Yet Another Value Podcast - Steve Clapham, author of The Smart Money Method

Episode Date: December 7, 2020

Steve Clapham, author of The Smart Money Method (https://amzn.to/3gwJJjb) comes on to discuss his new book and some of the valuation and research tricks and tips that didn't quite make it into his book.Chapters0:00 Intro3:30 Steve's one tip for improving as a research analyst10:10 Improving how you read a 10-K17:20 clever research tactics and tips21:00 Emerging accounting issues Steve's looking at25:45 Electric car company discussion34:20 Special situations discussion

All right. Hello and welcome to yet another value podcast. I'm your host, Andrew Walker. And with me today, I'm excited to have the author of The Smart Money Method, Steve Clapham. Steve, how's it going? Hey, thank you very much indeed for having me. It's a very cold winter afternoon in London. We had our first really cold day of the winter. And I'm excited to be here. Great. Well, hey, let me start this podcast the way I do every podcast. And that's by pitching you my guest. You know, I actually wasn't familiar with you. I got a, you were kind enough to send me a pre-order copy of a smart money book. So I think the best way to plug you is by plugging the book. And look, I've worked at large firms before when I was reading this. I picked up a trick or two, but I think the thing I was really thinking was, hey, if I was still working a large firm and I had an analyst coming in underneath me, you know, who had some background, I don't

think it's a book for beginner, but if I had an analyst with a little background, this is exactly the book I'd want to be giving to an analyst to get them trained and get them ready. I mean, I just think it's the perfect book for kind of the beginner intermediate investor looking to push themselves to the kind of intermediate approaching, not mastery because that takes longer, but intermediate plus levels. So, you know, if you're an individual investor looking for looking to go to the next level or you're just looking to pick up a trick or two, I think it'd be a perfect book. So, yeah, Steve, anything else you want to say about that? Do you Do you disagree? Do you feel like I did the book of this service there?

Well, I mean, I hesitate when you say it wouldn't be for the complete beginner. I've tried to make it very approachable. I mean, it is, as you say, designed to be helpful to the graduate trainee coming into the industry and understanding all the things that you need to do in order to research a thought. And it's not to say that as a private investor and particularly a novice investor that you would be able to do all the stuff in the book, but understanding. how the professionals do it is actually quite helpful to enable you to up your game. And I think one of the things that I would hope people would do is have the book there.

And when they're looking at something, you know, just look up the book and say, well, how did Steve do this? And use it as kind of a reference book as well. And hopefully, you know, it's easily enough written. So somebody says to me, you don't have an awful lot of numbers in this book. You know, I thought it was meant to be a book in investment. And that was the whole point, right? That it's not crammed with tables on every page, like a research note. Obviously, that is what I do, write research notes.

And what I've tried to do with the book is write something that people will enjoy reading rather than research notes, which are always terrible to read. Well, no, I think that's perfect. So you released the book, what, it came out about two weeks ago. I think it came out the Monday before Thanksgiving, and we're taking taping this uh basically two weeks after the release you've been on a tour to force a financial Twitter podcast i'd say how many do you think you've been on in the past couple weeks how many podcasts yeah um i don't know five maybe all right well i you know i've listened i've listened

in particular to the one with uh tobias carlyle of the acquires podcast so when i was prepping for this i was trying to think of some uh different style questions to hit you with that uh Hopefully, if you haven't covered in one of your previous five podcasts. So let's start with this. I've got a few titles at Rangley Capital, but one of mine is a head of research. So if I came to you and I said, Steve, I'm the head of research for Rangley Capital, what is the one tip that you could give me from this book that's most likely to improve my investing process? What would that be?

That would be you ought to come and visit us and take our forensic accounting course for your whole team. I keep getting asked, what's the one thing, right? And there isn't a one thing. That's the whole point about investing is it's a multifaceted, highly complex, very difficult process. And you can distill things down to one thing. I mean, I think, you know, when you get to looking at a stock, you can usually distill a stock down to three issues that will make or break it. and that are the reason for investing.

