We Study Billionaires - The Investor’s Podcast Network - TIP380: A Holistic Approach w/ David Schawel

Starting point is 00:00:00 You're listening to TIP. On today's episode, we have Chief Investment Officer of Family Management Corporation, David Shaw. Family management currently has close to $3 billion in asset center management, and David oversees the allocation across a wide foray of assets. For this reason, we had a very holistic conversation covering everything from what it was like to begin his career right as the global financial crisis began, his stance on the banking sector in today's environment, the most surprising metric of 2021 today's. and be sure to stick around towards the end where David offers a few stock selections that he's currently bullish on.

Starting point is 00:00:34 So without further ado, please enjoy this wide-ranging discussion with David Shaw. 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. Welcome to the Investors podcast. I'm your host, Trey Lockerbie, and today we have with us, David Shaw, first time on the show. Thanks a lot for coming on, David. Thank you for having me. One thing that I thought we could cover right here at the top would be your experience working for a company called Square One Financial, because as I understand it, you were more

Starting point is 00:01:24 or less thrown into the pit when the global financial crisis was just starting to happen, and you somehow climbed your way out. And I just love to hear that story in what you've learned from that time. So it was early 2008, and I had spent a few years working on Wall Street in Southside research, and my wife and I decided to come back to North Carolina. Obviously, we didn't know the financial crisis was upon us, and I joined a DeNovo bank called Square One Financial. And the easiest way to think about it is we were very similar to Silicon Valley Bank,

Starting point is 00:01:59 in that we were a bank that lent to venture-backed companies and the VCs themselves. And so I started in what they called the analyst training program, which would be a credit analyst. So I would underwrite new credit. So let's say a company gets $20 million equity round from VC, and then we might provide them with three or four million dollar line of credit or term loan. So I thought that's what I was going to do. And one day the CEO came to my desk and said, you know, hey, David, I heard you worked on Wall Street. we're having some problems with our investment portfolio and we'd like some help. And so long story short, and this is the bank's own investment.

Starting point is 00:02:43 So basically the deposits that are not lent out, we would invest them to the bond market. But the bank had been saddled with a lot of subprime and Alt-A mortgage-backed securities that were bought by their outsource manager. And so I told the CEO, his name was Richard. I said, Richard, you know, I'm happy to help you up, but I don't know anything about fixed income or credit, let alone mortgage back securities. And he said, well, that's okay. You know, we need your help. So basically, the bank had about half a billion of bonds that were going bad. And kind of every day they were, you know, falling in value. And to think about what was in, you know, it was very similar to what you saw in the movie The Big Short. You know, I remember looking at one bond. And, you know, The bond was only about six months old, and it was already 30% of the borrowers in that pool had not made one single payment on their mortgage. So kind of pulling back, you know, the covers and, you know, looking under the hood of

Starting point is 00:03:46 these bonds and looking at a loan-by-loan analysis. It was kind of remarkable and frightening to see just how poor a lot of underlying credits were at this time. So I really had a, you know, self-concern. teach myself. How old were you when this happened? I was only three years out of undergraduate. Yeah, so like early 20s. Yeah, yeah. It was interesting because nobody really knew what was going on at the time and everything was unraveling and I think people didn't know at the time how bad it was going to be. And so I really had to dig in. I started reading perspectives and modeling cash flows and having to meet with the regulators that came in, the Fed and FDIC and so forth. And, you know,

Starting point is 00:04:35 they surely didn't know what's going on. So it was really quite an interesting environment of having to learn in the biggest financial crisis, you know, the country had seen, you know, since the Great Depression. So it was quite the introduction to credit and fixed income in general. The way you described your boss, Richard, telling you that they were having some problems, He sounded so casual in your delivery there that I found it humorous. I was envisioning the boss from office space with a coffee mug just being like, hey, David, we're having some issues here. And I think that there was hope, you know, that, you know, things would turn around.

