We Study Billionaires - The Investor’s Podcast Network - TIP634: Value Investing Fundamentals w/ John Huber

Starting point is 00:00:00 You're listening to TIP. On today's episode, I'm joined by John Huber to discuss fundamental value investing principles. John is the managing partner of Saber Capital Management, which is a partnership modeled after the original Buffett Partnership fee structure. During this chat, we cover what John would include in his own personal MBA program, what base hit investing is, the three sources of returns for any stock, why Costco's stock reminds John of Coca-Cola in 1998, the three types of stocks that that John looks to invest in? John's view on today's current market and where he's finding the

Starting point is 00:00:34 best opportunities and so much more. John also touches on how investing in high-quality businesses has been taken a bit too far by some investors, reminding us that Buffett rarely paid more than 15 times earnings for a stock. John is an incredibly thoughtful guest and is one of my favorites to bring on the show as he brings a wealth of knowledge and insights for the value investing community. I think you're really going to enjoy this one. With that, I bring you today's episode was John Huber. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network.

Starting point is 00:01:10 Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Clay Fink. Welcome to the Investors Podcast. I'm your host, Clay Fink. And today, I'm thrilled to welcome back, a longtime friend of TIP. John Huber.

Starting point is 00:01:40 John, thanks so much for joining me. Yeah, it's great to be here, Clay. Always enjoy it. So I have a number of investment-related questions teed up for you,

Starting point is 00:01:48 but I wanted to start with questions that are a little bit outside of that sphere. So before you launched Sabre Capital Management, you put together your own MBA program,

Starting point is 00:01:58 we can call it, instead of going out and getting an actual MBA. And my question to you is if you were preparing to launch a partnership today, and you had

Starting point is 00:02:08 to put together your own personal MBA program, what would you include in it? Yeah, it's a great question. I put together John's MBA. I called it back then, which is basically a collection of my own, you know, I put together my own curriculum, basically. And I think the top of the list would still be Buffett's letters, you know, and I think it's widely acknowledged that those are an invaluable resource for business owners and for investors to study. But, you know, just because is widely acknowledged doesn't diminish the value of those things. So to me, that's like the number one place to start. If you were trying to learn about business, you're going to learn about all kinds of things relating to competitive advantage, the importance of returns on capital,

Starting point is 00:02:52 the pitfalls that businesses face, the blind spots that managers have and that investors might have the risks out there along with, and so the letters cover all that, and along with case studies, which is very important. So one thing I think I would focus more on is, and I did a lot of this, but I think, you know, I read a lot of investing books. And so like one piece of advice I'd have for new investors is you don't really need to read the next investing book. You should focus more on studying individual case studies or even just reading 10Ks. You know, I think I think the sooner you get into studying company annual reports and learning about a business and looking at it's past numbers. It's like looking at baseball card statistics, you know, like the more numbers

Starting point is 00:03:35 you soak in, the more you start to understand the margin profile of different businesses and the returns on capital and how much capital certain businesses require and all that sort of stuff. So I would do a lot of case studies. I would study all the Buffett letters and I would listen to all his annual meetings, which are also great. Those have been posted in recent years on CNBC's websites and go through all those. And then the final thing I would say is just read books on business. So not necessarily investing books, but read bios of some of the business greats, read books about certain specific companies. I think you can learn a lot about business just by soaking all that up. Yeah, I've recently been diving into a lot of the stuff that Lee Lou has put

Starting point is 00:04:15 out. And he said one of the best things you can do to become a better investor is to think of yourself as inheriting 100% of some sort of business. So you think of yourself as an owner of it. And then you've really come to understand everything you can about that business because, you know, it kind of puts it that most people just see stocks as something that can be easily traded. So you don't really think of yourself as an owner. So you don't want to understand that business fully. So he seems to agree on that case on diving into case studies and looking at real businesses. And since you mentioned Buffett there, we briefly crossed past in Omaha.

Starting point is 00:04:54 And I wanted to pull in something he said at the meeting. He had stated, if you're lucky in life, make sure a bunch of other people are lucky, too. I was curious to get your take on what this quote means to you and what you sort of take away from it. Yeah, it's a terrific quote. Yeah, I think to me, it's if you're blessed in life with certain resources and certain assets, and these aren't necessarily financial assets, they could be financial assets, of course. But I think making sure others around you are lucky is the quote says, to me, that's, you know, sharing what you've been given with those around you and in an attempt to try to benefit their

Starting point is 00:05:32 life. And so, you know, for me, it's looking inward at my family and those people around me, extended family members, obviously your immediate family members, your spouse, your kids. One of the things we all have is, or sort of that we're all governed by is the finite resource, the ultimate finite resource, which is your time. And so of course, you can give your financial resources. And if you're in the investment business and you're successful over time, you'll probably have excess financial resources to give away. But honestly, that to me is easier than giving away what is not excess or not infinite, which is your time. And so spending time with your kids and spending time with your family members and perhaps volunteering, donating your time.

Starting point is 00:06:17 What's interesting is, you know, people in general want to be happy. I think you pursue your career, you pursue your goals and an attempt to, at a very high level, you're trying to achieve fulfillment. And one of the ways you can get fulfillment is through serving, serving others and giving your time. And so I think that's to me what the quote means, just sharing what you've been given with others. Yeah. And outside of being of service to your clients, I really appreciate you doing things like podcasts and doing things like blogging as well, because, you know, that's just a tremendous service to others, too, that you never know. Just the outpouring that you receive from people in terms of like people shooting you messages or just thanking you or whatnot.

Starting point is 00:06:56 It can be really fulfilling to do things like that too, just sharing your knowledge. It absolutely is. And it's not, you know, it's not a completely unselfish endeavor. I mean, I get a lot of, like I mentioned, fulfillment, when you serve or when you volunteer, for example, or you coach your kids baseball team, you know, you might have some work to do and you might like not be looking forward to that practice on any given particular night or whatever it might be. but I've often found that afterward you come home and you feel a sense of satisfaction on what you just did. And so there is an element of it's a lot of fun to do. And, you know, when I started investing, I like a lot of investors.

