesn't affect me personally anymore. I'm not emotionally tied to market movements because my mind is so warped in some sense

Starting point is 00:30:10 that I just, it just doesn't affect me. I don't know why. I got to the stage of getting my ass handed to me so many times. I just do my systems. That's what I do. Now that said, and to Toby's point, I get cortisol through transmission from clients, like teammates and other people because they're not as warped and screwed up as I am. And so indirectly, like I do have a little bit of empathy left in me somewhere.

Starting point is 00:30:37 And, you know, when people are like their whole life savings is gone and like I can tell they're very stressed out, like it starts to affect me, mainly because I don't really care about the investment, but because I just feel bad that I can't coach this person to just be calm. And it's just, I just feel like emotionally drained trying to like be a psychology for other people to not get so bent out of shape. So for me, it was similar to Toby. It was just, I got cortisol via transmission from like our clients, basically. And that's just not fun to deal with. But me personally, didn't even think about it. I actually doubled down on value at the peak of the thing. I was like, I'll probably lose 50% more, but this has gotten too crazy.

Starting point is 00:31:20 And I never make calls. I only do that in my qualified account. It's my gamble, which unfortunately is not that much, but that's how I do it. Yeah, I remember that. You and Jack, I remember you tweeting or talking about that, so good call. Well done. Yeah, yeah. It was like March 22nd or something.

Starting point is 00:31:39 We're like, all right, screw this trend following stuff. We're going to go all in a deep value. We've got an intro month 50% drawdown, which is probably some sort of record. Like, this is just crazy. But of course, we were wrong. Should have been on momentum, which is the great irony of it. Like, you always feel good. You're like, oh, yeah, look how smart I was to buy a deep value.

Starting point is 00:32:01 And then it turns out, well, that was actually the wrong call. You should have bought the crazy momentum stuff that you would never have touched with a 10-foot pole. Yeah, value got after sucking for a decade, Valley then got the worst drawdown into it and it didn't recover as well. Terrible. That's life and investing, right? Simple but not easy. So the topic that everyone has been waiting for, Wes is going to talk about taxes. No, it's actually a very fascinating topic.

Starting point is 00:32:30 I shouldn't best Wes at all. It's a great topic. So Wes, why don't you take it away? So leave the worst for last, Stig. But hey, if you care about your money and you like to keep more of it as opposed to giving it to the government, then you should pay attention to taxes, obviously. And what I was going to do is just walk through like a very simple, explanation of the difference in tax structure in between buying a stock and your own individual

Starting point is 00:32:58 account or buying it in a mutual fund or buying it in a hedge fund and how stock transactions work in an ETF. And so really kind of unveil the man behind the curtain in why do people say ETFs are so tax efficient? So that's kind of the idea here. And so before we start with that, let's do the most simple portfolio ever, right? Let's say you have a portfolio. portfolio and you buy one share of Microsoft. And you do this in, let's say, 2012, and all of a sudden, you're sitting here thinking, geez, Microsoft's kind of expensive now. It's gained 50x. I want to sell that and go buy Carnival Cruise lines, let's say. Well, if you do that in your personal account, you know, the minute you sell, you're going to have a capital gain realization. Are you going to

Starting point is 00:33:46 have to pay a chunk of that back to the government? And then you're going to turn around with your proceeds and go buy your Carnival Cruise. Same thing would happen in a mutual fund. The mutual fund manager would sell Microsoft by Carnival Cruise lines, distribute via 1099 a capital game. A limited partnership, which is usually how hedge funds operate, same problem. And actually, if you did that transaction in the ETF where the ETF manager literally sold the shares, they would also distribute the capital game. So what the heck is different? about how ETFs operate. Well, structurally, an ETF doesn't trade with people out in the marketplace, right? Like you and I, when we go buy an ETF at Schwab, we're not actually buying it from iShare's.