Starting point is 00:05:14 But, you know, I felt like the more, you know, you peel back the onion and the more you saw, you know, the more you realize that, you know, these were going to be very problematic. And the way that a lot of these mortgage back securities are structured, is there's different tranches and subordination. So a lot of the bonds where if you sat in the senior part of the capital structure, they might have been okay, even if, you know, many of the underlying loans were bad. If you sat in more mezzanine and junior position, you could be wiped out,

Starting point is 00:05:49 let's say, if 20 or 30 percent of the loans went bad and started to take losses. So it wasn't just underlying credit, but where you sat in the capital, structure. And basically going back to that environment is you would get paid, let's say, another 10 or 15 or 20 basis points to assume a lower tranche in the structure of these bonds. And so, you know, they got paid in hindsight what was a very meager additional interest stream just to take on incremental credit risk. But, you know, the bank ended up raising additional capital. We made it through and, you know, I continued to manage the portfolio for square one, which was kind of, you know, the kitchen sink of credit, whether it was mortgages,

Starting point is 00:06:35 investment grade corporate bonds, municipal bonds, preferred stock, some high-yield bonds, and kind of everything in between. So it was kind of an interesting foray into the credit market. You mentioned some of the clients not paying their mortgage. My understanding was a big impetus for that crash was not only CDOs, but essentially these variable interest rates that were attached to these mortgages where there were sometimes sort of, I think even a zero interest rate for a number of years, and then it would pop to five or six percent.

Starting point is 00:07:08 And that's when a lot of families ran into trouble. They maybe expected to have more income by that time and didn't. And then they started falling short. When you were starting to dig into loan by loan, et cetera, of what was going bad, is that the main takeaway that you saw happening? Well, there were certainly some of that. There was a lot of different programs, and I think, you know, just for the listeners to highlight kind of what was happening, if you go back to the pre-financial crisis, over half of the

Starting point is 00:07:35 mortgages being originated were what you'd call non-agency mortgages. And basically what that means is that those mortgages did not have the backing of the GSEs, meaning Fannie, Freddie, and Ginnie Mae. they were not government back. And if you go to today, it's kind of all the way at the other end of the spectrum being almost probably 95% government back in the private, you know, the non-agency market is a pretty small deliver of the overall market. But at that point in time, pre-crisis, you know, there was a lot of creative programs that

Starting point is 00:08:13 were put into practice to get that affordability down, to get those teaser rates. And there was a number of different programs that would get. So the underwriting and, you know, the fact that, you know, more than half the originations were outside of the GSEs, you know, really led to a lot of creativity and, unfortunately, poor underwriting and that led to a lot of the problems. So you've moved on from working at a bank, but the banking sector is interesting in a lot of ways, somewhat appealing. and somewhat not, given obviously the interest rates are still very low, but then you have the fact that you're basically backstopped by the Fed and you're able to sell your bonds with the top bidder. And I'm curious, like, what is your general take on the financial sector in today's environment?

Starting point is 00:09:06 Well, the financial sector as a whole, you know, there's kind of a good and bad to it. So, you know, you mentioned the fact that, you know, the Fed has embarked in kind of unprecedented monetary policy, Fed funds being very low, and there's a lot of facilities out there that banks can borrow from, whether it's the discount window overnight to Fed or a lot of other programs that they've come out with them. So I think from a funding perspective, from a borrowing perspective, it's a lot easier. But, you know, obviously the problem right now is that to find earning assets at any type of yield is a lot more challenging. So honestly, I think that the banking sector is fairly low risk right now in that capital ratios are pretty high. Banks have a lot of sources

Starting point is 00:09:56 of liquidity and funding. The regulators are a lot stricter on what types of loans can be originated. And I think the asset quality is pretty good. And I think a lot of the risk in lending has kind moved out of the regulated banking sector and kind of more to the non bank shadow banking segment. With that, I'd like to kind of fast forward now to today or at least 2021 because what you were just saying is, you know, obviously asset prices are at high levels, highest all-time highs. What was your playbook going into 2021? Because obviously things were high even at the end of 2020. I'm curious, how were you approaching 2021? And how is it? potentially changed, if at all?

Starting point is 00:10:39 If you went back to the end of last year, you know, the 10-year Treasury was at 92 basis points, we had not had the Georgia runoff yet. And I think there was a lot of uncertainty just as far as who is going to control Congress, you know, and at that point, you know, what type of fiscal spending would come to be. So coming into their interest rates were pretty low. I think the general consensus on the street was that we probably have, you know, a split Congress, the Republicans would probably keep control of the Senate and the Democrats would have the House and maybe President Biden could get through some things, but probably not aggressively.