Starting point is 00:07:34 I reached out to a lot of other investors and people that came before me. And, you know, those people were very generous with their time. And so, yeah, doing these kind of things, there are a lot of fun. And to the small extent that I might be able to help someone, then that's all the better. Well, again, I really appreciate it. I'll transition here to the investing side. You write this wonderful blog. It's called Base Hit Investing. I know you really like sports, so kind of have a sports analogy here. And how about we just start here with what is Base hit investing? You know, I'm a baseball fan, sports fan, as you said. I love baseball. Baseball is my first love

Starting point is 00:08:13 in terms of sports. So it's a baseball metaphor, obviously. And from an investing standpoint, it's about, you know, getting on base, hitting line drives. I've always been an investor who prioritizes low risk investments. I'm not necessarily trying to swing for the fences, so to speak. You know, I'm looking for, as Buffett said, the one foot hurdles to use a different sports metaphor. But base hit investing is is about that. To me, it's more broad than just the investing side.

Starting point is 00:08:40 It's almost like a life philosophy where I'm trying to make incremental progress. every day. I'm trying to get better at what I'm doing. And the way you do that is to come in every day and follow a methodical process and put in the work. And over the long haul, those base hits can compile into a lot of production, so to speak. And so that to me is what base hit investing is. So one of my favorite articles you wrote up was outlining the three sources of returns. And one of the reasons I really loved this article is because it really helps simplify the game of investing and just kind of points to how, you know, it's pretty simple math at the end of the day on what drives the performance of a stock. So I was curious if you could outline the three sources of returns that

Starting point is 00:09:23 end up driving the overall performance of a stock. Yeah, as you said, there's lots of factors that go into this, but at the end of the day, there's three things that matter. There's three things that determine the stock price. It's earnings growth. It's the change in the P.E. Multiple, so up or down, and it's the amount of cash that you receive from the company via buybacks or dividends, so capital return. So growth, the change in the multiple, and the capital return are the three engines. And the stock price is going to be governed by those three factors. The stock price is appreciation. And of course, you could use sales growth. It's really growth in the multiple. You can use sales growth and price to sales ratio, the change in that, or you can use

Starting point is 00:10:05 free cash flow growth and price to free cash flow, as long as the growth metric is the same as the denominator and the valuation multiple. But those are the three things that determine your stock price. So I think it's helpful to keep those in mind when you're thinking about stocks and you're thinking about those three drivers, because that is what's going to determine your returns over the long run. We'll be getting to how you invest in some of the opportunities you're sort of seeing in the markets. But I think it really just points to returns from a stock can come from a variety of different ways. So I had read in one of your articles how you just sort of outline this basics example where you can have one company that has 20% return on capital. They reinvest everything.

Starting point is 00:10:50 And if your multiple stays constant, you're getting 20% returns over time. And then you sort of flip that and say, you have another company that has zero percent reinvestment, but they're trading out a multiple of five and they're buying back or paying out dividends with all of their earnings. And that also leads to a 20% return. So it's not all about just earnings growth or it's not all about just share repurchases and dividends. And I think it just points to, you know, when you enter any position sort of setting the expectations on where your returns are going to come from. Yeah, absolutely. And, you know, I think in recent years, part of the reason I wrote that article, the three engines is because it's such an obvious thing, I think, when you think about it,

Starting point is 00:11:33 but a lot of people naturally gravitate towards the growth engine. And so the, you know, the term compounder has been, in my view, I've been using that term for 10 years and I kind of feel like it's been hijacked. And, you know, there's so many businesses now that are referred to as compounders, but what you really want to do is you want to compound your capital, right? It's not about finding the best, it's like Charlie Munger says, it's not about finding the best business, right? It's about finding the best investment, the highest quality investment. And a great business oftentimes can be a great investment, but it occasionally can be a very poor investment or even a risky investment at a certain price.

Starting point is 00:12:08 And the simple math on that is, like, if you use an example of a stock that grows at, or let's say, 7% per year, you know, that stock is going to double. That earnings of that company is going to double over the next decade. So 7% per year over a decade is roughly at 2x. If you paid 10 times earnings for that stock and it goes to 20 times earnings, that is another 7% growth on the PE multiple expansion. And so it's very important to not pay too much because it's nice to have that tailwind. If you have the opposite, right, if you pay 25 times earnings and you end up at 12 or something like that, that's a, you know, your multiple gets cut in half. And so you can achieve great returns in stocks by buying something that's undervalued and seeing a tailwind to all three of those engines.

Starting point is 00:12:59 7% earnings growth, 7% on the multiple. That gets you to, let's say, roughly 14. And then perhaps if some of that is returned to you in the form of a dividend or a buyback, you can achieve a further return from that third engine. And so you want to look at the interplay of all three of those, not just growth, because a business that's growing at 20% a year, is phenomenal. There's two things to worry about there, though. One is it's very difficult to grow at that rate for a long period of time. But even if you could sustain that rate of growth, and that would be, let's say, roughly a six or seven X or a decade or something, you know,

Starting point is 00:13:36 if you pay too much for that stock and the multiple shrinks by half or even more, that eats into a lot of that return. And I think that's the risk of some of these growth engines. And so you just want to be very careful with paying too much. And that's, you know, or I mentioned in a post recently about how Buffett rarely pays over 15 times earnings for a stock. And that's, I think that's a big reason why is he understands that you don't want to have that headwind on that second engine, right? You want to pay a price that's fair or preferably below fair, right? So you get a tailwind on the PE going up. You don't necessarily have to rely on the PE multiple going up. But I think people underappreciate how significant that can be even over a period as long as a

Starting point is 00:14:16 decade, right? If you buy a stock at 10 PE and it goes to 15, that's a 4% per year tailwind over a decade, right? And if it happens in five years, that's like an 8 or 9% per year tailwind. So that's really important to consider. And you can earn great returns. You can have high rates of compounding on a fairly modest rate of growth if you don't pay too much. And that's basically the lesson there. I think this ties in well with one of the poster childs of compounders, which is Costco. You had said that Costco today may see some resemblance to Coca-Cola back in 1998. I was curious if you could explain why you see a resemblance there. I do see a resemblance there. And I just want to say, like, I am not, you know, I don't want

Starting point is 00:15:02 to receive hate mail. And I'm not anti-C Costco. I'm not rooting against the stock. I'm not rooting against the company. I'm rooting for the company. I love Costco as a customer. I don't own the stock, but I love the company and I admire the company. but it's valuation. It's, you know, Costco trades at 50 times earnings. And so my, and I've had this discussion with some friends of mine and it, I'm perplexed at how, you know, how you get to even a decent return at the current price for Costco. And it's simply because, you know, when you have a $250 billion business and you're three times larger in terms of earning power than you were a decade ago, it's naturally going to be harder for you to grow at the same rate

