We Study Billionaires - The Investor’s Podcast Network - TIP522: Unconventional Wisdom From The Greatest Minds In Investing w/ Joseph Shaposhnik

Starting point is 00:00:00 You're listening to TIP. My guest today is Joseph Shepashnik. Joseph is portfolio manager of TCW's New America Premier Equities Fund. Joseph also serves as a senior equity analyst in the Equity Research Group, with coverage responsibility for the industrials and basic materials sectors. Prior to joining TCW in 2011, he was an equity analyst associate at Fidelity, where he focused on the semiconductor and entertainment software sectors. In this episode, you will learn unconventional wisdom from

Starting point is 00:00:30 strategies that Joseph has learned from working under Joel Tillinghast, Will Danoff, and under mentorship from Brian Jellison. How he has shaped his strategy for his fund that has outperformed its benchmark by 3.5% since inception. In overview of some of the fund's top holdings, including Constellation Software, FACCet and Broadcom, insights from Buffett's investments in TSM and precision cast parts, and a whole lot more. Joseph brings the type of level-headedness and consistency you would expect from someone who's consistently beaten the market for more than a decade. There's a lot here, so without further delay, please enjoy my conversation with Joseph Shepashnik. You are listening to The Investors Podcast, where we study the financial markets

Starting point is 00:01:14 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 are super excited to have on the show, Joseph Sheposhnik. Welcome, Joseph. Thank you. Great to be with you, Trey. We're so excited to have you here, mainly because you've had this incredible career working under so many incredible names in finance. And I'd like to cover a few of them here at the top and kind of help us understand how you shaped your own investment approach through working with these Titans in the space.

Starting point is 00:01:56 So the first one that stood out to me was Will Danoff. When you were an analyst covering semiconductors at Fidelity, you were funneling ideas up to Will and he managed the contra fund. So for those unfamiliar, the Contra Fund is the largest actively managed stock or bond mutual fund run by one person. As of late, it's had around $100 billion in assets. I have a hard time imagining what it be like to be responsible for $100 billion, but I'm wondering if you got a glimpse of it while working underneath Will and any other styles or lessons you picked up while working for him. Will is an amazing guy. I was at Fidelity right out of college. So as you said,

Starting point is 00:02:34 I cover the semiconductor industry and then later on the software industry for the firm's U.S. domestic equity funds. And obviously Will was running a lot of money back then as he's running a lot of money today. He, uh, you know, just an amazing man, incredibly passionate about helping his investors, you know, an investor wrote a letter to him just as he started his fund and talked about how they were putting money aside for their newborn. And they hoped that money would grow and grow into something that they could finance that newborns college experience. And Will posted that letter on his wall. So all of us as analysts understood how seriously Will took his job and how seriously we

Starting point is 00:03:17 should take our job. So he got a huge heart, super passionate about what he did. He was as close to Peter Lynch as you get at Fidelity. You know, he took the same level of passion, energy, style in terms of earnings growth as his focus. And what I remember about him is he brought a very high level of intensity to his job. He, you know, his style was to meet 10, 11 companies a day at Fidelity. And so at Fidelity, we had a whole floor dedicated to company meetings. And I think Will lived on that floor and was there every day seeing one company after another and looking for the great ideas. He was all about

Starting point is 00:03:59 focusing on great businesses that were getting better. And so, So he would spend a lot of time with management. He would spend a lot of time understanding the stories. And he'd spent a lot of time asking basic questions. You know, I can remember being in a meeting with him and the Chipotle management team on the IPO road show. He walked in and he asked them, you know, if they made burritos, if that was their business. He'd asked the basic questions and he wanted to see how management would articulate their business and whether management really understood their business. He spent a lot of time focusing on investing with successful.

Starting point is 00:04:32 people. So he'd call it betting with billionaires. And so one of his approaches, one of his strategies was finding successful people and then doubling down on them and betting on them again and again and again. And that was a strategy that worked incredibly well for him. I can also remember Will was a learning machine. He would learn and adjust and learn and adjust. And I can remember going to one of the Berkshire meetings with Will sitting next to him and just watching him take notes. throughout a three-hour meeting, you know, in a large stadium listening to Buffett. He was just learning and learning and adjusting. And just over time, he became an incredible investor.

Starting point is 00:05:16 And obviously, today he's managing, I think, you know, $100 billion in Contra Fund, but, you know, another $50 billion and a couple of other funds at Fidelity. So just an incredible passion, a strategy that was focused on investing in good businesses only that were getting better and a great heart and super passion about helping his investors. What I'm kind of curious about is if you saw a strategy that led to Will letting go of companies, what was the turnover like? You know, everyone wants to find these long-term holds. Was there a thesis that was broken along the way or some example that notify him that maybe informed you of what to look for when you knew it was time to get out of a position?