Starting point is 00:11:18 And I think that that playbook kind of changed once the Dems swept the runoff in January. And you start to see a lot of the cyclicals rally. Interest rates started to pop. So, you know, they went from, I think, the end of September last year, 10-year at 65. basis points to they peaked at just about 175 at the end of March last year, or this year, rather. So it was, you know, over 100 basis point rise and really rotation into cyclicals. So I think I think the speed at which that happened was probably a little bit surprising for a lot of market participants, but we had also been, the market had not been accustomed to a scenario where

Starting point is 00:12:04 you had not only monetary policy being easy, but also fiscal spending. You know, obviously during the COVID pandemic, you know, there was the emergency spending and PPP and different types of stimulus, but obviously since then they've also enacted other programs. So the type of fiscal spending to plug the demand gap, you know, that happened as the economy went to a standstill, you know, something we really haven't seen before. So I think, you know, the combination of all that and the additional spending really, you know, gave a lot of fuel to the market. And for a while led to a pretty big rotation and, you know, interest rates going up, cyclicals rallying and, you know, kind of a change in market leadership, which probably lasted until May and early June when, you know, I think the Delta variant fears came back and interest rates have kind of given back some of their.

Starting point is 00:13:02 gains and yield since then. The S&P 500 is up a little over 20% year-to-date. Russell's up 16, NASDAX up 21, just year-to-date. And this is at the time of recording, obviously, which is early September. What is the indicator that has recently made you sit back in your chair and just say, wow, given where you maybe thought we'd be at this point last year and what has transpired? Is there anything, any metric that stood out to you that's, you know, kind of blowing your hair back a little bit? No, it's a fair question.

Starting point is 00:13:37 I think the thing that's been most amazing this year has been the revision and earnings for the market. So if you think about coming into the year, I think the consensus for the S&P earnings for 2021, was probably around $160 per share. And typically economists and sell side is pretty optimistic on that. But in this case, you know, the market has dramatically underestimated just how much the S&P would earn this year. And now fast forward to, as you said, we're in early September. You know, the market is assuming that the S&P can earn north of $200.

Starting point is 00:14:27 per share. So really, you know, there's been a significant push upward in earnings estimate, and I think it's worth looking into why that's happened. Your next question is probably going to be, well, why have earnings come in so much higher than expectations? And so, and particularly with all the headlines about rising costs, input costs are going up, you know, and whether that's transitory are permanent, you know, yet to be seen. Labor costs are going up. So how in the world have S&P earnings gone up this much? And I think the answer is twofold.

Starting point is 00:15:07 One, top line growth has really exploded. Revenue growth has really gone up far higher than people thought. And then the second thing is, I think, on a cost structure, going into COVID last I think a lot of firms really right-sized their business, you know, maybe cut back on different types of expenses that they didn't feel like were, you know, necessary and maybe probably prepared for an environment where times were probably going to be rough. And I think that that seemed pretty reasonable to think, you know, in a pandemic that companies would have to cut their cost structure.

Starting point is 00:15:47 And I think what's happened is revenues exploded and the cost structures have gone up, but not nearly as much as revenues have, and therefore, we're really at record operating margins. So profit margins are now at record highs despite all of the stuff happening. And so I think most market participants, unless you're looking at these type of things day by day, are not realizing that this has really been an earnings-driven year. I think most people would probably think earnings, you know, maybe they're up a little bit, but maybe the multiple on the market has skyrocketed. But it's not really been the case. You know, earnings have really driven, I think, bulk of 50 years' games.

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Starting point is 00:20:47 I might postulate one third factor, which is related to what you said, I think. But if you're looking at the S&P 500, you know, 25% of it is the Fang stocks, essentially, right? And so those companies get even more operational leverage because they don't have a lot of, I'm not going to phrase this right, but it's not like their costs of goods is that it's actually physical. It's usually software-based. And when everything went online during the pandemic, more or less, I mean, there's this huge gold rush onto Amazon and other platforms because retailers were closed.

Starting point is 00:21:22 Do you think that those companies, having already high margins that got even higher, is playing a big factor into the aggregate of the S&P? If you look at the free cash flow margins and, you know, all sorts of profitability metric on mega-cap tech, just head and shoulders of the market. above the rest of the market from a profitability perspective. And going back decades, kind of the rest of the market is trading at very similar profit margins. And it's really been, as you're alluding to S&P being a market cap-driven index, it's really

Starting point is 00:22:01 been a lot of those mega-cap technology companies that have driven a lot of the growth and profitability in earnings. You mentioned that there was a lot of liquidity out there that was piling. into the market, I'm curious if you follow how much money is still sitting on the sidelines, given that we've already seen such a huge run-up. Are you seeing money still on the sidelines that could potentially enter the market? Well, that phrase is kind of controversial, and I guess there's a lot of semantics with the whole cash on the sidelines, things that. Not going on that rabbit hole. But I think, I think to answer that question a different way, I think a lot of market