Starting point is 00:15:41 over the next decade. Most retailers at any point in their life cycle will grow slower next decade than they did the previous decade. And that's simply because if they're a successful retailer, they're bigger now than they were a decade ago. And it's going to be harder to sustain that rate of growth. But let's say that Costco can do that. They can defy the odds. And despite being three times larger, let's say they can grow at the same rate. And they've grown earnings at operating earnings around 12% or so. Their sales growth was around eight and a half over the last decade. If you assume that all the great things about Costco will remain and they'll be able to actually continue to grow at that rate, 12% over a decade is about a 3x. So earnings will be 3x

Starting point is 00:16:22 greater, three times larger a decade from now. That would be a 12% return. But you have to make an assessment on what investors are willing to pay for Costco a decade from now. And my hunch is it won't be 50 times earnings. If it's 25 times earnings, which would not be necessarily a cheap price, but probably a more reasonable price for a great company like Costco, you know, that multiple gets cut in half. So you have a 3x on the earnings growth and a 0.5x on the multiple, and now you're down to 1.5x. And that is about a 4% compounded rate of return. And so that's the risk is you, even if the business does achieve what most people think Costco will do, I don't have any reason to believe they won't do it. I'm just saying, even if you assume they're as

Starting point is 00:17:08 good next decade as they were the last decade, I think shareholders are looking at like a low to mid single digit return. You might get an extra percent or so from the dividend, but that's about the returns you can get if they achieve what I think would be an incredible fundamental result, which is continuing to do what they've done. If growth rate slows just a bit, if it's like eight or nine percent, you know, now you're talking about the sort of the lost decade. You know, or even though the fundamental result's great, the stock might not go anywhere. And so So that's the risk and I just want to point that out like that. It's not me being anti-C Costco. It's not me thinking the stock's a disaster or anything like that. There is a great company.

Starting point is 00:17:46 It's one of the best companies in the world. But Coke was one of the best companies in 1998. And it continued to produce great fundamental results for a decade. And I think the stock returned. I think it went nowhere for a decade. And over the next 20 years, it may be returned like mid single digits. Microsoft is another example, you know, the famous example in the late 90s where the business continued to do quite well. earnings continue to grow. Fundamental result was superb, but the stock went nowhere for a decade.

Starting point is 00:18:12 And so at a certain price, even for the best companies in the world, you can wind up with a mediocre or even a poor investment result over a long period of time if you pay too much. And that's the risk that potentially could exist with Costco, I think. Yeah, very well said. And I think another way of sort of framing it

Starting point is 00:18:31 is within the PE ratio, their expectations built into the market. If the P.E. is at 50, the market is setting very high expectations. So if you're buying that stock expecting to, you know, achieve a high level of investment performance, and you're expecting implicitly that they're going to be able to far exceed those very high expectations that the market's setting. Yeah. Another way you could look at it is what do you need Costco to do fundamentally to achieve a 10% return.

Starting point is 00:19:05 And for me, I'm looking for a significantly better return than that when I buy a stock. But even to get 10% returns, it's challenging. You would need, like I said, the same fundamental growth as you got last decade. And you would need the P.E. multiple to be closer to 40 in a decade. And it's possible that you could do that. But that's to get a 10% return. So think about those three engines. How much are you going to get from the dividend and buyback?

Starting point is 00:19:28 At a 50 PE, you're not getting much. you're getting a 2% earnings yield. You're getting around a 1.5% free cashful yield. And then, you know, you think about the nature of retail is not, it's not easy. So it's not a cinch to me that Costco 10, 20, 30 years from now will necessarily be as dominant as it is now. Again, I'm not predicting anything bad happening to Costco, but I'm just saying that there's not a lot of upside if everything goes right.

Starting point is 00:19:54 And if they do stumble, there is a huge amount of downside because, you know, if the business grows at 7%. and the P.E. is at 20. You can do the math on that and you're at negative returns in that standpoint. When you buy a stock, you're looking for low risk and potentially skewed upside potential. What you don't want is limited potential and skewed downside in a situation that you might not expect, even if it's low probability. And so that's just something to be mindful for. But again, I want to be clear. I'm not predicting anything bad happening to Costco fundamentally. it's purely, the reason I think it's Coke in 1998 is Coke continue to do great as a business.

Starting point is 00:20:33 It's just shareholders didn't do well because of the valuation. And that's the main thing to be concerned with there, I think. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord. And every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history.

Starting point is 00:21:14 This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedomform.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference. It's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing

Starting point is 00:22:29 your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of your choice to connect directly to your real business data. This isn't some add-on, it's AI built into the system that runs your business.

Starting point is 00:23:10 And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, demystifying AI at NetSuite.com slash study. The guide is free to you at netsuite.com slash study. NetSuite.com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just

Starting point is 00:23:58 getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB.

Starting point is 00:24:41 That's Shopify. dot com slash WSB. All right, back to the show. One of the things I really liked in reviewing your previous appearances and reading some of your blog articles is how you don't box yourself in to just one type of investment approach or one type of company. You outline three types of companies. Would you mind sharing those?

Starting point is 00:25:07 And I think it fits in well with this framework of where returns come from. It also just points to how the market sort of changes and you need to change with it and be able to find those opportunities that are being presented. I mean, I modeled my fund after the Buffett partnerships of the 50s in terms of the fee structure. You know, and I also in some ways kind of modeled the portfolio approach, obviously adapted it to my own circle of competence and my own skill sets and that sort of thing. But I liked how he had different categories of investments. And he was very flexible. I mean, he owned American Express and he owned Disney. And he also owned like workout situations and cigar butts and things like that.

Starting point is 00:25:47 For me, I think it's important to think in first principles, again, just to reiterate, the goal as an investor is to not, you're not trying to pigeonhole yourself into investing in a certain type of company. Your goal is to compound your capital, right? It's to grow your capital. It's not to invest in growth stocks is to grow your capital. You could do that by investing in gross stocks at a certain price. You could also do that in value stocks, right? But I don't think people should think of themselves as I'm a value investor or. or I'm a growth investor, you should look for opportunities that make sense to you that fit

Starting point is 00:26:17 within your own circle of competence and that you can understand. And you think have a high probability for success. And so for me, companies and stocks come in different categories. This oversimplifies it, but I have three categories that I tend to, my investments tend to fall in one of these three categories. And it's compounders, again, a term that I think has been overused as of late. And I can tell you my definition of that, but compounders, would be high-quality companies that are very well managed with capital allocation that I

Starting point is 00:26:48 understand. And so that does not necessarily mean fast growth. It's high quality, good returns on capital. It could be fast growth or it could be moderate growth. It could even be low growth, but the goal is compounding your capital that you invest in it. So it could be a stock at five times free cash flow that's very durable, that perhaps is underappreciated, that's giving you a 20% return via the capital return, the buyback or the dividend. That is going to compound capital. And so it's really businesses that are very high quality and durable that I think I can own for a decade. The second category would be what Ben Graham called unpopular large caps. And I've written a lot about this where it's interesting, but even the largest stocks in the