Starting point is 00:34:34 We are buying it via a broker-dealer or a market maker. And only market makers, specifically people designate as what they call authorized participants, can actually transact with an ETF company, like I shares or what have you. And so what happens is let's say that ETF owns that same Microsoft share. It's just a one-stock ETF. And it wants to go by Carnival Cruise lines, but that ETF manager sits back and says, wait a second, I don't want to be like everyone else because if I sell Microsoft, I'm going to have to deliver a lot of tax to my clients. That's crazy. We're not doing that. So what an ETF can do is it can transact in kind. And so what you would do is the ETF manager would create what they call a custom redemption

Starting point is 00:35:20 basket where that basket would include this one share of Microsoft. And that would be delivered in kind out to the market maker or the authorized participant. And in simultaneous to this asset, this Microsoft share being transferred out, well, we have to have something of equal value coming in or the funds getting screwed over. So the simple way to think about it is it would deliver in-kind shares of Carnival Cruise Lines. And so why does this work? Well, in-kind transactions are non-taxable. So when you redeem out through that custom redemption basket, that one share of Microsoft, that is a non-taxable transaction. That market maker or authorized participant who receives that share, but then turn around, sell it, get the cash, go buy the share of Carnival Cruise lines,

Starting point is 00:36:13 on your behalf and then deliver in-kind to the fund Carnival Cruise Lines. And the way a fund accounting works is that whenever you receive an asset in-kind, you receive it at its mark-to-market basis. So essentially, ETFs have this ability to essentially cleanse capital gain and basis out of stocks, which is awesome because now if I run a buy-and-hold strategy or sometimes want to trade and rebalance into different names, I no longer have this issue where I'm always having to make a taxable decision. Where it's like, geez, I would really like to sell Microsoft and buy Carnival Cruise lines, but if I do that, I'm going to have to pay half of it back to the government, but I'm not going to do that. Now, in an ETF structure, you can just think optimally. There's other constraints,

Starting point is 00:37:03 we don't have to worry about taxes. So it's a wonderful way, if you're going to try to deliver some sort of active strategy or something that has like turnover, you know, all else equal. If you could somehow buy that or own that or deliver that via an ETF mechanism, you're just going to be able to deliver your clients a way better tax outcome, you know, in the context where you're dealing with taxable money. So that's basically the magic. You get rid of a cap or basis in stocks via the ETF wrapper. Hey, Wes, is that, is it this the equivalent of like the 1031 exchange in real estate? Very similar. And I usually call like ETFs like 1031 for stocks, but then a lot of people are like,

Starting point is 00:37:44 well, what the heck is 1031? It's the same idea. Yeah, you're back to another word. We're like, okay, what is that? So yeah, same thing. We're in real estate. If you buy something like property, you can you can roll that basis into that new property and keep punning the taxes down the road. ETFs are obviously super tax efficient, but they're also super tax fair. Because if you go buy into a partnership or buy into a mutual fund, like Sequoia is a good example, and they own a stock, they bought it one and now it's worth a thousand, well, when you buy that fund, you're indirectly buying a tax liability that's not even yours, where the ETF basically says, hey, that's not fair. Your tax situation should be managed on your behalf. And we don't want there to be a negative

Starting point is 00:38:30 of externality problem where just because of dumb luck and success, the fund can actually hurt you if you buy into them, you get to own someone else's tax problem. Like, that's just crazy. So the ETF, I think, is just a fair way to intermediate, or basically if you're going to manage money on behalf of other folks, it's a fair way to deal with the tax issues. So, yeah, check it out if you're not already doing it. You had this little blog piece on your site. This is going back a few years.

Starting point is 00:39:00 I don't know if you remember this one or not, but it was comparing the returns from short-term capital gains to long-term capital gains to, I think it was buy and hold, where you said, this is the return that you need to get. I think you said it like 15% buy and hold, and then what that meant in long-term capital gains and short-term capital gains. Do you remember that? That post is old now, like seven, eight years now, and the math always changes. But the simple idea is an ETF allows for essentially tax deferral. And so you have to figure out how much can you earn on whatever you're paying out in tax today and whatever you compound on that tax savings in the end is going to be the benefit. So if you're a day trader, an ETF is worthless. It's not going to

Starting point is 00:39:46 help you if you're buying and selling the ETF all day. But if your intention is to own a strategy for 20 or 30 years or maybe die with it, you know, pass off to your kids, the more you can keep the tax man and woman at bay the better because that's more capital you have with the opportunity to compound. And so the assumptions about, well, how valuable is it is obviously highly contingent on your situation, tax rate, etc. But it's important to know that once you've paid the tax out to the government, you're never getting that back. Whereas if you have tax embedded like liability in your current book, there's a million people you can hire that can help you figure out how to plan around that and you have a lot of option value.

Starting point is 00:40:30 And people always undervalue optionality, whereas you have no option value if cash is out the door and went to the feds. So I'm a huge fan of maintain your optionality on tax planning front. You've still got the float on it too, though. You can still earn on it, right? Like if it's Buffett talks about it a little bit that he's got an outstanding tax liability to the federal government, but he's still able to earn on that tax liability until they crystallize it.