Starting point is 00:05:54 He was very flexible. If you provided him with facts that were different or confronts, to the investment thesis, he would change. And back then, his turnover was higher than it is today. So he was flexible and he would change very, very quickly. I think for him, I think great investors have a North Star and his North Star was always earnings per share. And so he was constantly assessing his confidence and maybe the analyst confidence level around where earnings per share was going to be a year, three years, and five years out. And if he sensed that that story or that confidence or the actual earnings were shifting against the story, he was likely to make a change. So he would stick with businesses for some periods of time. He could stick with them for long

Starting point is 00:06:43 periods of time. But if he felt as though the story was changing or his North Star was shifting, he would certainly make a change. And you were an expert in semiconductors at the time and you were rolling up ideas to him that way. But then you mentioned Chipotle, right? These are very different industries. Was there a circle of competence involved with Will? Were there ideas that would flow up to him that you would obviously see were much more in his wheelhouse than others? And he would be careful about picking between the two. Certainly, he was always looking for the great winners. And so one of the areas he looked for the great winners in were new issues. He was always looking at new issues because he thought these businesses could become big over time. And he was

Starting point is 00:07:27 always thinking about what is the next Starbucks, what is the next Home Depot, what is the next Cisco. Those are the businesses that he saw get really big over his time. And so he had the ability to stay young and stay nimble and stay flexible at looking for the great winners as he saw them, the 10 baggers, as Peter Lynch called them. And of course, that term persisted throughout Fidelity. So he would look for the early, early businesses, early in their maturity cycle. And of course, he was looking across all businesses to find those businesses that could grow earnings per share at a high rate with managements that were high quality that he could get comfortable with.

Starting point is 00:08:09 He would stay away. He tended to stay away from the cyclicals. He tended to stay away from businesses that were kind of low quality or low return on capital. And he tended to focus on technologies, consumer discretionary, somewhere. what consumer staples. Those were his key areas. And another legend over there is Joel Tillinghast, and you were working under him at Fidelity for a while as well. He was a portfolio manager of the equities division there. Talk to us a little bit about your experience with Joel, what you picked up from him along the way.

Starting point is 00:08:41 You know, it's interesting. Joel, Will, and Jeff Finnic, who ran Magellan at one point, all came out of the same analyst class at Fidelity in the early 80s. So an amazing class of investors that came out together. Maybe that had something to do with their success. Maybe it didn't, but quite an amazing group of investors that all came out together and grew up together. I think under the influence of Peter Lynch, so they learned from, you know, the great one of that time.

Starting point is 00:09:09 Joel had, you know, obviously Joel was a great value investor, very much focused on valuation, very valuation sensitive. And, you know, what I remember about Joel is he could run multiple value strategies inside of his fund. So he was, he was looking for high free cash flow yield. He was looking for small cap and cheap. He was looking for low EV to sales businesses. And he could piece all of that together and run multiple strategies. And at the time, I think, was a $30 billion small cap fund, which is amazing.

Starting point is 00:09:46 Most small cap funds close at three or four billion. I don't know what he's running now, but I'm assuming it's quite a bit of money. But under, you know, in a portfolio that had that level of that high level of assets, he could run multiple value strategies with the, I think with the focus of being able to outperform in different market backdrops. He was very successful at doing that. So when I think of him, I think of somebody who could follow a thousand stocks well, run multiple value strategies at the same time.

Starting point is 00:10:16 time well and do that for quite a long period of time. So just, you know, another legend over there who was, you know, influenced, certainly very influential in shaping the way I thought about investing. Now, before you got into investing, you were an intern at Microsoft. I realized you always kind of knew you wanted to get into investing. So I believe there was an experience you had with Bill Gates at his house for dinner and probably had a big impact on you. I imagine what was that experience like being around Gates, especially at a young age, how did Gates direct you on your investment journey when you asked him about it? It was an amazing night. He invited some of the summer employees of Microsoft to his house for dinner. And of course, we didn't really know what to expect. And it was a beautiful

Starting point is 00:11:02 dinner out in his backyard, on the lake. And I remember him coming down from his house and speaking with us. And as you mentioned, I had the opportunity to talk to him about investing, which was what I was really interested in. Microsoft, not that interested in it, but I remember him being incredibly fascinated by Warren Buffett. I remember him talking about how he spent a lot of time with Buffett and spent a lot of time reading about Buffett. And I remember him saying two things to me. The first one was that successful people in most adventures start really early. So he had seen a study that he, I think, thought was important, and he mentioned that to me. And I think that was something that was super encouraging to me because, as you mentioned,

Starting point is 00:11:49 I started really early. And the second thing you mentioned and emphasized was that I should immerse myself in Buffett. And I was fortunate to, at an early age, do that and to attend the meetings and read his letters and spent a lot of time studying what he did with the partnership, studying how he ran Berkshire and built Berkshire, and just learned a lot by doing that. So what about Buffett did you kind of hang on to? And then where did you find path to diverge from? I think Buffett is so interesting because everybody takes something different from his incredible body of work. You know, he is such a great teacher and also obviously a legendary

Starting point is 00:12:33 investor that we all learn something different, I think, from him. You know, what I learned from him was when I analyze his success, to me, his greatest investing successes came from investing in high-quality businesses. And when I think of his great investments, I think of Coke, I think of Gillette, and I think of Cap Cities. And when we go back and we study those investments, we find that he was willing to pay up for the great businesses of his time. So as you think about Coke, I think he made the original investment in his time.