Starting point is 00:27:30 market can be very mispriced at times. And it usually doesn't happen. It often happens when the market is down or there's some sort of market-wide fear. But I've noticed that the degree with which even the most well-followed companies in the market can get undervalued or mispriced in one direction or another is pretty significant. And you can look at, I've done some posts on where I show this chart of the top 10 largest stocks in the market. And the gap between the 52 at high and the 52-y glow is almost always, on average, 50% or more. And my point is basically the intrinsic value of those businesses, these are the biggest companies in the market. world, the intrinsic value isn't fluctuating that much, but the stock price does. And so at times,

Starting point is 00:28:11 there's an opportunity there. And you could look at extreme examples like, you know, Facebook going from $100 to $500 a share in the course of 18 months, like things like that. That's an extreme example, but there are a lot of examples where stocks fluctuate a lot more than business values do. And so I keep an eye out for large caps because those are in, if you can find the really high quality ones, I think those are really low risk investments. And then the third category would be what I call bargains, for lack of a better word, or I refer to them as bargains. And they could be stocks trading below liquidation value. They could be some special situations.

Starting point is 00:28:46 I have a group of stocks that I refer to as like my Ben Graham basket. But these are very safe. I don't even think of them as cigar butts. They're not melting ice cubes. They're very safe companies with good balance sheets, cash flow productive businesses. And they're just undervalued. And so at various times, any one of those three categories, You might find more opportunities than one or the other, but I like to have those three as sort of

Starting point is 00:29:12 arrows in the quiver. Yeah, I think of the Ben Graham, Sikharbutts you mentioned, that's a, I feel like that part of the market is almost reserved for people who do this full time. They have all this time to, you know, really get to know businesses. But what I liked about Ben Graham, he also shared a, I believe he shared a write up on what he called unpopular large caps, which really points. to you the second category you mentioned there. I was curious if you had some of the numbers on Apple because you added Apple to your fund

Starting point is 00:29:44 in 2016. And that's just like a prime example of an unpopular large cap. It was trading at a very attractive valuation. And then it had all three of these engines working for it from 2016, definitely up to now. Yeah. Do you have some of the numbers on Apple? I mean, very simply like Apple, in 2016 it was viewed as a consumer hardware. business or a hardware manufacturer electronics company that, you know, almost like Dell or,

Starting point is 00:30:13 you know, like a computer manufacturer that didn't have a moat, believe it or not. I mean, it's hard to imagine, but eight years ago that there were numerous worries on Apple. I think people viewed it as certainly better than Dell, but it was trading it 10 times earnings. And so it was trading and people said it deserved that because, again, it's a hardware manufacturer and hardware is more or less a commodity, is how that company was viewed. And there was really no value ascribed to the ecosystem that it had built. And even more than the ecosystem, to me, I would look at the long lines and I would say, well, the hardware is to me recurring revenue. It's not like Dell or these other, you know, it's not like these other phone companies,

Starting point is 00:30:51 even like Samsung. It's people will line up to get another iPhone. And I view that as recurring revenue that should have a higher stream of income. It's like Starbucks or Nike. Like people that like Nike will go buy another pair of shoes. It's not technically recurring revenue, but it has a brand. It should be valued more like a brand, like a consumer brand and not like a hardware electronics business. And so, you know, from time to time, you find opportunities like that where you have maybe a different view than the market does. And Apple also was at the time, there were worries about competition from Samsung. And there was also worries about competition from two specific Chinese manufacturers that were growing very fast in 2015 and 2016. And China is obviously a very big part of

Starting point is 00:31:33 Apple's revenue. So all of those things sort of had a common. Confluence came together and had this impact on the valuation, which traded at 10 times earnings. And so the simple math is you had a business trading at 10 times earnings. And those are free cash flow earnings. So you had a 10% free cash full yield. And my thinking at the time was you're getting a 10% free cashful yield that I think is durable. So you get to 10% return right there plus whatever growth you get. And I knew growth was going to be modest at that point, just like now Apple's more or less a mature business.

Starting point is 00:32:03 And it wasn't growing fast. But if you could grow at 5%, that's a 15% return, the free cash flow of 10% of free cash flow of yield plus the 5% growth. And then on top of that, you might get a change in the multiple. And I didn't know, I had no idea, by the way, that the stock would do what it did or the multiple would go to 30 or anything like that. But I just thought, you know, maybe it'll go to 15. And then you get a really nice return.

Starting point is 00:32:26 You get all three of those engines. And so you could paint a scenario where you could earn 20% returns. But what ended up happening vastly exceeded what I would have expected. but sometimes it happens in stocks, which is nice. But the multiple went from 10 to 30, and that's a 3x. And you got more or less modest growth. I don't think the growth exceeded what I would have expected by much, maybe a little bit, but not much.

Starting point is 00:32:48 But you got some growth and you got a 3x on the multiple, and then you got a significant amount of buybacks because they reduced the share count by almost a third over the period of years that I owned it. And so you had all three engines working in your favor. And that's kind of the point I've used that, an example of a stock that can work out really well is when you get all three of those working in your favor. And that was what happened with Apple. And now you have a different situation with some

Starting point is 00:33:12 of these stocks where I think you're going to have perhaps not a headwind. 25 or 30 PE might be fair, but you're not going to have the same tail wind. And so when you're looking in the rearview mirror at the stock price result over the last 10 years, you've got to be mindful that you had those tailwinds that are no longer tailwinds, right? You're getting a lower capital return because the buyback yield is lower because the stock's more expensive. You're going to be mindful. You're You're not going to see the PE go from 30 to 90 to get the same 3x return there. And it's a bigger company. And so your growth is going to be more challenged as well.