Starting point is 00:22:39 participants really feel like equities are the only game in town, especially with interest rates so low and on a real basis after accounting for inflation, you know, yields are negative, you know, treasury yields are negative on a real basis. So I feel like, you know, a lot of participants feel like the equities really are, you know, one of the only games in town and that, you know, sure, they've got a lot of indebted gains, but really where else are they going to, to realistically put this money if they sell. So I think from that perspective, I think that a lot of participants and investors might feel like things are expensive, but they're also going to tell you that they don't feel like

Starting point is 00:23:23 there's a lot of good places to go otherwise. Yeah, as you were saying that I was thinking about your clients, right, being that you're an advisory. What's the sentiment of your client base? Is it very risk on or is it becoming more risk off as prices have gotten higher? Well, I think to take a step back, I think obviously every client situation is different and we have to account for that. I think the other thing to think about is we try to set up client portfolios to be resilient during a multitude of scenarios. So for instance, we're not going to try to set up an

Starting point is 00:24:00 allocation to win under one or two outcomes and lose heavily under others. So I think I always like to say we try to be approximately right. We'd rather be approximately right than precisely wrong. That being said, I think, you know, your question is clients certainly are surprised that the markets continue to run and where we are and, you know, to think back where we've been a year and a half ago, it's pretty, it's pretty amazing to see. But I think, you know, our goal is to try not to predict the near term, but set up portfolios to be resilient for a lot of different outcomes because, you know, the smartest minds in the market, and I'm certainly not one of them, don't know what's going to happen, right? And so it's really, you know, I try to think about it being,

Starting point is 00:24:51 you know, more of a scenario analysis. How do we structure portfolios if the market ends up running two years longer than people think versus we really do see mean reversion and different things and broad asset prices fall down. So it's really a balance between that. And then also handling the psychological profile of each client because a lot of investing is really not, you know, really it's not making bad decisions at the long time. You can really, you just need to not make poor decisions a couple times a year. And if you can avoid doing that, then historically you've been good.

Starting point is 00:25:30 So there's certainly a psychological component to not only when asset prices are high, but also when they're low and falling. I think that's very wise. I am reminded of, you know, something Howard Marks just said on our show, which was that they were essentially moving ahead, but with caution. And that resonates with me because I would have told you probably back in 2015 that the market was pretty overvalued. I mean, it's just, who's to say? It's been running for so long. And I hate to beat that drum anymore. But there is something you posted on Twitter recently about valuation suggesting that

Starting point is 00:26:05 25% of tech companies based on the current valuation is suggesting that they might grow at a compound annual growth rate of 15% every year for the next 15 years. So when you see something like that, what do you take from that? I just have to start with you. What do you take from that? Well, to a certain degree, the market is enamored with growth. And I think there's some reasons why that's reasonable, you know, because I think sometimes growth can cover up a multitude of sins, right? Take something like Google.

Starting point is 00:26:39 You know, Google is still growing, I'm just going to pull it up right now, Google is still growing top line probably over at or near high teen top line, topline growth. And that's even $4 trillion plus company. and I think people say themselves, okay, well, if you look out five years at this horizon point, if we feel confident in the durability of their moat in their competitive position, then we can really stand to believe that at this point in time they're going to be this big, and that leaves a lot of room for valuations to compress given a certain growth rate. So looking out in the future, I think investors have become enamored with growth companies. Now, there's obviously a downside to this because the other side of coin would say, well, a lot of these companies are being priced to perfection, and they're being priced that they're going to grow, you know, not only 15% per year, but a lot of these higher flying companies to grow substantially more than that into the far, into the far future.

Starting point is 00:27:44 So it's, and I think the other thing, you know, people bring up interest rates a lot, but when majority, the bulk of your cash flows are, in the future, and that's the case in growth companies, right, because they're longer duration assets, more earnings and sales are going to become in the future. You know, there's going to be a higher value placed than that when the time value of money has, you know, low interest rates like right now. So certainly an environment like that, but I really feel like in this environment, a lot of investors are gravitating towards growth covering up a multitude of fins is what I would describe it as. Very interesting. Yeah, I hear you say that and I'm not sure it was you, but recently on Twitter, I saw someone highlighting the fact that I don't know what it was 10 years ago today or something.