Starting point is 00:13:06 in 88 or 89. And he paid, I think when we looked at it, 24, 25 times earnings, which was a 50% premium to the market multiple. Similarly, in some of these other high-quality business cases or high-quality businesses, he was willing to pay up for the great businesses that would compound at high rates and generate high returns for a long period of time. So my lesson from Buffett wasn't that you should look for the cigar butts, look for the cheap businesses that you would hope or believe would turn around. It was to find the great

Starting point is 00:13:40 businesses that generate high returns and great free cash flow and be willing to pay a little bit more for those businesses in order to partner with a great business and a great team. So while I love learning about Buffett and he's kind of my go-to, I always love learning about people you don't hear about every day. You've had some mentors along the way who are well-known in their industries, but might not be as well-known to the masses outside of finance. So I'd love to kind of learn a little bit more about your time being mentored by Brian Jealouson, who seemed to be this very amazing mentor to many people along the way and a very generous person with his knowledge and philanthropy and other things. He was a head of Roper

Starting point is 00:14:20 Technology. So I'm kind of curious how you came across his path and anything else you may have gleaned from him. Well, I was fortunate to be the industrialist, the TCW, from 2011 to 2018. And at the time, Roper was not called Roper Technologies, but it was called, I believe, Roper Corporation, or just Roper. And I think it was Roper Industries. And Brian became CEO of the company in 2001. And the company at the time was a billion dollar market cap business. So a billion dollar market cap maker of industrial pumps. So cyclical business, he had come from an industrial conglomerate before that.

Starting point is 00:15:04 And I think he learned all the things he didn't want to do with Roper from working at a conglomerate. When he retired in 2018, Roper had a market cap of approximately $30 billion. So it was a 25X over that 17-year period of time. What I took from following him, we were fortunate to invest in 2012. So we've been investors now for quite a long period of time. What I learned from following him and reading everything that he had. written is that it's important to think differently, even as industry, and to develop a North Star. So his North Star was focusing on cash return on investment. So he was focused

Starting point is 00:15:48 on cash flow and the investment required to generate that cash flow. That drove all of his decision making. So he had a business at the time when he took over it and had a relatively low cash return on investment, highly cyclical and relatively undifferentiated. And he spent the next 15 or 16 years transforming that business into a business that owned dozens and dozens of niche businesses that were highly recurring and that generated consistently growing free cash flow. And I think that the focus on niche businesses is a real differentiator. He focused on niche businesses because he thought niche businesses attracted less competition and were more defensible. So his focus was on building these smaller but healthy growing niche businesses that would generate

Starting point is 00:16:43 cash flow, throw it off, give it to him and allow him to reinvest it in other good businesses. For him, it was a progression. So he moved the business from industrial focus, which was heavy capital intensity to industrial focus with low capital intensity. So, hire free cash flow. So he bought a bridge tolling business, which he'd consider to be industrial. And so the bridge tolling business would sell tags, which were recurring. And that was a defensible niche. He then moved the business to a business that would invest in network-like businesses. So he bought a freight matching business. And then he progressed the business to health care consumables. And in the end, he began to focus

Starting point is 00:17:29 on software. So his North Star was always cash return on investment and the rate at which he could compound free cash flow per share over a long period of time in a defensible way. So he over time transformed the business and more recently Roper has announced that they're spinning off the remainder of their industrial businesses. So it was a full transformation that he presided over. And I think the other key lesson from Brian, just a great man, was he certainly adopted a decentralized model, which of course is common for many successful businesses like this. And I think he studied Buffett and he studied the decentralization model that Buffett had adopted along with others. And that was incredibly helpful for Brian and being able to manage 35, 40 different businesses

Starting point is 00:18:21 and to continue to be able to add on to those businesses and those platforms. So as I think about him, those are the key lessons. And just think of him as somebody who would get up at an investment conference and incredibly colorfully talk about why a roper was great, super differentiated, and why everybody else was way out to lunch and not running their business in the right way. So it's just a really great, great CEO, a great guy to be around. And unfortunately, he passed away a couple of years ago. But just think of him incredibly fondly.

Starting point is 00:18:56 somebody who certainly shaped the way we assess businesses, whether they're industrial businesses or data analytics businesses or software businesses. So it sounds like he was influenced by Buffett, but maybe Charlie Munger as well on that last point there. I think that's right. I think that's right. Let's take a quick break and hear from today's sponsors. All right.

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Starting point is 00:23:22 So with all of these experiences and these different strategies you've come across, what conventional wisdom have you come to disagree with, especially the ones that we're all pretty familiar with? I imagine there's some that stood out to you that said, you know what, this doesn't actually jive with me or my strategy? I think there's several. The first one is, from our perspective, I had been an analyst covering the most cyclical industries, semiconductors, then industrials, then chemicals. And so, So I had seen what it was like to invest in deep cyclicals, businesses that had limited modes, and businesses that were super capital intensive.