Starting point is 00:33:43 So those are all things you want to think about when you're looking at stocks. But yeah, the unpopular large caps, they do present themselves every couple of years, you'll have opportunities to swing at some stock that you know if you keep a watch list of even the largest companies. And that was, that's something I've always kept in mind is people think these stocks are fairly valued because there's 200 analysts following them. but most analysts are focused on the next quarter, the next year at the most. And if you have the mindset and the discipline to look out, say, three to five years and understand what that business looks like down the road and look past sort of the next year, the next iPhone cycle or the next quarter, whatever it might be,

Starting point is 00:34:19 you give yourself an advantage as an individual investor when you can do that. Yeah, for the listeners, if you haven't done it, I'd encourage you to do what he said there, where you look at the 52 week high and the 52 week low, even of some of the biggest companies in the market, and you see a 40 or 50% gap, the business itself, the intrinsic value is not changing that much. So that sort of points to the opportunity that the market presents itself in companies that, you know, everybody knows about. There's plenty of analysts covering Apple or meta or whatnot. I think when you do that, you sort of realize that, you know, there are opportunities in the market. You just have to

Starting point is 00:34:55 have that patience and then be ready to pounce when the opportunity arises. Right. And it's always going to look, I mean, not always, but most times it will look bleak. You know, there will be something that people are worried about. And so, but you don't need to, you know, like Buffett says, there's no call strikes. So you don't need to swing at everything. But you will find if you pay attention, enough opportunities in that second category, the unpopular large caps, there will be something that happens where you can look at it and say, I disagree with this. Or, you know, I think this is a short term thing. And maybe the iPhone cycle won't be good this time, but it'll be good next time. Or, you know, maybe the

Starting point is 00:35:34 movie business looks bad right now, but it'll be fine next year because there'll be more movies coming out or, you know, there's certain consumer behaviors that you might be able to predict longer term, even if you don't really know exactly what it will look like next quarter or next year. And those are sort of the, that's like the time arbitrage. You want to be able to look past where most people are focused. You know, it's hard to do that as a professional because you have clients and you have, you know, I've tried to structure my firm where I don't worry about that. I have my own money invested. And so I don't worry about that. And I've tried to purposely structure it because that is a real risk is people have to make money this year. And so

Starting point is 00:36:10 you're as an individual investor, you don't have that same requirement or that's constraint and that institutional imperative. So you can look past that and give yourself a real advantage. And that's, that's really the time arbitrage, which I think is the biggest edge in markets today. It's not information. It's not analytical. It's more of this behavioral mindset that anyone with the proper behavior and proper mindset can achieve. Ever since you started your fund, it's been quite a challenging time, I think, for money managers and if they're working to try and beat the market, because you've had this big tailwind of, say, big tech, they've had substantial earnings growth. They've made up a substantial portion of the index. And then they've seen that tailwind of multiple expansion as well,

Starting point is 00:36:51 which has led to quite an interesting dynamic in the markets today with big tech now becoming an overwhelmingly big portion of the index. And then you have hot industries like AI and then you have a big chunk of the markets that haven't performed as well or haven't really moved over the past year or two. I'm curious to get your take on how you're looking at the overall market today. Yeah, I think we could look at the three engines of the stock market in the same way that we would look at a stock. So the S&P 500 when I started my fund was trading around 12 times earnings, you know, 11 years ago or so. And, you know, sort of not at the bottom of the financial crisis, but sort of coming out of the financial crisis, 2011, 2012, 2013. You were paying a 12 times multiple. In the last decade, earnings have grown, let's say, around 7% per year.

Starting point is 00:37:39 And the multiple has gone from 12 to 25, roughly. And so the combination of those two factors is around a 15% return or so. So growth might have been a little bit less. It depends on how you define the multiple. But roughly, that's, you know, that's approximately what happened. And so the point is you had a nice fundamental result from earnings growth and you had a really nice tailwind. The tailwind now, it has turned into, in my view, probably a modest headwind. That 25 PE is probably on the high side.

Starting point is 00:38:09 It's not, it's not anything to be worried about if you're an index investor or anything like that. If you're a long-term investor, you know, you just want to hold stocks for the long run. For the first time in my career, I am not overly enthused about the S&P 500 as an index. I've always recommended it to friends and family. You have a small amount of money and you're trying to start your savings and you're starting your career and you're putting some money aside. Index is always a good place to be. And it probably is, I still think it is over the very long term.

Starting point is 00:38:36 But I do think the reality is over the next decade. It's probably going to be a much lower return than we've had over the previous decade. It's probabilities. We don't know, you know, you have to assess probability. here, but if the multiple goes from 25 to 20 or to even 16, where it historically has been, that that would be, say, a 20% to a 35% decline in the multiple. And your growth engine will overcome that to a certain extent. But if you get 7% growth and you get a 20% decline in the multiple, you're looking at like

Starting point is 00:39:08 5% annual returns, something like that. And so I think that's where I see the market right now is it's not overly attractive at the highest end. But what's interesting to me is when I first started my fund, I had some small caps, but I also noticed like really high quality large cap companies like Apple at 10 times earnings. Microsoft, believe it or not, traded at 10 times earnings. It's just hard to believe because those days just seem gone, but really high quality companies that would be defined as growth companies, but they're just very high quality

Starting point is 00:39:39 businesses with high returns on capital trading at 10 times earnings. those are now, for largely, those are trading at 30 times earnings. And where I'm seeing opportunity now is sort of in the smaller end of the market, not necessarily small caps per se, but small caps, midcaps, and just companies that are sort of outside the S&P 500, there are a lot of stocks. And people describe reasons for why this has happened, but there is a dichotomy in my view between the largest stocks in the market

Starting point is 00:40:07 and just even medium-sized of small caps, like below the medians, let's say. And with 10,000 stocks, there's a lot of opportunities. So I do think there's some real bargains. And it could be just the fact that I think what a lot of people think is all this money that's gone into passive investing have sort of pushed up prices for the largest stocks in the market. And the stocks that are not in that index have not benefited from those flows. But that's to your advantage as an investor. And David Einhorn talks about like, I think he said like the market is broken.

Starting point is 00:40:38 And to me, the market's not broken. And it's not a negative thing. It's just the reality is if you buy a stock at five times earnings and it's cash earnings, and you're getting a 20% return, you don't need to worry about what the multiple does. So there are opportunities like that out there. And not a lot of them at 20% yields, but there are some, believe it or not. And you can find many with double digit free cash bill yields that I think are very durable businesses, very high quality, good returns on capital, and probably have some modest growth potential

Starting point is 00:41:10 and some potential for multiple appreciation. And so those are where I think if you're looking for like mid-teen returns or even double-digit returns, that's where I am looking. I read through Josh Terraceoff's recent piece where he discussed conviction and quality. And his writing felt very similar to Nick Sleep's work, who happened to both be highly influenced by Robert Persig's books. And in looking for quality characteristics within a business, I wanted to share the, items that Teresoft shared in his letter here. So he wrote, wow, customer experiences, mission to solve an important problem, domain mastery, or being the best of what they do, first principles based thinking and invention, unlimited ambition combined with no nonsense,