Starting point is 00:28:35 The Palm Pilot was valued more than Apple and Google combined, something ridiculous like that. And it's such an interesting wake-up call, you know, to say, yeah, you can project these thing out 15 plus years in the future. But then you remember cutting-edge tech as that was back then and how things can change. as drastically as it can. No, you know, you're absolutely right. And I think if you look across a lot of the high flyers today, and I'm not going to, I'm not going to include mega cap when I say this just because I think, you know, mega cap is really not valued, you know, nearly as high as some of the smaller, you know,

Starting point is 00:29:14 small and midcap high flyers. But they really do have a high, high hurdle to reach when not only meeting these these thresholds but exceeding them. And I think an important thing for listeners to remember is you take a company like ServiceNow, which is a prototypical SaaS company, they've just had extraordinary growth. But they started from such a lower multiple that, you know, they not only got the benefit of far exceeding sales estimates, revenue estimates, but, you know, they also got the benefit of multiple expansion, whereas now on some of these, you know, you're starting from a very full price to sales or price to EBITDA multiple five years out, that it's not saying

Starting point is 00:29:59 that you can't win, but the bar to having whatever IRA you're wanting, your underwriting for is a lot higher than before. So I think that's where the margin for error is significantly less than it was five years ago in these spaces. How are you thinking about allocation and are you, how much are you factoring things like alternative assets or even emerging markets? I'd love to talk about both. Well, I think alternatives just for our particular firm, we do utilize alternative assets. Primarily, what we use alternatives for is to add non-correlated or less correlated return streams to traditional assets. So, for instance, if we added, and I won't name names,

Starting point is 00:30:44 But if we added certain, for example, a multi-strategy fund that was, you know, historically been non-correlated with stocks and bonds, you know, it might produce, you know, more steady stream, better risk-adjusted stream going out into the future. So, you know, pretty much, you know, the vast majority of our alternatives are not to shoot for, you know, market beating returns, but really I kind of refer to it as moving the path out. you know, you can try to optimize for path of assets or portfolios and try to optimize for destination, but you can't really do both. So I'd say a lot of the alternatives that we're including into portfolios are really to smooth out the path, you know, to limit downside and to

Starting point is 00:31:33 provide a better, you know, risk-adjusted return for the overall portfolio. Now, whether or not these alternatives end up providing that, obviously one can debate, but really the goal is to add some return streams, which are less correlated to traditional stocks and bonds. Right. I know there's a Ray Dalio quote about the holy grail of investing is something like 15 uncorrelated bets, as you're kind of alluding to. And so, and there's also a wide range of alternative. So I'm wondering if you could give us maybe one example of an alternative that you found maybe recently appealing. I won't talk specific funds, but I'll give a highlight some examples. For instance, in the fixed income arbitrage space, this would be an example of a non-directional

Starting point is 00:32:24 fund, meaning that if they're investing in credit and interest rates, in the case of interest rates, they're not betting on whether interest rates are going to go down or up. And in the case of credit, they're not necessarily betting on credit spreads going to contract or widen or vice versa. But, you know, one example of a trade might be taking betting on the mortgage basis. So, for instance, you know, you might be betting for investing such that mortgage spreads would tighten. So you might be long, they call it long the mortgage basis. And that, you know, you'd be long agency. mortgages and short the risk-free treasuries against it. Or there might be treasury ARP where,

Starting point is 00:33:10 you know, you might be buying a nine and a half year treasury and selling a 10-year treasury. So basically trying to find little inefficiencies and arbitrages in the market in which you can exploit. And theoretically, those would not be tied to, for instance, the direction of the S&P 500 or the direction of the Barclays Ag, but would have a different profile. file towards that. That's fascinating. I'm wondering how much you might be thinking about emerging markets at a time like this. Is there anything outside of the U.S. that's appealing to you at the moment?

Starting point is 00:33:45 From time to time, we'll look at that. I think that there's a lot of idiosyncratic risk to those segments and obviously driven a lot by FX and how those currencies do against the dollar, depending on which type of emerging assets. So from time to time, potentially for tactical positions, but I wouldn't say that we're investing substantially in emerging markets. But that doesn't mean that, you know, our position is, you know, that's just my personal preference, but it doesn't mean that can't change. You know, maybe in our eyes, you know, they become very attractive in six months or vice versa. Given your personal preference or your experience, which seems heavily weighted in the

Starting point is 00:34:30 credit space, how are you thinking? about bonds? I know it's a generalized question, but how do you think about bonds at a time like this with interest rates as low as they are? I think a lot of investors and maybe casual observers kind of ooh and ah over that. I think that there's a couple of things at play. One is that there's a lot of forced buyers of these assets, whether it's sovereign wealth funds or central banks or banks or there's a lot of forced buyers of these types. this type of paper. You know, the other thing is obviously demographically, you know, there's a lot of studies that point to demographics being, you know, major driver, lower,