But you need to cover all the ground, right? I mean, you can't. But let me push back. So you say there's not a one thing. And I don't disagree, right? But there has to be, like you've worked with a lot of other hedge fund managers, analysts and everything before, right? So I'm not saying that there's not one thing that you're going to go from a

complete loser to hear it with. But there has to be one tip that you frequently, one thing you frequently see the head of research or portfolio manager or something where they're subpar at, that you think that they could improve on it, where if I said, I'm the head of research, you say, base case, most likely Pareto principle, this is the thing you could improve on. Well, I think the one thing that people could improve on, and the one area where if they spent more time, energy, and focus, that they would get a much better result and a much greater improvement in their performance would be reading their accounts. Because a vast majority

of investors, whether they be amateurs or professionals, don't read their cants and certainly don't read them with sufficient diligence that would enable them to understand the business that they're investing in. So simply reading their can't would give you a massive leg up. It's astonishing to me how few people really understand this and how few people really pay attention to it. I used to watch when I would go into, when I was in a salesperson. side and I'd go into investors' offices. And you know, you could tell the good ones, because the good ones had accounts on their desk. The bad ones didn't. The bad ones had research reports. And if you wanted one thing, one area to spend more time, more focus on, it'd be reading the

accounts. Well, I do spend most of my day reading accounts that's good here. And it was your book. And just to prove that I read it, your book had the quote that within 24 hours of a 10K getting filed The SEC says the 10K has only been open. I think it was nine times or was it 28 times? So, yeah, that's the study by, I think it's William Lofron from the University of Notre Dame. And he and a colleague did a study of filings. And they found that the average annual report, the 10K, was downloaded from Edgar 28.7, I think, times on the day of results in the following day. And, you know, that's just like a staggering statistic.

I mean, I'm not sure if it covers all the bases. I mean, had various discussions, various arguments with different people about this because some people think that the accounts aren't downloaded from Edgar. I studied the top 10 companies in America and the S&P 500. And, of course, all the tech companies store the 10K on their own server. So, of course, they wouldn't be downloaded from Edgar. but it was actually I think it was Kyle Bass told me that when you download the accounts from Bloomberg the Bloomberg's got an API to the SEC server so that would count in the 28 times as I said okay

there's 300,000 Bloomberg's in the world so maybe there's a lot of accounts being downloaded from Bloomberg you said no that that goes straight to the server no I was wondering that because I get mine like on BAM SEC or something so I was wondering if BAM SEC if SEC would download that that accounts from there. Honestly, I don't know the technicalities of it. But interesting. So there's two other pieces of evidence around this point that I didn't put in the book. One is there was an interview with the CFO of GE in 2015 in the Wall Street Journal.

And he said that in 2013, the 2013 of Cancer GE were downloaded 870 times. and the 2014 accounts for GE were downloaded 3,400 times from their website. Now, GE is a huge company, and it's got literally millions of shareholders. It is inconceivable that those people, none of them, are downloading the accounts. I tell you what, those 2013 and 2014 accounts, two of those of the 3,400 were me, because I look, no, you're laughing. I downloaded it at least twice because I couldn't make head or tail of the GE accounts. Yep.

They were, I mean, they were incredibly complicated, incredibly difficult to understand and completely fabricated, actually. So I think that's one piece of evidence that says people don't read the accounts. The other piece of evidence is a study done by PWC, the accounting firm, ironically, because they're responsible for auditing accounts. but they surveyed, I think it was between 450 and 500 analysts. And these were equity analysts, credit analysts, buy side, sell side, even analysts at rating agencies. And I think there was 65% of those analysts that were surveyed said that they used the 10K of the accounts. So one third analysts admitted that they didn't open accounts. Now, if one third admit that, the actual incidence is probably,

closer to 50%, which is just extraordinary to me. So, you know, it's so difficult to find an information edge in markets, but guess what? You might just find an information edge in the 10K. Now, let's say I'm, okay, let's say 10K, all right? I'm going to take your advice and what I'm going to do is spend more time reading the 10K. What do you think one thing is that most investors and analysts you work with who read 10K? what is something that they're doing sub-optimally when they're reading a 10-K? Reading the balance sheet. Reading the balance sheet.