Starting point is 00:24:03 So one of my key takeaways is predictability is far more important than a low starting valuation. If you can't predict the business or where the earnings are going to be in a year or two, you can't determine whether the business is fairly valued or not. So as I think about just the sheer number of variables that go into what impacts a stock, it's enormous. And I think about all of the analysts that were studying Facebook and how they couldn't anticipate that Apple was going to come in and disintermediate the ad model.

Starting point is 00:24:40 I think about everybody that was studying Intel and AMD. And I think that almost nobody 10 years ago would have predicted that AMD would be larger than Intel or the same size. And I think that, you know, the data indicates that half of the S&P won't be in the S&P 500 in 15 years. So for us, it means that we're really focused on narrowing the number of variables down to a number of variables that we can actually get our arms around in order to predict where the business is going to be. So we focus a lot on recurring revenue and businesses that are in defensible niches. We think that if a business has substantial recurring revenue, it decreases the risk that

Starting point is 00:25:24 we're going to be wrong in assessing where the free cash flow will be in a year or two or in five years. And so it's one incredibly important element that we think reduces the risk of making a decision. So I think one of the first unconventional lessons is predictability is as important as a low starting evaluation. I think the second key takeaway, as we think about conventional wisdom and what's important, is limiting your turnovers. So as I think about, and I think about that in a basketball context. So the great Mick Cronin, UCLA's current basketball coach, he talks about the importance of limiting turnovers.

Starting point is 00:26:06 And he brings it to a mathematical formula, which I think applies to investing. He says, if you have fewer turnovers and you have more rebounds than the other team, you're likely to have more possessions and you're likely to have more shots. So I think the same rule applies to managing a portfolio. If you can limit the number of businesses that declined substantially, you've got a much better chance of outperforming. If your portfolio is constantly taking significant drawdowns and positions, it's much harder for your winners to overcome those declines and for you to deliver good performance. So I bring it back to basketball and limiting your turnovers, which in investing means trying to narrow the magnitude of the outcomes with the investments that you make in order to reduce the investments that are going to hurt you the most.

Starting point is 00:26:58 So again, that goes back to predictability, defensiveness, and we'll get to free cash flow, but free cash flow as well. I think the third key unconventional lesson is that what we found is that cheap businesses are usually cheap for a reason. Inexensive businesses, particularly those that generate low returns on capital and that are incredibly capital intensive, they tend to not be long-term winners. And so if that's your focus, you're always focused on trying to buy them cheap and then ride them when the business improves and then sell them before the capital intensity ramps up again or the story gets more difficult or the economy goes.

Starting point is 00:27:39 goes the wrong way. And so that creates a significant tax bill for investors. And it creates another job for the investment manager, which is you have to now take that money and find another place for it. So that's difficult. From our perspective, why not just buy a great compounding business that will get better over time and one that you don't have to sell? The fourth out of five is that free cash flow is king. It's not EBITDA, it's not revenue and it's not earnings. We think that free cash flow physically move stock prices. It allows companies to reinvest in projects. It allows companies to buy in their shares and increase your ownership, assuming you're not selling. It allows a company to buy other businesses and improve those businesses and hopefully add value to the

Starting point is 00:28:30 franchise itself. So for us, free cash flow per share is our North Star. And as we think about building a compounding machine, which is what we focus on building a compounding machine, we are focused on finding those businesses that can compound free cash flow per share at the highest rate with risk under control. And so for us, it's not about revenue growth or EBITDA or necessarily earnings. It's about what does the business generate at the end of the day, which is free cash flow. And the last key, I think, unconventional lesson is that if a stock has doubled or even tripled, you haven't missed it. When you think about the great compounding businesses, the great

Starting point is 00:29:12 businesses of our time, as you think about Microsoft or Starbucks or Mata when it was great, or some of these other businesses, these businesses, they go up many, many fold. If you look at Roper, I mean, Roper went up 25 fold over the course of that period of time. You could have bought it in the second inning of the story. You could have bought it in the fifth inning of the story, and you would have done remarkably well. So one of the, you know, I think one of the, you know, I think one Other lessons is the great CEOs, the Bill Gates's, the Larry Ellison's, the Jeff Bezos of the world, they're not selling after the stock's doubled or stocks tripled. They're holding on to these great businesses for long periods of time.

Starting point is 00:29:51 So I think the key conclusion is if a stock has doubled or even tripled and the story is getting better over time, you haven't missed it and it may be worth your time to look at. Okay, so now let's talk about Joseph Sheposhenick, because you have had a story. incredible run in your career so far and you're just getting started, but you've been running the TCW New America Premier Equities Fund, which is benchmarked against the Russell 1000 growth index, and the fund has produced 15.84% since its inception versus the Russell's 12.3% so 3.54% of alpha. I want to dive into a few of the top holdings of the fund, and some of them are especially interesting because they would be considered, quote, overweight, you know, in a lot of other funds.