Starting point is 00:41:56 realism, overcapitalized balance sheet, and a founder's mentality. In other words, it's their life's work. I'm curious, has it been somewhat difficult for you to find these sort of characteristics of quality when searching in these small and midcap areas in the market? I would say that the opportunities are, I think, just as prevalent. It's just that you're going to, not on a percentage basis. So you're going to find opportunities. It's just you have to sift through a lot more opportunities. Just by the very nature, there's, you know, you could look at the Russell 2000 and there's, you know, roughly 2,000 companies there. And the vast majority of those are not attractive to me as a business. I don't want to own those stocks. The list of attributes you just

Starting point is 00:42:39 rattled off, they don't have any of those or very few of them. But there are some and there are enough, which is interesting to me. And the more you look, the more you find, there are numerous family-owned operations. I own stock in one of them right now that I can think of that is a third generation, you know, family-run business for the last 80 years. And it's extremely high quality by almost any measure that I prioritize and care about. It's a very high-quality company, and it's very cheap, in my view, of course. But, you know, so you do find opportunities.

Starting point is 00:43:11 They're not widely acknowledged, usually. You have to kind of dig into it a little bit and learn a little bit, perhaps even meet the management team or talk to people that know the management team if you're not able to meet the management. But I try to do some on-the-ground research there to try to get to know, to the extent that I can, but some of these smaller companies you can do this, where you can get to know the leaders. at the business and how they think about capital allocation is a big thing for me.

Starting point is 00:43:33 But yeah, there are a lot of overcapitalized balance sheets. There are founder-led businesses. There are businesses that treat their shareholders well that care about their minority shareholders that are very good stewards of capital. And that to me is at the end of the day as a shareholder, that's what I want. You want to have all of the constituents in that you want to have your customers happy. You try to have all of those in place. I've learned that there are tradeoffs.

Starting point is 00:43:58 There's no perfect company, no perfect investment, no perfect valuation. I don't think it's realistic to try to have everything lined up perfectly because there's always tradeoffs. You know, if you think about employees, there's different constituents every company has. There's employees. There's customers. There's shareholders. There's management.

Starting point is 00:44:16 There's vendors, right? Costco prioritizes its customers. I think it does a great job with its vendors, but there's always a little bit of give and take there. You know, Google might, historically at least, was very good. to their employees, perhaps at the expense of shareholders in some way, although it's hard to argue with Google's results there as well. But, you know, every company kind of has different cultures and different sort of personalities, really. And so there's give and take between

Starting point is 00:44:41 those different constituents, but nothing's perfect. But yeah, there are opportunities in the small cap space and the mid-cap space that I think are perhaps not conventionally viewed as high quality or not well understood, but very high quality. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure

Starting point is 00:45:21 and keeps your deals moving. Instead of chasing spreadsheets and screenshots, Vanta gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with Vanta. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at Vanta.com slash billionaires.

Starting point is 00:45:50 That's vanta.com slash billionaires. Ever wanted to explore the world of online trading but haven't dared try? The futures market is more active now than ever before and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&B 500, NASDAQ, Bitcoin, gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone.

Starting point is 00:46:25 Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity, you'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify.

Starting point is 00:47:02 Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors. private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8%, and the average annual

Starting point is 00:47:51 total return since inception 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 fund fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. Another theme since the launch of your fund, I'm sort of putting you on the spot here. It seems to me that you primarily focus on the U.S., but you are willing to venture outside the U.S. markets. And we've seen the U.S. become more and more expensive generally.

Starting point is 00:48:32 So how do you think about that? Yeah, I have looked outside the U.S. I've made a couple investments outside of the U.S. at times. Really, I have one investment in Canada, which I would consider, you know, it's very similar. North American markets are similar, so that technically outside the U.S., but I view that as the same, more or less. Western Europe. I don't have any investments in Western Europe, but I would consider that similar in terms of the culture and the jurisdictions and the rule of law and things like that. But there are a lot of markets around the world that I think are probably cheaper than the U.S.

Starting point is 00:49:03 So yeah, I have a copy of the Japan Company Handbook and I've been leafing through that. For me, it's all about circle of competence. It takes a lot for me to, especially with smaller companies, I want to get to know the business very well. I want to get to hopefully talk to the management team. Unless you're making like a numbers or a basket bet where you diverse, you know, you can buy a basket of net nets in Japan. And I think that's going to work out really well. And you don't need to talk to the management teams and you don't need to do all that. Like Walter Schloss made a career. He's one of my favorite investors of all time. And he did 20% a year for five decades. Just a phenomenal track record. And in terms of

Starting point is 00:49:40 its returns and its longevity. And he, very rarely from what I understand, talk to management teams, he would make bets, make investments based on the numbers solely and sort of a classic Ben Graham numbers based approach. You know, he achieved his expected return, he achieved the values that he was expecting, the expected values, the returns he generated were done through like the law of large numbers. He had a group of stocks that collectively would, you know, result in that 20%. And so that's how you diversified away that risk of not knowing. But for me, I try to absent like a basket bat or something, which I've considered, but I'm always more comfortable. Like if I can understand what the business does, understand the dynamics, the returns on capital, how the

Starting point is 00:50:21 management thinks about allocating that capital. Those are things I want to answer. And it's harder for me to do that in overseas companies. So I tend to stick with the U.S. for the most part. I noticed in your year-in letter for 2023, your top five positions accounted for around half of your portfolio, which I always like to see a concentrated approach that puts a lot of their money and their best ideas. And your top position was actually a pretty sizable portion of that. And I don't want to get into exact percentages here, but how did that top holding get to become pretty highly concentrated? And how do you think about managing that level of concentration? Yeah. I mean, the biggest investments for me are the ones where I feel extremely confident

Starting point is 00:51:02 in the downside or lack thereof. Like, I'm looking for companies where where my biggest investments are the ones where I think I have the lowest likelihood of losing money permanently. And obviously that's not meaning the stock price, any stock price can go down, but in terms of losing money permanently. And so, you know, I'm thinking about things like, what does the balance sheet look like? How much cash do they have? What's the liquidity? What's the margin profile? This particular company, they own mineral rights. And they are, it's a bit of a special situation, but they're very soon to be debt-free and they will have no liabilities whatsoever. And they have a essentially they're because they're mineral rights, they take a royalty and they have