How are they reading the balance sheet wrong? Well, I don't know how they're doing it, but I know from having conversations with peers when I was on the buy side, that if you ask a question about the balance sheet, people usually can't answer it. I give you a remarkable example. So I made a statement. stupid mistake, Vodafone sold down its interest in its Indian subsidiary. And I thought, you know, sentiment's going to warm towards this. And Vodafone is about the only stock in Futsi 100 that's trading, other than the banks, obviously, it's trading at a discount to book value. Now, there's various reasons that the Vodafone book value is overstated. I won't go into the

technicalities of it. But I thought, you know what? I'll maybe have a few of these in the fund. And so I bought Vodafone. And because I bought it, a small position, I then went and listened to the then chief executive, tutorial Collar, present at the JP Morgan. I think it was Tech and Media Conference. And in the front row was this very well-dressed lady who was asking very aggressive questions.

Clearly knew the business inside art. So after the meeting, I went, over to her and said, well, it's very interesting you're questioning about Botafone. You obviously know it very well. Oh, yeah, I've followed it for years and years. And I asked her a couple of questions. And I said, so what do you think of the balance sheet? And she looked at me, what are you talking about?

You don't need the balance sheet. Now, here's a company that's trading, it was then trading maybe a small, a tiny premium to book value. You would think that a stop that's trading at that level. people would spend a large amount of time worrying about what the assets were. Because if the assets were correctly stated, you've got a stock with a very skewed upside downside ratio. Because if those assets were correctly valued, it would be bound to be worth the book value. And if things went well, it was trading in quite a low multiple, a high dividend yield.

You could get quite a high return over a two or three year period. So I would have thought that the first thing you would do in trying to judge the downside in Vodafone would be to ascertain what the book value was and what it really represented. But clearly she hadn't. Let me push back on that because, like, you know, I got my start investing in Ben Graham style net nets, right? And I used to really want book value support and anything I did, right? And I do think there's something this month is taken away. But until last month, a lot of the regional banks were trading for 70% of book value. And that was pretty, that was pretty rare.

But you say Vodafone's trading at book value. And the first thing you'd start with is the balance sheet. And I'd say, well, what about, you know, Facebook probably trades for a hundred times book value, right? Like book value has no bearing on Facebook's business. And for Vodafone, like what they're projecting there is Vodafone's book value is the historical cost of for them laying what, laying equipment out in London. but that doesn't have a lot of bearing on the returns and the actual operating income that they're going to get going forward. No, but the fact of Facebook's trading at whatever multiple book value it is tells you

that the book value is less relevant to your understanding of the valuation for Facebook than it is for Vodafone. Why is it more relevant for Vodafone than for Facebook? Because if the book values correctly stated, that's effectively your downside, isn't it? But that's assuming the book value is correctly stated. I could say that for any of these companies. Yeah, but if the book values correctly stated, then so wouldn't you, if you were looking at a regional bank and it was trading at a 30% discount to book, wouldn't you want to

understand whether the book value is correctly stated? I would have said that that was one of the first things I would want to look at. Well, like, so I don't disagree, but like, just to push back a little harder on this, so for Vodafone, right? Like, I think one thing, A, the, again, the book value is the function of legacy accounting. And people might be saying like, oh, like it costs for Vodafone. It costs them $10 billion to lay pipe into downtown London or something. But Liberty Global is going with Project Lightning and Liberty Global's overbuilding that.

And Liberty Global is doing that maybe at a non-economic return. So that thing that they put $10 billion on, it's only going to get $6 billion. That would be one. And then point two would be Vodafone, AT&T, Verizon, all these guys have an absolutely disastrous history of acquisitions. So maybe the market is interpreting the book value correctly, but what they're doing is putting the discount on, these

telecom management teams are not good at acquisitions, and we're discounting the shares a little bit because we're saying in the future they're going to destroy value doing that. Yeah, I mean, in actual fact, when I'm talking about book value, I'm excluding the goodwill, because obviously the good

will is not relevant to the valuation. So I would never think about looking at the book value, including Goodwill, simply represents how much they've overpaid. But no, I mean, this was the book value X goodwill. And if a stock's trading that close to book value, you know, I would certainly,