Starting point is 00:35:14 not only nominal, but real yield in developed markets. So that's certainly, and that's not a new trend. I mean, that's a 30-plus year trend, but obviously the implications for where risk-free assets, trade, impact everything else. You know, there's no question that, how risk-free trade impacts other things. And clearly, central banks have become buyers, and, you know, which is at a different dynamic. So it's one of those things, I think, used to be a source of income for clients and institutions. And really, you know, I think gone are those days. I think a lot of retirees used to look forward to the ability to buy Muni that 4% tax-free yields, and that's not a factor anymore. I don't think that means that bonds are completely useless. I think if you think about treasuries,

Starting point is 00:36:12 particularly the long end of the curve, long treasuries traditionally have been one of the few places that have provided really risk off exposure. So when, you know, when things get really bad, So it's interesting, you go back to March 2020. So when things are kind of bad, for instance, investment grade credit, investment credit munis might get a bid, but then if they get really, really bad, well then when, then investors want to dump those two. So it's kind of this funny thing where if the markets get bad enough, things that are perceived as safe, munis, investment credit corporate,

Starting point is 00:36:53 those asset classes, which are originally a flight to safety end up becoming dump. So that leaves the depths of last March, you know, treasuries with positive convexity are one of the few things that can really provide diversification and performance when times are really bad. But I think from that perspective, you know, you can't completely throw away the space as an asset class because, you know, there's certainly, you know, benefits to those in adverse market environments. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:40:39 found in the income fund fund funders.com slash income. This is a paid advertisement. All right. Back to the show. Now, I'm kind of curious about the negative yielding debt in the world. It's turned around a little bit. There was about $18 trillion back in December, whereas now it's something like $12 trillion, but we're still talking about $12 trillion in negative yield. So not to say you're invested in that, I'm just kind of curious what your take on that is. What would be the desire to go into something like that? An individual might be able to metaphorically speaking, keep cash under their mattress,

Starting point is 00:41:15 but larger institutions have to have, might be required to have certain positions, in certain quantities. So, you know, whether that's commercial banks or others, they're kind of forced into holding that. And, you know, I think the Fed is clearly, you know, we're not in a position where I think we've had a entertain really going, they call it Neganum, you know, negative nominal rates. Could that happen in the future? I don't think it will.

Starting point is 00:41:45 But clearly, we've seen it in the developed world and, you know, other G6 countries. and certainly a fascinating thing to look at. We're certainly in negative real rate territory at the moment, and a lot of that is due to some of the risks we've highlighted with the supply chain issues and the inflation involved. What is the biggest risk for the market right now, in your opinion? The biggest risk, probably something that we're not thinking about or looking at right now.

Starting point is 00:42:16 I mean, traditionally, typically, there's things that come up every year, oftentimes multiple times a year. So are we going to get another drug? I'm sure. Is it going to be now or is it going to be 10% higher from here? You know, nobody knows. But I think a lot of the kind of obvious one would be, you know, would corporate tax rates go up? You know, that's certainly, you know, something that could happen and become a headwind. Could there be, you know, some other strain of COVID? You know, I think that, you know, I think the markets kind of brushed that off to a large degree with the Delta variant. But obviously, things could happen.

Starting point is 00:42:59 But typically, it's probably an unknown factor that's driving things. And markets are never about absolute numbers, but all about from a relative perspective, what's going to happen relative to what the market is expecting. So we might still have a recovery and things might still be going good from a earnings perspective. whatever, whatever, but maybe relative to what everybody's thinking, you know, it comes in short due to X, Y, or Z. So that, you know, it might be a kind of a cop-out answer, but most likely it's going to be something that we're not thinking about at the moment. No, I like it. You did mention demographics earlier, and what came to my mind was something

Starting point is 00:43:38 I read recently about possibly running out of Social Security money in 12 years and things like that, which to me just implies more printing, more devaluing of, you know, and, you know, our dollar and possibly risking our position in the world, at least our credit worthiness. Is that of any concern in your eyes? I think absolutely, do we make capital market assumptions? Yeah. I think, you know, with the United States being a currency issuer, our big constraint on borrowing is really, you know, inflation.