Starting point is 00:40:56 That's right. And you can always lend against it too. So a lot of times we put insurance, like you have an asset, you know, that that's public and liquid. You can always go to your local friendly banker and say, hey, will you lend against my Tesla stock? They might be willing to sit on the other side of that. And it's another way to just get access to your capital or your float to maybe do other things. But if you've paid it, you can't do that. It's sunk. So would it be a good summary to say then that if you're if you're long term committed to an act, strategy, then ETF is definitely the wrapper that you want to be in. Yes. And even in lowish turnover strategies, it's pretty effective. But if you're buying hold individual securities for 20-year horizons, maybe it's a marginal benefit. But it's definitely important for anything that has any level of activity for sure. 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.

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Starting point is 00:45:37 all stocks back in the day before it slided like 80%. So I learned a lot from past mistakes. And what you quickly realized, and what you guys obviously know is that as soon as you own a stock, that's whenever you actually learn about it. You can do so and so much research on that stock, but before you own it yourself and reading those statements with a different lens is really, really difficult. So I took a small position in Franklin Covey, and I wanted to hear your guys' thoughts on that and especially like why it's a bad investment because I kind of feel I'm a bit too excited about some of the good things about the company and no like they say you should focus on the downside because the upside typically takes care of itself. So let me let me introduce frankly

Starting point is 00:46:18 COVID to you guys and if you think that the name sounds familiar and then perhaps not at all it's because covey that's the name from the author Stephen Covey the author of seven habits of highly effective people and Covey leadership was founded in 1985 and was then latermerged with Frank Inquest in 1997 and since then have been selling training, leadership, course materials. Now primarily it's a lot of online stuff, but they also go live on the premises. And since 2016, they undergone a transition from primarily on-premises business to a subscription business that is increasingly digital. And that has also been accelerated by COVID. So whenever you look it up and just in case you are looking up as you listen to this podcast,

Starting point is 00:47:01 the numbers look ugly, like really, really ugly. This is different. definitely not a company that seems appealing, but if I can use Jake's onion analogy, that's trying to peel that onion and see what's underneath. And so what has happened since 2016 is that now 60 to 7% of the revenue or subscription-like service, and it would likely increase to 90% within a few years. And what they're really focusing on is the subscription to the all-axis past all of their content. So companies are paying tens of thousands of dollars for the services, sometimes more, of course, depending on size of the organization. And on top of that, there's a lot of extra services that they can then purchase. It could, for instance, be on-site

Starting point is 00:47:41 training or whatnot. And so the incremental gross margin for that is 85% for the old access pass. That is what's growing right now. It's growing with high teens. So interesting and typically, for every sale they do, they do another 50% of that dollar amount in ad-on sales. To fully understand the power, but also the pitfalls with Franklin Covey, you also need to understand a bit of accounting. So if you consider the fiscal year 2022, and keep in mind as you're reading through this, because this is a bit odd. Well, to begin with, it's probably a bit odd if you're into accounting. But if you are into accounting, please note that the fiscal year ends 31st of August. So there's just a bit of math you just need to focus on if you're looking

Starting point is 00:48:20 at some of the quarters and if you kind of feel you want to match up with what happened with COVID. But anyways, yours only paying around 11 to 12 times free cash flows whenever you make the adjustments. It's actually quite appealing. And this is for a SaaS business that's growing relatively fast. And so why I'm looking at 2022 already? Well, not to make it more difficult as it meant sound, but if you ever analyze the SaaS business, you will look at the deferred revenue on the balance sheet. So you have a lot of revenue that has already been invoiced and is already signed, but you can't recognize it as revenue before the service has been provided. And that deferred revenue is now more than $100 million. And it's growing rapidly, if you look, looking into the

Starting point is 00:49:00 the SaaS part of the business. So again, don't look at the top line, look at what's happening with the revenue for the SaaS business inside, and keep in mind that incremental of that, we're looking at something like 85%. So revenue retention, that's 90%. So how should we look at that 90%? Well, it's all the rates right now that you should be more than 100%. We all like that. We all like to grow revenue without getting new customers. But keep in mind, this is not your AI, something sticky kind of thing that you can never get out of. Like, this is a lot of. Like, this is still training. This is leadership training. And so with that in mind, the 90% is not directly comparable to a lot of other revenue retention rates that you see in the market right now.