I mean, not saying everybody would do this, but I would certainly have a look at what the book value represented. And I will always look at the balance sheet. And, you know, the fact that this, what I was just going to finish off with was, this particular lady wasn't alone because six weeks later, I saw the CFO present in a group meeting at another of the bulge bracket firms. And I was sitting beside a guy who works for quite a well-known hedge fund in London, you know, multi-billion dollar hedge fund. And he was there

and either he was long or short. And so afterwards I chatted to him about the balance sheet. And he said, Oh, man, I didn't realize that it was trading so close to the tangible book. That's really interesting. I must go and have a look at it. This was just, you know, an illustration of the degree to which the balance sheet is overlooked by many investors, by many analysts. I was saying everybody overlooks it. Obviously, people have different approaches to looking at investment. You asked me, what was the one area where, you know,

know, I felt that most people had opportunity to effect an improvement. And I would say that area is the balance sheet, because I think it's hugely informative and generally overlooked. Okay. Okay. No, that's great. What about, so, you know, that was areas to kind of improve the downside, improve what I do. What about, what are some of the most clever, the book actually has quite a few. But what are some of the most clever kind of research tactics or tricks that kind of got left on the cutting room floor for the book? Well, there were a lot of things. So the editing process was quite rigorous. So my editor at Harriman House, my publisher, Craig Pierce, really nice guy and, you know, really quite competent as, you know, an investment books, because they do

nothing but investment books. So Harriman House is a very specialist publisher. They only publish investment books. And I've had a misfortune to come up against a number of rather more illustrious authors in their Christmas run-up-to-Christmas programme. So they started off with Morgan Houssel, the psychology of money, which if your listeners haven't read that, it is a fantastic book. If I've read Morgan Housel's book, I wouldn't even have started my book because he writes so fantastically. It was, I mean, amazing. And they then followed that up with Jack Schwager's book, The Unknown Market Wizards, which I've just finished, another really fantastic book. And I've got two in my reading pile. They've got Josh Brown and Terry Smith,

so an anthology of Terry Smith's writings from Bunsmith, which I'm looking forward to reading. Unfortunately, I'm not doing quite as well as the other four because both Terry Smith and Josh Brown, Josh Brown, obviously is hugely popular in the United States, a million followers in Twitter has had to try it less hard at promoting his book than I have. Both of them are out of print. My book still in its first print run and we've, you know, picking up the mistakes now, which we didn't pick up. But Craig was a very strict editor, and he would ask very detailed questions about things he didn't understand.

And because he's quite financially savvy, we left some of the more complicated stuff, some of the more complicated techniques, some of the more forensic accounting techniques we left on the cutting floor. And I'm not sure that that's a bad thing because, you know, if I ever decided that I wanted to write another book over my wife's dead body, obviously. We got the sequel. that I've got the sequel because I can do all the stuff that was left in the cutting floor and do a book on forensic accounting, which I would kind of like to do, but it's probably a good idea to leave it for a while and see if this one actually sells. It's interesting, you mentioned forensic accounting. So one thing I've been bowling over, and obviously you're familiar with the space from your Vodafone,

but the cable and telecom companies over the summer, there was this huge debate and issue with them where they had, in the U.S. it was the Keep America Connected program, right? Where they said, hey, anyone who can't pay us because of COVID, we're not going to disconnect them anymore. And it created this huge debate for bad debt expense, right? Because you've got these customers that aren't paying. You've agreed not to disconnect them. Nobody knew how to account for these customers going forward. Nobody knew how to model kind of unemployment going forward. I think a lot of the banks had and everything. It was this really interesting, like, you know, in the grand scheme of things, I don't think for the cable and telecom

companies, that debate mattered. But for COVID, a lot of these companies are kind of flying blind on assumptions, you know, bad debt expenses, growth, all these things. Are there any sectors with kind of emerging accounting problems? And it can be COVID or not COVID, that you find particularly interesting with your kind of forensic accounting eye. Well, we did, I was asked, funnily, I don't quite know why, but I've got quite a lot of customers. customers, clients in Australia. Australia is a pretty small country, right? It's 20 million people, but they've got a very developed stock market because they've got this peculiar pension. They've got very, you know, rigid pension requirements where you've got to invest in a pension.

So a lot of that money goes into the stock market. They've also got a lot of really sophisticated investors because they've got a large... John Hempton. I love John Hempton. He's in your book, Australian. Yeah, well, John, I've got tremendous amount of admiration for, and I occasionally run into him. But there's a bunch of Australians, so, you know, family offices. So one of my pals used to work for the Louis family office. And, you know, these people are all billionaires, but they're devoting a lot of time and energy to investing in the stock market. So the Australian stock market, for me, was almost off limits because you've got a huge flow of money into it, which means that stocks are artificially buoyed up.