Starting point is 00:30:35 So you were talking about looking for companies that avoid disruption. I find this so interesting because technology is kind of built to be disrupted in a way, but they're also the most asset-like businesses that throw off the most free cash flow. So there's almost sometimes this trade-off. And I always find it interesting to study these types of companies who can have sort of monopolistic, let's say, attributes or potential monopolistic attributes, but then also might be at risk of being thrown out by something else. Your point about Facebook and Apple a minute ago, kind of stands out. So the top holding here is Constellation Software. And I first learned about Constellation when I was interviewing Larry Cunningham, who's the vice chair of the board, but I never

Starting point is 00:31:15 took a great deeper look at it from that conversation. So I'm hoping to come back to it now and learn from you about what makes Constellations such a great business. Well, you know, our strategy, as we've talked about, is focused on investing in predictable growth businesses that generate consistent free cash flow, partnering with management teams that treat shareholders as partners, businesses that have a track record of great reinvestment of their free cash flow and the opportunity to do more of that, and businesses that traded a reasonable multiple of free cash flow. Constellation is the embodiment of the free cash flow compounding machine. As you may know, it's an owner-operator of several hundred vertical market software

Starting point is 00:32:01 businesses across many different industries. 70% of revenues are tied to long-term maintenance contracts on the software that is embedded with customers. And it's a decentralized business that has hundreds of constellation software leaders across the world looking for great investment opportunities and acquisition opportunities. And it's a business that's compounded free cash flow per share at 30% for I think 20 years or so with a very unusual formula of, some organic but mostly inorganic growth. I think the ideal business generates high returns on capital with the core business and it has the opportunity to reinvest the cash flow that it generates to generate more

Starting point is 00:32:47 high returns or to continue to generate high returns on invested capital. And for us, you know, we're always looking for defensiveness. And this business gives us great defensiveness, super diversified, 70% recruit. current revenue, critical software, which is difficult to replace, niche focus, not looking to compete against the biggest software players in the world. So as an example, they sell software to golf clubs. They sell software to bowling alleys. They sell software to construction equipment makers, window repair shops, basic software for basic customers. And so we love the defensiveness of the business. You know, in the Great Recession of 2009, they continue to grow free cash flow.

Starting point is 00:33:30 they continue to generate reasonable growth. The defensiveness is incredibly attractive, no customer concentration, super diversified, highly recurring, and as importantly, run by one of the great capital allocators of our time, Mark Leonard. And so Mark is a very unique individual. He spent his life studying the great compounders and building a business that worked for him, but embodies all of the lessons of the great compounders. So he's studied Buffett.

Starting point is 00:34:03 He studied ITW. He studied Jack Henry. He can tell you everything about those businesses. And he built this incredible decentralized business that has a culture that works, that has a culture that takes care of the customer and has the ability to expand out and decentralize the capital allocation decisions to. the farthest flung employee. If that's in Japan or in Sao Paulo or in Spain, all of those individuals and those teams are empowered to make investment decisions and acquisitions.

Starting point is 00:34:41 And I think that's given Constellation an incredible advantage over the software-focused private equity firms in the U.S. domicile private equity firms who are competing for similar assets as well. it's allowed constellation to buy very small businesses and do many, many small acquisitions, which for large businesses is time consuming, but for a company that is decentralized decision making, it allows that to occur efficiently. And what we found is that those small acquisitions tend to deliver the best returns. And so that has allowed constellation to deliver incredibly high returns on capital. It gives you a sense.

Starting point is 00:35:23 today the business generates about 40% returns on capital, and it deploys all of its free cash flow to acquiring other businesses. So just incredible, you know, a good business in the United States might generate 18% returns without diluting those returns with acquisitions. This business has been able to generate 40% for the long period of time while doing, while redeploying all of its excess free cash flow. So it's an incredible compounding machine run by an exceptional manager who runs it very conservatively, it has an incredible record. So it's something we've been very comfortable with. And as you mentioned, it's been our largest holding now, I think for five or six years. And as you talked about, it's been, you know, between 10 and 15 percent of the

Starting point is 00:36:08 fund for a long period of time. It's a bit unusual. We think that it provides us with great downside protection and we just have great confidence in the durability of the model and the team. And speaking of the team, another point that's worth. noting is the level of insider ownership of the company. So that currently sits around, I believe, $3.5 billion worth of ownership. And that clearly shows major skin in the game from management. And I imagine that's another point you look at when you're studying management and something to give you a little bit more reassurance. We certainly do. And I think one of the other key penance of ours is to look at what management incentives are. So we spent a lot of time

Starting point is 00:36:50 looking at the proxy and analyzing what their incentives are. And, you know, one of the great parts of the Constellation incentive structure is that management and employees are required to take their cash bonus and purchase shares on the open market. So, and hold those shares for three years. So Constellation has never issued options and they have never issued shares to employees. So I think share count has been 21 million shares since the IPO in 2006. So his focus on caring for investors and incentivizing employees to invest in the business is unusual. And for us, it's just so special that everybody is really invested in the success of the company.