Starting point is 00:49:39 Stock is training at $31 this morning. In my opinion, should be a value at least 60. And I would say even today, but what you would probably see happening here in the time to come is it could be a potential compounder. They have converted now the North American business, but they're also taking the international business now and converting that into the same system. A lot of great things going on for this company. They are building up the sales team, which is something I would really like to focus on. Being a small business owner myself, I know how difficult it is to build up a sales team. It's really, really, really hard. The goal is within a five-year period that they want their salespeople to sell $1.3 million annually once they're fully rammed up. In the reason

Starting point is 00:50:21 earnings call, they provide an update in that and said that the sales team outperform the metrics by 20% better than expected. They have like, you can go into the earnings con, which we'll make sure to link to and see like, what do we expect of the first year, second year, third year and so on. But again, as a business owner, I can just say, it just never happens. Like, your salespeople are never better than what you expect them to be. And so a few key metrics that I would like to pay close attention to. Will the management succeed with this full SaaS business transition in 2024?

Starting point is 00:50:52 They're targeting 90%. The reason why they're not doing more than 90% is simply because a lot of the sales funding that they have is very much they have someone speak to the board, like a one-time, like one-off kind of fee, and then that's the funnel that they're going into a subscription base afterwards. So 90% is probably the max, but can they go from the 60, 65, they are right now up to 90%? That's one thing. The second thing is, will we continue to see the lifetime value per account increase as has been in the past?

Starting point is 00:51:21 And will it then also continue to have 90% plus of revenue retention? especially a third thing I'm looking at is also will continue to see the growth in the subscription service. And so what you're seeing right now, the reason why the top line is flattened, even a bit declining, is that the legacy business is just being cut off, and you just see the SaaS business just growing right now. So that was my pitch. That was all the good things. I do have a few bad things to talk about later, but I'd like to throw it over to you guys. I remember a pitch for Franklin Covey in 2009, and I didn't buy it, and I just went back and looked at what it's done over that period of time and it's 10-bagged.

Starting point is 00:51:59 So I don't know if I'm qualified to ask too many good questions here. I did a fairly deep dive on it, probably three or four years ago, met the CEO. And I like the model that seemed to be developing where they, I mean, so imagine that you're just like a leadership author or something and you write a book about it. What's another way for you to monetize the IP that you created? Well, you team up with Franklin Covey and make a little class for it. And then they can provide that in their all-you-can-eat buffet pass that they created. And it's zero marginal cost to them to add one more person to watch it.

Starting point is 00:52:35 And it's sort of little Netflix adjacent in that way except for training. I also ended up not buying it, not for probably any real good reason, but it was a very interesting model that was developing. There were some good things. And it kind of went into my, a little bit into my two hard pile and a little bit into, I want to see that some more execution first. And so that's kind of where I've fallen with it. Thanks for the feedback.

Starting point is 00:52:59 It's tricky. You mentioned before, Jake, is it kind of Netflix adjacent? You know, that's one of the things that they like to talk about. Actually, one of the things that talked about multiple times is that they expect that they will get to a point where content creation would be paid for. And so because I don't know if that's ever going to happen, but they're like, hey, this is the mode that we have. People want to be in our company.

Starting point is 00:53:19 They want us to be able to upsell their products too. And so to be a part of our All Access Pass, why? Why should we pay millions and millions of dollars to create our own content if other people can be included in this? And because of the upsell potential and because of the brand, they should actually be paying us. And so that hasn't happened yet. Being born pessimist, I don't necessarily think it's going to happen.

Starting point is 00:53:40 I just wanted to put it out there. I would say that one of the concerns that I do have with this, and I have, well, I have a few, but the first one is probably the mode. I don't necessarily think that the mode is as wide as they would like to say. It's hard. It's hard to sell something like leadership and personal development. And it might sound like one thing I really, really liked about this company was that they actually sold a lot of that during COVID, which was a bit surprising to me to see, actually. You would expect that some of that would be the first to be caught. I don't know how wide that mode is. You know, if you look at some

Starting point is 00:54:14 the competitors, you know, you have Designed to Mention International GP, Strategies, Corp, LinkedIn learnings, like you have a lot of other great companies who would also say if you ask the management, have a great brand? Do you have loyalty? They'll probably say the same thing. You know, it's just because we are now talking about Franklin Coe, right? That's the company we're talking about. So I would probably be a bit concerned with that. Another thing that I really don't like is, as I was going through the 10K, I always like to figure out how the management is incentivized. And it's always, it's always a bit tricky because you hear about these million dollar salaries and you're like, what's the market rate? It's always a bit tricky. But one thing that I don't like is that they have this