Starting point is 00:51:41 virtually no operating expenses. So it's like literally it's a 90% profit margin business. And so there's very little business risk. They have reserves in the ground which you can measure and have an idea of how long these reserves last. And it's many decades. And so there's a lot of things that give me comfort that this business has a margin of safety and has very low likelihood of permanent capital loss. And then when you couple that with the valuation, in this case, the valuation is really compelling, very high dividend yield. I think there's very low likelihood of losing money on it in a nutshell. And so those are my biggest positions. And so it's a comfort level. Those don't come around very often. But from time to time, you know, I find a business

Starting point is 00:52:20 in a stock where I think everything lines up. And I like the management team. I like the business. I like the durability, the competitive advantage it has and the prospect for, you know, attractive future returns. And so those tend to be my biggest positions. But yeah, I think like it makes sense to have some diversification. I don't think you want to have all your eggs in one basket, but I think like having, you know, having eight to ten stocks represent 70 or 80% of your portfolio is adequate diversification while also giving you the chance to outperform, you know, if you're right on balance. And so that's, that generally tends to be how I think about my portfolio. We do have a, that third category I mentioned of bargains, those tend to be smaller

Starting point is 00:52:59 positions and they tend to be more numbers based. So that you could almost think of those as a basket, and they sometimes work out in a fashion that's uncorrelated to the general market, which is nice. We do have a few more investments recently in that category, but for the most part, yeah, we own a concentrated group of companies. Yeah, when I think back to 2022, for example, I think you saw a lot of multiple contractions. So you saw a lot of just like sentiment change where people were anticipating a recession. Well, if something's trading at a free cash flow yield of 20 to 25%. It's hard to get too much contraction, if any. So that's why you can see a bit of uncorelation, I think, with the markets. Yeah, I think so. I mean, you know, interest rates are

Starting point is 00:53:43 rising or they're higher than they were. And so there's, you know, if you think about like, if you own a stock at 30 times earnings, the simplest way, like for most of your listeners or, you know, for people thinking about this just at a very high level oversimplified, if you have one percent interest rates and you have a 3 percent earnings yield and rates go to two, that ate up half of your, you know, you can think of it like a margin of safety, you know, the gap between your 3% earnings yield and let's say a 1% risk-free rate. But if you have a 12% free cash full yielding, you can think of it like a bond, like an equity bond, like, you know, these are stocks we're talking about.

Starting point is 00:54:16 But if you have a 12% yield and rates go from 1 to 2, the impact on valuation is much less to the 12% than it would be to the 3% bond. And so obviously that's simple math there. And it's way oversimplifies it. But in a nutshell, that's what we're trying to do as investors is, protect ourselves against these various risk. Interstrate risk is one of the things you want to think about. And in general, low valuations, I think, are an antidote to that to some extent.

Starting point is 00:54:42 Over the years, you've talked a lot about how the game of investing has a very long feedback loop. And you're obviously very reflective in your investment approach, doing journaling, thinking, writing, all these sorts of things. And thinking about your investments and whatnot, based on your experience, how long does it take for you to decide that you've made a mistake in an investment, given the long feedback loop? Yeah, that's a great question, Clay. I think it's hard to, it's hard to know, it's hard to give a precise answer because I feel like every case is so different. I think one of the things you want to be as an investor is you want to be humble. You want to be willing to change your mind and be

Starting point is 00:55:22 willing to admit when you're wrong, right? This game is not about being right and wrong. It's about trying to compound your capital. I think Peter Lynch said, like, if you bat 600, you'll be in the investing Hall of Fame. That means getting four out of ten wrong. So you're going to be wrong a lot. To me, I've always tried to very quickly change my mind when I determine I'm wrong. And so it could mean, you could buy a stock and a year later you can determine that the business is not what you thought it was or you made a mistake in analysis or perhaps the business has changed. You want to be very quick to change your mind when you realize you're wrong. It could be a year. It could be three or four or five years. You know, businesses are not static. They're dynamic living

Starting point is 00:56:00 organisms that change and evolve over time. And so I don't think there is such a thing as like a set-in-forget-it investment. Buffett invested in Fannie Mae. And I mentioned Peter Lynch. He did, you know, Fannie Mae was a great investment for both those guys, Peter Lynch-and-Wauntbuffett. And throughout the 1990s, it was a compounder. It was a stock that went up many, many-fold over that decade. And it had a lock on that portion of the market, the securitization market. It generally had like, it's a duopoly basically, but it had a strong position. And you can see why those guys liked it. But Buffett sold it in 2001 because he noticed that I think it was actually Freddie Mac in particular in that case.

Starting point is 00:56:41 They were doing certain things with their capital that were outside of their core competence. Without getting too much into the wheeze, they were starting to make bets on the direction of some of the securities that they were underwriting and putting together in these packages. And so part of that was sort of the precursor to what. ended up bringing down the financial system in 2008, 2009. But, you know, he noticed that change in 2001 and he sold the stock. And so I thought, wow, that's really interesting because, you know, that's a stock that went up like 10fold for him and he owned it for all those years. And he decided to sell it. Now, in that case, it wasn't a mistake. It was just he noticed that the business change. So I think you have to be always looking at your companies and being willing to change your mind

Starting point is 00:57:21 when something changes. He did the same thing with Wells Fargo, right? The management change, the culture change, the business change. He changed his mind. And so, It could happen very quickly. It could happen after many years. I think it just depends on each case. But the key thing is I think you want to be very willing to recognize facts and not try to fit things into what you want it to be. You've got to look at reality for what it is and not what you want it to be, basically,

Starting point is 00:57:46 be willing to change your mind. I also wanted to touch on the big tech companies. You did a write-up on them and how their capital expenditures have changed over the years. So the numbers I have here is Facebook, Alphabet, and Microsoft, they spent $28 billion on CAPX in 2017. In 2024, their estimated CAPX is expected to be $152 billion. So that's over a 5x increase in their capital expenditures. And these businesses are pretty well known for being capital light to a large extent.

Starting point is 00:58:19 So you see some things changing within these companies. I was curious if you could touch on this as well. Yeah. I mean, these businesses are getting more capital intensive. And so I wrote a post about this where they're different businesses than they were. And this is kind of, it sort of dovetails into what we were just talking about. And this isn't necessarily something to worry about if you're a shareholder of these companies. I've owned a couple of these companies for many years.

Starting point is 00:58:44 I think they're great companies. I do think they're changing, though. The makeup of the business and potentially the returns on capital are changing because of the fact they're getting so much more capital intensive. So Microsoft, I think, is a decade ago, it had around $5 billion of KAPX, and they're guiding towards somewhere north of $55 billion this year. So like an 11x increase in a decade, and a large portion that increases come just in the last few years, really in the last four or five years. And so, you know, things like data centers and the last day has been all about the cloud, right, moving computing power from on-premise to the cloud. and the cloud is basically, it's moving from Microsoft's customers on premise to Microsoft's premise, right?