Starting point is 00:37:34 And, you know, as a corollary to that, Mark doesn't like when the stock gets too high or out of whack relative to what he thinks the fundamentals are. So, you know, he doesn't really do investor meetings and he doesn't do a conference call anymore. So if you want to see him, you have to go to the shareholder meeting. The first shareholder meeting I attended, which I think was in 2016 or 2017, the stock was around $600 a share. And he was actively telling those in the audience that he thought the stock was too expensive. And stocks now, I don't know where it is today, but it's I think 2,900, correct me if I'm wrong on that. But at 600, he was telling us it was too expensive.

Starting point is 00:38:14 I remember a year after that, I came back to the meeting. And he said the same thing the stock was maybe at 800 at the time. And he thought the stock was too expensive. So I think that indicates that he's very focused on the fundamentals and making sure that the stock doesn't get out of whack and not being promotional. But I've also found it's very unusual that a management team thinks their stock is too expensive. And if they say something that unusual, it's worth paying attention to. To me, it was something that was attractive and consistent with his understated personality and the way he ran the business. but it certainly was something that you don't cure very often.

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Starting point is 00:41:51 is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income Funds Perspectus at Fundrise.com slash income. This is a paid advertisement. All right, back to the show. Yeah, I wonder what Mark would say today, because at the time of this recording, the stock is currently at $2,316, which is essentially its all-time high. It only hit this level right at the end of December 2021, much like a lot of companies who are hitting their all-time highs right before the bare market began. But what's so remarkable about this stock is how quickly it's recovered

Starting point is 00:42:36 back to its all-time high, even after 2022. It is. And when you look at what's occurred underneath the business, it's a little bit less remarkable. I'll tell you why. Number one, the business always is traded at a moderate free cash field. So today it trades at a 4.5% free cash field on 2023 free cash flow. And it never really gets expensive.

Starting point is 00:42:59 So it tends to trade on the fundamentals. And number one, because so much of revenue is recurring, It doesn't fluctuate, the organic revenue doesn't fluctuate to a great extent. But I think number two, through the pandemic and coming out of the pandemic, Constellation continued to execute extremely well. And the stock went down with the market, but has since come back primarily because I think in this environment, you know, they say the stock market is a voting machine in the short term and a weighing machine in the long term.

Starting point is 00:43:30 The stock market has become more of a weighing machine this year and last year, relative to in 21 and in 20, it was more of a voting machine. So because it's so cash generative, the market, I think, is given it a little bit more credit and has allowed the business to come back. It was not one of those businesses that was driven on revenue growth or the metrics that dominated the post-pandemic rally. So I'm not that surprised that it's come back as well as it has. I think they've done a really good job of growing the business in the pandemic and through

Starting point is 00:44:03 the pandemic. So if you just, you know, if you look at, you know, the performance, business has continued to grow. This year, it looks like it grew 25, 28%. It's going to continue to grow at a high rate. And the stock, I think, is representing the fact that all of that is translating a good free cash flow growth. So that's kind of an interesting point about its cheapness, if you will, with the four and a half percent free cash flow yield, multiple. And it's a $50 billion dollar company and its PE is sitting at 75, right, which is pretty high. I think no matter what kind of business you're looking at, it would be considered high, even though this is a very established business with strong earnings. So for a company like this, that's especially more mature and a tech

Starting point is 00:44:44 company, I guess, if you will, knowing that you don't emphasize valuation when you're looking at these numbers, what metrics should investors focus on if it's not the PE ratio? Well, I think that at least on the forward basis, it trades closer to 32. times earnings, which is not low by any means. Our focus is, you know, our North Star is free cash flow per share and a multiple of free cash flow per share. So the way we assess businesses is we're always looking at what the free cash flow per share is for these companies on a forward basis and the rate at which we think those businesses will compound free cash flow per share in the future. So we're always looking at as we think about making investments and as flows come

Starting point is 00:45:28 in, flows come out, we're always looking at what's the best return on our capital, at what rate can we generate compounding with the particular business, and what's the multiple of free cash flow per share that we will have to pay to get that rate of compounding. With constellation, today, as we look at the market and we look at rates, we tend to think that the current multiple or the current yield of four and a half percent is relatively attractive relative to the other opportunities for capital in these protected durable compounding businesses that we focus on. So we're not particularly concerned about the current valuation. And I think that relative to the other options and the multiples on free cash flow,

Starting point is 00:46:12 it continues to be something that is attractive. So there's another holding that reminds me a little bit of constellation I want to talk about, which is FACSET. It's almost like another semi-niche tech software type of company, if you will. I'm wondering if this is sort of a smaller version of Constellation that could grow up to be something more like a constellation, if you will, because it's only around a $420 stock at the moment's about $15 billion market cap. Talk to us about what FACSET does and why you're drawn to this as well. You know, FACCETA, as you probably know, and anybody in the financial services industry probably

Starting point is 00:46:46 knows the business. It's a leading provider of financial data, economic data. to financial professionals around the world. It's a subscription service that many of us use to find information on businesses. So a company has over 180,000 global users and 95% of revenues are generated through subscriptions. So those subscriptions are fairly expensive. I think what's also attractive about the company is that it's grown revenues, 42 consecutive years and earnings, 26 consecutive years as a public company.