Starting point is 00:54:54 adjusted EBITDA that they talk about all the time. And they have these milestones about adjusted. They actually call it qualified adjusted EBITA just to make it even more complicated. And if you, if you dig into what that means, I don't necessarily think that you're 100% aligned at all times with the management. That's one of the things we definitely don't want to see. There is actually a high inside ownership, but they also give themselves stock. So keep that in mind, and they use compensation consultants to figure out what the target should be. And like Jake was talking about before, how you should go through like the from 1994 on CNBC for the annual shareholders meeting from Berkshire Hathaway, which I did. And I cannot remember how many times

Starting point is 00:55:35 Chalemonger have said, do not hire compensation consultants. I think that's probably the only thing in the world he hates more than Bitcoin. This is a tough sell, right? And so if you look at how they're incentivized, they have these, in my opinion, quite conservative metrics. And you might say, you know, it's nice that they're conservative, the management is conservative, but why wouldn't you as management have conservative metrics if you're being compensated by how much you outperform? There's different things built into that. If we take some of the bigger accounts in terms of depreciation and amortization, those are real costs. If you look at how that's been built up, yeah, there is a bit in terms of some of the billings and some of that where you're like, yeah,

Starting point is 00:56:12 you know, that's not so much the issue, but like the rest of the cost is more or less real cost. And they're spending millions of dollars right now. That's, of course, they're being amortized, but the course material they're billing right now, but that costs millions of dollars. And so that's not their target. That's someone else's money, right? That's the investor's money, and that's not how they're being compensated. So that's one thing I don't like. Another thing I don't like, and I think I mentioned before that I needed more to the bad case. And here I am just telling you guys how bad this pig is. But I've seen a bit too consistent restructuring costs. And I just, I don't like that. It's just, I hate whenever you put things down, especially

Starting point is 00:56:47 whenever you're compensating on qualified, adjusted, a bit down. You have that in 15, 16, 17, 17, and 2020. And it's only like, so it's $500,000, $700,000, 1.4, and then 1.6 last year. It's just one of those where I'm like, would you like your employees to just steal 100, then that's okay, as long as they don't steal $1,000. It's more just like a slippery slope kind of thing. And if you read through the statement, why they made those changes, why they said that money aside for the restructuring cost, is because they were making a transition into a subscription service. And I was like, no, no, no, you did that in 2016 and talked about in 2015. Why are you putting things down in restructuring costs this year because you're actually

Starting point is 00:57:30 executing that strategy? I don't know. There was just some red flags. Sounds like a good growth area for them. It's compounding really nicely. Can I ask you a question about, I've just got the 30-year financials from Guru Focus, that they run them all the way back to 1991. And from 1991 to 2000, it's just like this vertical ramp of revenue per share takes off. And then in 2000, it just completely reverses course. And it spends the next 10 years. And it bottoms in 2009.

Starting point is 00:58:01 And since 2009, it's had this really nice run again, although not as sort of vertical as it was in the initial period. I just noticed as part of that too. Like, the last 12 months, it looks like revenue growth has gone backwards, 21.7% and everything else has gone backwards. Is that part of the transition or is that they are impacted by COVID? Yes, and yes. That is a part of the transition.

Starting point is 00:58:25 But also, like, they're doing so many things from the legacy business that's on-premise, which has just been very, very difficult for obvious reasons during COVID. So that's one of the reasons why we've seen that. So the way it's built up is that they have education business and they have an enterprise business or a division. The education division is also transitioned into a subscription and that has been quite difficult. They had a generous donor to look like the first few years. And now with the new rollout that's coming out right now, there's probably, with the current

Starting point is 00:58:56 administration, a lot of money for them to tap in terms of the type of programs they're doing, but it's sort of like left to be seen whether that's going to happen. But if you do look into the different segments, not just those two divisions, you can just see the legs of business just like being abbreviated like last year. It was just tough. Some of the international expansion has been tricky. So from Australia and for UK, it's expected to be relatively easy to transition into this all-axis thing. It's a lot trickier in some of the other countries, specifically China and Japan, whether or not as developed. They don't have the same digital setup. And so a lot of that has just been just been like gone. It's just done. It's just

Starting point is 00:59:33 not going to happen. So that's just another thing to add to that. I always kind of wondered if it's similar, at least my opinion of Netflix, where you're kind of on a content creation hamster wheel. And I, you know, how, what's the shelf life of this, of your inventory of new courses? Like, I think there's a fair amount of what's popular today. Like, it's a bit of a recent hits thing. All of which is to say that, you know, you think that you're going to be able to amortize all these content costs over a really long period of time. And maybe it's a little bit more like vegetables on the shelf that they go bad within a shorter period of time.