Starting point is 00:44:13 And that gets a whole other rabbit hole of what inflation is. get a guess that's far brighter on that topic than I am. But yeah, I think from that perspective, certainly certain market proponents believe that we have a lot of capacity to borrow more to spur demand. You know, I think others believe that, you know, we can't just run up the deficits that we are without there being some kind of, you know, longer term implications and that there could be unknown consequences. of the types of stimulus programs that we're doing. But I think the answer is I try to, we're certainly going to be looking at all the inflation and demographic situations and fiscal environments. And I think all those things are very important when making investment decisions.

Starting point is 00:45:06 But I think it's also important not to let my personal opinions on what's happening with the Fed or Congress or whatever. view my thinking in terms of, because, you know, think about we can't control, I was just talking about talking about this with somebody on Twitter, no matter what we think, whether we think policy is the best or the worst or in between, we can't control that to a large degree. We can vote. We should, but we can't control things after that. So, you know, from an investor's perspective, an allocator or active managers, you know, it's our responsibility to invest in the environment that we we have. So back to your original question, certainly, you know, those are things that we

Starting point is 00:45:51 think about, but whether or not they're going to impact today or the near term or the medium term is more of the issue. I like that. And it obviously harkens back to, you know, investing from the ground up. So I'm curious if you had, let's call it, three businesses that you could invest in over the next, say, five to ten years, which companies, in your opinion, are best suited to kind of endure whatever might be coming over that time frame and outperform. I'll give a couple of ideas. The first caveat being that we do own positions in these securities, how far from and myself personally.

Starting point is 00:46:34 But I think, you know, one company that I like a lot, and I'll talk, I'll talk business-wise, you know, which businesses do I think, you know, are going to do well, you know, whether or not, so I'll hedge a little bit, you know, whether or not the stock is actually do well, kind of early to tell. But one of them is a payments company called Adian. So Adian's a Netherlands-based payment company. And so basically what they do is they offer a single payments platform to accept payments anywhere on any device, whether that's e-commerce or in person. And that's an interesting thing about Adian, and most people haven't heard of them, maybe more so in the last year or so. But really, they were built from the ground up in 2006. And the reason that the

Starting point is 00:47:20 founders did this is because the way that things were set up before, it was kind of a hodgepodge of different systems that were built on old infrastructure. And so, you know, a lot of these old payments companies kept acquiring, bolted on, cut costs, and really the underlying technology wasn't really that good. And so I think adding the one platform anywhere, you know, whether you're in U.S. or Brazil, whether you're online or in person, you know, this has really been a great business. And, you know, a lot of their growth has been in large enterprises. So if you think eBay, Spotify, Uber, Etsy, you know, last quarter, I think they won Louis Vuitton.

Starting point is 00:48:09 And this is a business that I think can really grow revenue by probably 30% per year for the next decade, really. And not only that, but their EBITs that margins are in the mid-60s. So they're insanely profitable. Optically, the company is expensive. But I think, you know, these trends of kind of unified, you know, in Omni Commerce, meaning, you know, maybe order online and then you can return it to the store, or maybe you go into a shoe store and they don't have it in store, but then you can buy it in store and ship it home. This Omni Commerce is becoming more and more part of the way that the world is working, especially post-COVID and a e-commerce boom.

Starting point is 00:48:54 And I think Adion is really positioned at a lot of super, super important secular growth trends. And, you know, I think to that, because obviously, you know, you're paying a little bit of a higher multiple for the growth. But I think, you know, the bet is that with a lot of great companies over time, I think investors can focus too much on the stated valuation and not as much on the optionality that those companies have. So great, fast-growing companies historically have had other sources of revenue and profits that emerge. So, for instance, if you went back, I'm not comparing Adi into Amazon, but the way that a lot of people look at popular growth companies that really have durable growth profiles is they kind of underpriced that

Starting point is 00:49:48 optionality. And so I think my belief is that a company that's growing like this and has such great loyalty and basically less than 1% firm, so much revenue growth coming from existing clients, is that they are going to find new sources of revenue. So I believe in the, a hotline growth of their poor business, but I think that there's other things that are going to come about, whether that issuance of cards or whatever, that, you know, they're going to drive this company into the future. So I think that's certainly one that I like a lot for the future. And obviously caveat being that, you know, that we have owned this company for some time. What's your takeaway on the competitive moat exactly? You know, what's going to

Starting point is 00:50:32 stop another payment company to kind of infiltrate their space, given that they're kind of somewhat regional today? Regional base there, but, you know, as far as their growth, you know, they've been growing all over the world. But I think their technology, because of their technology, they have less, less fraud, less, you know, losses and things like that. And I think that their ability to adapt to the environment compared to a lot of these legacy players. And I think that's one of the big things. The legacy players are so bail and unable