Starting point is 00:59:24 Data centers that Microsoft has invested in. And these are like billion dollar data centers, very high capital requirements to build these things. But it's been a great business. So that, I mean, that's worthwhile return on capital they've earned from that. What's interesting now is now we're getting into AI. And AI is very capital intensive because it takes a huge amount of computing power to run these, you know, these LLMs and these things that are required beyond my pay grade to try to explain it,

Starting point is 00:59:50 but it's a lot of capital and it's a lot of energy. And it's, you know, these companies have a lot of advantages, but they're spending a lot of capital to build out these businesses, these AI revenue streams. And so, you know, what worries me as a, if I own stock in these companies, I would be concerned about what are the returns on capital for these huge investments that they're making. And what's interesting is that, you know, the nature of accounting is the investments they're making now in, let's say, a data center or a server flows through the cash flow statement today, but it takes five years to flow through the income statement because it's depreciated over five or I think these servers are now six years, let's say. But the expense is amortized

Starting point is 01:00:30 over that period. And so only a fifth of that expense, you can look at the cash flow statement and see while they're going to spend $50 billion this year. They spent $40 billion last year. You can look at and see what it was. Only a portion of that flows through the income statement. And so there's a risk that the earnings are actually elevated right now versus what their true earning power is because the depreciation is lagging the capax. And that's natural for any business that's growing and investing in their business. So that's not anything to be concerned about. That's normal.

Starting point is 01:01:01 But in this case, it's so significant and so extreme that you have to have a view on what those returns will be on those investments to properly determine, you know, what your returns as a shareholder will be. And, you know, if the stock's at 10 times earnings, you don't need to be overly worried about what those returns are going to be. But if the stock's at 30B, then you need to have a little bit more precision. And so, you know, it's another way of saying your margin of safety is lower. And so, so, yeah, like Microsoft's going to spend 50 or 55 billion on CAPX and their depreciation is 15 billion, 15 billion, 15. And so even if the CAPX plateau is eventually the depreciation is going to catch up that capital expenditure amount.

Starting point is 01:01:39 And perhaps the sales growth and the earnings, you know, potential the business will grow and absorb that. And that's really the question that you have to answer. You had mentioned earlier that writing and doing things sort of in public isn't something that's very selfless. You know, you get a lot of benefit yourself from doing it, especially just like in the writing process. There's a fund manager I follow who releases these very thorough investment memorandums where he outlines essentially his investment thesis in a company. I was curious for your investments, if you do something for yourself, write some sort of investment memorandum that outlines your thesis for the investment and not so much to, it requires a lot of work to do something like that, write a 10, 20, 30 page memo

Starting point is 01:02:26 on your thesis for a company. Is that something you do with each investment? I don't write a 10 or 20 page write up, no, but I do write, you know, mine tend to be quite simple. So I do a large amount of research and there might be 10 or 20 pages of what I would call like scratch notes, you know, digital scratch notes where I'm collecting all sorts of data from the 10Ks and I'm clipping different sections and linking to different things and sort of building almost like a journalist trying to build a story, right? You're collecting information from all over notes on phone calls you made. All that stuff does add up to a lot. But in terms of the final write up, I do a write up, yes. I try to make it very simple. like, you know, one page, two pages.

Starting point is 01:03:07 Sometimes they're longer. I've tried to actually get better at writing more succinctly. And I joked in one of my last letters. Like, I only have time to write a long letter, like the Mark Twain quote. Like, I didn't have time for a short letter, so I wrote a long one instead. It's always a challenge to do that. But I think if you can boil down your investment thesis into one page or a thousand words or less, you really don't need a lot of the minutia.

Starting point is 01:03:28 That's more for you than it is for whoever's reading it. You want to capture the essence of the investment and the key drivers, the key variables that will impact that investment. And to me, that doesn't need 10 or 20 pages, although I don't begrudge anyone for doing that. I mean, different schools of thought on that. And I'm not saying you shouldn't write 20 pages, but to me, that's, you know, I don't do that. That would be overkill for me.

Starting point is 01:03:52 But I keep a journal. I write daily. I write a lot. I use a piece of software called base rate. It's more than a piece of software. And it's more than a journaling tool. It's an incredible thing. In fact, my friend Jake Taylor, who I think you know Jake, started this company called base rate. It used to be called journalytic and they changed the name to base rate. But it's more of a decision engine where you can, as an investor, it's great because you can log your journal entries and your thesis and you can look back on all over your past entries and see what you were thinking in real time. And then it will also serve up all sorts of different data and analytics and all kinds of things. That's really kind of cool. But I use that. that is a tool to track my investment write-ups.

Starting point is 01:04:33 And so you can tag each specific company. And so I have like all the companies I follow on my watch list have different, you can think of folders, but different tags of articles underneath it. And like I say, I have a write-up for each one that I buy. And then I also have a string of ongoing notes and thoughts as the businesses develop and change over time. So that is my system. And I do think it's very valuable to write.

Starting point is 01:05:00 You don't have to be good at it. It's a forcing mechanism. It clarifies your thinking. It sort of forces you to look at things that are not well understood yet in your own mind. And then it gives you the ability to go and address those things that you're not sure about yet or not you don't fully understand. And so it really is a helpful tool as an investor to sort of improve your understanding of whatever you're working on. Yeah, well, for those in the audience who haven't checked out, John's blog, I highly recommend it. It's really helped me clarify some of my thinking and fill some of the gap.

Starting point is 01:05:30 that just needed a little bit of improvement or a little bit more clarity. Well, John, I really appreciate you joining me. It's such a pleasure, and I always appreciate you coming on to the show. It's definitely a fan favorite here at TIP. Before I let you go, how can the audience learn more about your work, your blog, and anything else you'd like to share? Yeah, well, thanks for having me on, Clay. It's always fun to chat with you.

Starting point is 01:05:54 You mentioned my blog is called Base Hit Investing. That's sort of my thoughts on investing. My firm is called Saber Capital, and you can find it. We have a website, obviously, and I'm on Twitter. You can find me on Twitter as well. But yeah, I would say the blog is the best place to kind of check out my thinking on investing. But, yeah, it was a fun discussion. Thanks for having me out.

Starting point is 01:06:14 You bet. I'll have all that linked in the show notes for those in the audience that would like to check it out. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. 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.

We Study Billionaires - The Investor’s Podcast Network - TIP634: Value Investing Fundamentals w/ John Huber

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.