Starting point is 00:47:20 So we appreciate the consistency of the company. And what we also appreciate is the recurring revenue nature of the company. And I want to take a minute and step back and just talk a little bit about the way we look at recurring revenue. We think not all recurring revenues create equal. Oftentimes recurring revenue is divided into subscription recurring and transactional recurring. So I'll give you an example of both. A transactional recurring revenue business would be one of the credit bureaus where there's only

Starting point is 00:47:49 three credit bureaus in the United States. And normally, if somebody's credit is being run for a mortgage or something credit related, you have to pay two out of the three bureaus for a score. But if mortgage activity declines, that revenue will decline as well. So that'd be considered transactional recurring revenue. In the case of facts that, it's a subscription recurring revenue business where somebody pays a subscription on an annual basis for the use of the product and oftentimes it's multi-year subscriptions in the case of a fact set. So we think that there's a real difference between the two. And of course, we favor subscription recurring because of its durability and predictability.

Starting point is 00:48:33 It's been a business that we've owned primarily because we're attracted to the predictability of the company and the fact that the business generates 40% or so returns and fantastic predictable free cash flow growth. So from that backdrop, it's, it's attractive for us. And I think one of the key triggers for us was a new CFO coming into the company who had come from other businesses like FACSET. And our impression is that Linda Huber is going to do a great job in getting a little bit more control over the cost of the company, perhaps improving the capital allocation decision making, and continuing to business. position the company to generate predictable free cash flow growth and revenue growth for a long

Starting point is 00:49:19 period of time. So it's a great business that's performed really well over the years. It's a business we really understand because we use the product. And it's a business that we think is very durable and predictable. So it really fits our approach. You mentioned the hiring of CFO. A lot of major companies in this industry, or I guess in software, et cetera, tech are laying off people at the moment, you know, getting ready for this impending recession. Everyone's talking about. Meanwhile, this company's hiring it would appear. Are you seeing differences like that in the news or are those indicators, if you will, of stronger businesses or companies that are more supported or more set up to succeed in a period we're heading into?

Starting point is 00:49:58 You know, I think that the businesses that have tended to lay off people in tech have generally been those businesses that have seen demand pulled forward because of the pandemic. So, you know, Sotia Nadella talked about that on the Microsoft call a couple of nights ago, maybe I think two nights ago, where he's seeing customers optimize their spend because they've made such strong investments in IT over the last couple of years, somewhat driven by a pandemic pull forward. So I think at the same time, those software companies had to invest in people and grow their staff to respond to the demands that customers. put on them over the last couple of years. As I see it, companies are just making an adjustment to bring their staff back to a more normalized level. But as we look at the data on employment

Starting point is 00:50:55 or tech businesses, companies are not bringing their staffs back to a level that looked like the 2020 or 2019 level. There's someplace in between 2020 and where they were at the end of this past year. So there's been some modest reductions. I think we tend to think that they're going to be muted generally. In the case of FACSET because of its business in supporting financial professionals with great market data, it wasn't particularly impacted by the pandemic negatively or positively. So we tend to not think that there's going to be much of an impact there or much of an impact from the customer base as well. Yeah. And to your point about Sotchanadele Microsoft, they announced 10,000, I think, layoffs recently, which is only about 5% or so of their

Starting point is 00:51:41 overall employment. And if you were looking at it through the eyes of Jack Welch, you know, at GE, I believe he would cut 10% annually, you know, just as a rule of thumb. So you're right. It could be looked at as a very reasonable move or something almost prudent or practical. Yes. I think that's right. So switching gears a little bit, I want to talk about semiconductors because they've received such a large amount of attention over the last few years, especially after supply chains broke down and semi-shortages began to affect what felt like nearly everything. Berkshire Hathaway even recently took a stake in TSM and others seem to be following suit. But given your background, I wanted to get your opinion on the space. And if you had to pick

Starting point is 00:52:19 a top semiconductor business to invest in today, which one would you choose? I think that the semi-hundred industry has evolved significantly over the last several years. It continues to be, I think, an attractive place to look for ideas. But we're always very cautious about investing in semis. because they're at the edge of technology change. And so we generally stay away from businesses that are undergoing technology change. Buffett has a line where he says generally the best investments or the best businesses or those businesses that are doing something somewhat similar to what they've been doing over the last couple of years.

Starting point is 00:53:00 So with semis, it's always a challenge because product cycles tend to be very short. and there's a lot of smart people that are driving a lot of innovation in semi. So they tend to be a little bit more difficult to predict in general. So we're very, very selective if we make an investment there. We have been investors with Broadcom and Hawk Tan for a number of years. And I think that there's so many incredible attributes to Hawk and to Broadcom, but one of the key features of the approach at Broadcom is a real home. approach to running the business. They're not looking to make the hot new product that will

Starting point is 00:53:44 take over the world. They're looking at making incremental changes to their existing franchises to make them better and respond to customer needs. So what's attractive about Broadcom is that they're involved in 30 key markets, which they call franchises, where they're the dominant provider of the technology, and it tends to be areas that are relatively unattractive for the fastest growing semi-companies. So they're the dominant player in hard disk drive. Hard-disc drive is not the sexiest place to be in semis. They're the dominant provider of chipsets that go into cable set-top boxes. And they're the dominant player in fast-growing networking equipment as well. but they generally take a conservative approach to investments and they generally take an incremental

Starting point is 00:54:36 approach to R&D development. So we like the fact that they have these dominant niches that provide them with a level of recurring revenue, that provide them with a level of stickiness and protection. And we like the fact that they're not out there competing against the heavyweights in the cutting edge areas of semis. And I think as important, Hawk Tan has proven to be an unbelievably gifted capital allocator and investor. You know, some of the greatest CEOs are the greatest investors. You know, Hawk and his team have built a business.