Starting point is 00:51:04 to innovate that, you know, not only with the e-commerce growth going forward, but the existing share that I think they can take from these legacy guys that I think is really

Starting point is 00:51:16 underappreciated. I think the second one I'll say, and it'll be more boring, but I don't think it's any less, you know, important as Google. You know, I think, you know,

Starting point is 00:51:26 I could highlight Google or Amazon because I like them, I like them both, but I mean, if you think about Google, obviously, you have your core business with their ad, ad revenue, which is still, which is still growing. But I think, you know, one of the booming things has become YouTube. And just, you know, YouTube, think about an amazing story, right? You know, YouTube being purchased for, I think it was a billion dollars. And don't quote me, I'm close. I'm probably within 500 million. But, I mean, it was a heavily. scrutinized acquisition at the time. And the interesting thing is people didn't even know how they were

Starting point is 00:52:06 going to make money. So a lot of people thought it was going to be on the TV aspect. And if you think about how amazing of a business YouTube is, you have people creating YouTube's own content, right? So they're the content creators of this and the flywheel effect of, you know, more content drawing, you know, more viewers and more ads. And so that business, I think, is just such an amazing company. And I think up until probably the last year or so, it's really been underappreciated because it's been kind of hiding under the Google umbrella. But that's become big.

Starting point is 00:52:48 And then I think, you know, after that, through a similar degree, you know, Google Cloud is growing pretty substantially, and it's certainly no question. It's a distant third to AWS and Azure, but there's limited errors to a cloud provider in the world right now. I think you have to have substantial capital to do that, and I think that they are going to, you know, even if they're not a big, even if they don't displace AWS or Azure, you know, I think it can be, there'll be a great business over time, even as the number three player in the U.S., but not only that, just the amount of free cash flow that they're generating, last 12 months as of 630, you know, it looks like close to 60 billion of free cash

Starting point is 00:53:34 flow. And so not only does that give them flexibility for, you know, acquisitions, which I think, you know, they've been pretty conservative on, but also buyback. They've started to really hold a buyback lever, and I think that they've been a lot more conservative on that than And, you know, at least, you know, next to somebody like Apple, you know, which has utilized that a lot more. And I think that that's going to become a bigger, bigger and bigger thing. But it's hard to believe that a company like Google is still, they do, you know, $210 billion of revenue for 2021, but they're still growing in the mid-high teens.

Starting point is 00:54:12 I mean, it's really remarkable. So I think that, you know, it's a reasonable valuation going forward. and you've got quite a few engines underneath their core business that are going to grow. And I think as you look out a couple years, not that many years, look out a couple of years with Google's growth. I mean, they've certainly re-rated in the last year, but it's very reasonable compared to a lot of companies in F&P that are trading in the low 20s T.E right now with revenue growth, that inflation are just a little bit higher than inflation. I think you can take Google for similar multiple, a little bit higher multiple, but on a forward basis, you know, significantly cheaper. So I think that there is some safety in the growth as far as mega cap tech goes. So, you know, what happens with the regulatory environment?

Starting point is 00:55:05 I don't know. You know, will something happen to some of these? Probably will it be punitive to the stock? My guess probably not. in that it's probably going to take a long time. And at that point in time, these companies might be a lot larger than they are now. And potentially the pieces might be sold for more than the sum of the parts. So that's another thing to think about.

Starting point is 00:55:27 But certainly at least the headline that could be a headwin. Well, David, this was so much fun. Thank you for sharing a few of those ideas. I think they're super interesting. And this is a very holistic discussion on markets. on companies, on a whole number of things. And so I know our audience is going to glean a lot of insight from it. I really hope we can do this again sometime soon.

Starting point is 00:55:52 And I'm going to continue to follow you on Twitter and enjoy your commentary. And I hope we get to do it another time. Likewise, try. Thank you for having me on and I look forward to it. All right, you beautiful people, if you're loving the show, please don't forget to follow us on your favorite podcast app so you get these episodes in the app automatically. The guest today and I originally connected on Twitter, so if you want to reach out, you can

Starting point is 00:56:14 always grab me at Trey Lockerby. And lastly, if you're trying to learn the intrinsic value of a company, look no further than the TIP finance tool. Just simply Google TIP finance and it should pop right up. And with that, we'll see you again next time. 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.

Starting point is 00:56:37 To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

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