Starting point is 01:00:12 My wife and I are re-watching friends right now on HBO. So I don't know if that's a good example. But one of the things that they have been saying is that, oh, you know, this is timeless. It is a good example because it's one show out of the thousands of shows that aired during the 90s and most of them are worthless. Right, exactly. And so whenever they were talking about seven habits of highly effective people, yeah, I would say that the shelf life is probably better because it pertains to principles, which

Starting point is 01:00:42 by definition are somewhat timeless. But it's probably not as timeless as they're trying to sell it to be. We still need new bells and whistles. I think last year they spent $5.4 million and then like a new content creation that's now being amortized. And you would be like, hey, if all the content is timeless, why do you need to do that? So I think that's part of it. Another part of it is that they spend a lot of money upgrading and making everything,

Starting point is 01:01:07 not just digital because I think most things are all that, but like the whole portal right now that looks much better than before, let me go back to the edit book about Berksa Heatherway. You know what? I would say that to some extent as much they're trying to sell it as we're building in that mode. It's like whenever they had those looms back in the day and you're like, yes, this is more efficient.

Starting point is 01:01:25 But it's not like LinkedIn or not upgrading on this at the same time. So it is a real capital expenditure. one way the other. And it is required for them to keep the lights on in the business. Can I ask you, Jake and Toby, you've looked at this before. Would you look at this again with what we talked about today? It's still in the two hot piles slash stick is just not smart enough to figure out that it's too hard and he shouldn't be looking at this in the first place? No, I don't think there's ever any reason not to look and see if you can learn something and often revisit things that kind of like that saying that no man ever has.

Starting point is 01:02:01 crosses the same river twice because it's not the same water and he's not the same man. And I think that same thing applies to the research process. I'm doing a lot of scut type thing right now also because I'm just building a position. So if you are, if you're listening to this and you're working from, for Franklin Covey or your company have been buying their products, just hit me up on stick in the ams podcast.com. I would actually truly love to jump on a call and just learn more about, is this product truly superior. One thing is that the management is telling me that it is, but all management are tabled in sense of us to say so. So if you have a really good bear case to this, especially

Starting point is 01:02:36 if you're working with them and using their products, I'll love to learn more. And hopefully I can give something in return. Yeah. Anything else that you guys wanted to chat about? Just like to say, thanks Stig for reminding me why I don't pick stocks anymore. Lots of brain damage. It's hard. It's hard picking individual stocks. if you don't love it, it's probably like, you know, people running a marathon and other people are like, why on earth would you put yourself through that and you're in pain? I can see you're in pain. And you're like, I just love the game. I need the game. I need to do it. That's the best way I can explain why I'm still picking individual stocks. Because you're right, Wes, it's painful.

Starting point is 01:03:18 It is. When we have the 10-year anniversary of this podcast and it's up 10 times, then you can say that's why I do it. Right. Great. All right, guys. So, as always, it's amazing to have you guys making time to sit in here on the show. Jake, Toby, Wes. Wes, if we stop with you, where can the audience learn more about you?

Starting point is 01:03:41 Alfargetec.com or just on Twitter at AlphArchitect. Perfect. Toby? Yeah, I have Acquiris Multiple.com. And I'm on Twitter at Greenbacked, G-R-E-E-E. and B-A-C-K-D and my fund website is Acquireasfunds.com. Jake?

Starting point is 01:04:01 Farnham-Streteat-com for our investment management firm and then Farnham, Jake, one on Twitter, and then Toby and I and Bill and apparently others lately do a little weekly thing where we get on and basically just give each other a hard time for an hour. And that's called Value After Hours. So not too hard to find, I think, any three of us. Wonderful. It's a great podcast. So I just want to say that. And if any of you are really interested

Starting point is 01:04:30 in value investing, that's the place to go. Jens, thank you so much for making time speaking with me here today. Thanks for having to stick. Thanks, Dick. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to the investors podcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is

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