Starting point is 00:55:14 Basically, in 2009, the IPOed a billion dollar, $2 billion market cap company. Broadcom today is, I don't know, the 30th largest company in the S&P 500, a couple hundred billion dollars in market cap. And they did that by identifying the fact that the semiconductor industry was too fragmented, unconsolidated, and an industry that Hock believes grows at GDP plus a couple of points. And because that needed to be consolidated, and he took a strategy of consolidating the industry over the last 15 years or so that allowed him to put together these strong, niche businesses and also allowed him to now pivot when the environment for acquiring semi-conducted businesses turned against him. So as you may know, he tried to acquire Qualcomm

Starting point is 00:56:09 and the U.S. government blocked that deal. And I think that he paused, looked at the opportunity set in semis, and decided that the evaluation in semis were too expensive and that the attractive deals were no longer available to him. And so instead of giving up, he looked elsewhere and applied his principles to software. So he then acquired CA technologies and a couple of other software businesses, which were synergistic with his semi-business. He was able to drive significant returns from those acquisitions. And so now his business, assuming he closes the VMware deal, is going to be 50%

Starting point is 00:56:53 semis and 50% software and a business today that generates 60% plus for cash flow margins. So it's the most profitable semi-business on earth. And it's the business that is probably the most predictable of all of them. I mentioned Berkshire buying TSM, but given your background, I'm curious to hear your thoughts on Berkshire's purchase of precision cast parts because you were an analyst on that space as well for a long time and have intimate knowledge of that In your opinion, where did Buffett go wrong here? And how are the company's future prospects looking? Well, you know, nobody bats a thousand. And of course, he's the greatest investor of our time. But I think it shows you that we all can make mistakes. And I think with precision cast parts,

Starting point is 00:57:41 what was evident to us as analysts was that precision was losing market share to its competitors and that precision operated an incredibly difficult and competitive space. So in addition to that, the business was highly reliant on just a couple of customers. So if you lost those customers, if you lost Rolls-Royce, or if you lost Saffron, or if you lost GE, you were in deep trouble as a company. They certainly had enormous amounts of market of power over PCP. And I think that it's a lesson for all of us to assess the competitive position of a company carefully before making a decision. And I think that that's the difficulty.

Starting point is 00:58:31 I think that the macro environment also went against the story. Precision had a significant amount of exposure to energy. And the energy patch went south after the deal as well. But I think the key lesson from that acquisition is that the competitive dynamics were deteriorating before the deal was announced and had been deteriorating for quite a long period of time. And I think that it's so important to not invest in a situation where the competitive dynamic is going against you. And as Peter Lynch would say, wait for the data to go your direction before you make the investment. Some would say that the market revalued

Starting point is 00:59:13 stocks before you can see the proof of that. But most of the time, you have enough time to assess the situation in the new data and determine that the story is getting better. There's still time to make the investment. So I think the learning lesson is that if the competitive dynamics are deteriorating, just wait and see how the story plays out before you can step in. And look for companies with the diversified revenue streams, as you've kind of highlighted through a few of your examples here today. I really encourage everyone to look at the New America Premier Equities Fund from TCW. Joseph, before I let you go, I want to give you an opportunity to hand off to the audience

Starting point is 00:59:51 where they can learn more about the fund and about you and a couple other things you might be working on or where you want people to learn more about the fund or about you. Well, of course, it's been so much fun to be with you. And congratulations on all the success of the podcast. They can find more information about us, myself and TCW at TCW. And of course, there's fun information available there as well. Fantastic. Well, Joseph, I really appreciate your time and I hope we can do this again soon.

Starting point is 01:00:20 Really fascinating portfolio you've got here and I'm going to be digging a lot deeper here. So I appreciate the time and let's do it again. So much fun. Thank you so much, Trey. All right, everybody, that's all we had for you this week. If you're loving the show, don't forget to follow us on your favorite podcast app. And if you'd be so kind, please leave us a review. It really helps the show.

Starting point is 01:00:36 If you want to reach out directly, you can find me on Twitter at Trey Lockerby. and don't forget to check out all of the amazing resources we've built for you at the Investorspodcast.com. You can also 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. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purpose. only before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network.

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We Study Billionaires - The Investor’s Podcast Network - TIP522: Unconventional Wisdom From The Greatest Minds In Investing w/ Joseph Shaposhnik

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