And you're always behind the locals in finding the shorts. I mean, it's been occasional short opportunities, but hard area to invest. But interestingly, in my online training school, I've got not only Australian private clients, but I've got a number of Australian institutional customers. So people that are working for institutions in Australia and are looking to improve their knowledge and educate themselves. And so Australia has been a very popular area for me. And, you know, I've got a lot of admiration for the people that operate there.

And John, I mean, John Hempton is just a genius. He must be the best analyst I've ever met. So he did a presentation a few years ago at London conference by VideoLink. And he went through how he'd proved that this gold stock was a fraud. And the mine was out in the middle of nowhere. And what they did was they followed the railway line and with Google Earth until they found the station. and he then phoned the station master and asked had there been anybody come through that station had there been any trains to pick up the gold that's great you know it was just but you know he

he told this story and i was like i was just mesmerized by it and um the other the story about john um oh i better not tell the other story about john my favorite my favorite one and i remember this so specific is so funny there was an online dating company that was it was a fraud of some form but john created a profile that was like i'm a 400 pound man with every just every nasty disease you could ever imagine on this dating profile and he said within an hour he got hit by like 25 women who were just looking to marry him in lockdown right there and it was like i've got pasta oozes out of my oars and i'm homeless and broke and wait 400 pounds and all and there were these beautiful women just bet and he was like this is clearly like it's a fraud and i can't remember if

it was they were trying to defraud the people who were on it or the financial was just fraud but he was like this is a clear fraud and i just i i mean some of his stuff as you said with the gold and this it's so creative i really i mean really got a huge amount of admiration for him and and also the other thing you've got to have a huge amount of respect for is his ability to to to is self-deprecating You know, amazing humility. So wire card, which he spotted so early on. And, you know, you feel really that somebody who's been that clever should be rewarded by the market. Yep.

But, of course, he was too early. And, you know, it's a great danger in shorts. If you're too early, especially in the frauds, they get pumped up and pumped up and pumped up. And you're forced to reduce your position. Yeah. So in the end, he said he made a loss on wirecard. And you're the thing, that's, there's something slightly wrong about that because he deserved to win, right? And it's one of the things that's really, I've really struggled with, particularly the last few years I've said with Shorting, like, you know, are you familiar with Nicola?

Yeah. Yeah, you know, Nicola, they come out and like, it's a SPAC, which I think SPACs have their own set of issues. But, you know, they come out and they say, hey, the thing they raise money on, they literally pushed a truck up the hill and rolled it down the wrong. road, you know, and like the chairman, founder, whatever, has to leave because of all, all of these issues, including some sexual harassment issues, if I remember correctly, and I'll serve something. And you look and you're like, this is the best short I've ever seen, right? It's a pre-revenue company that rolled out a fraudulent product. And you go look at the stock and it's trading for, I mean, I think the market cap might be like approaching some of the smaller automakers and

they've never done anything. It's been proven fraudulent. And you're just like, I don't know how you can, maybe it's just unique to this market, but I don't know how you can make money shorting when like things that are proven fraudulent or have all this air on them. You know, Nicholas at 1870, the SPAC price was $10. So it's up 87% from the spec date, you know? I get it's come down from its halts on highs. But how do you make money when the market's this forgiving of things that are getting kind of proven fraudulent in some form? Well, that particular one, I'm really find bizarre. I mean, it peaked at $20 billion and it's now got market cap of $8 billion. And you think, well, you know, I mean,

it's an option, isn't it? It's an option on the fact that they may have a technology that works. But I mean, I don't even think the technology is particularly unique to them. I mean, I just didn't, you know, I looked at it and I just didn't even understand what the people that were buying it saw in it. I mean, you know, it just is a complete mystery to me why anybody would own something like that. And, you know, I mean, we've seen the same thing with the Chinese electric car, Neil. I mean, I remember before it came to stock market, they were exhibiting at the Good Road Festival Speed. So there's a couple of very big automotive events here that I usually attend. And they had this massive stands. So, you know, the big car manufacturers

have stands in this particular event. It's not a show, but they have a stand to promote their products and I looked at this thing. I just thought nobody, nobody would own this share. Nobody would buy this car. I mean, just the hype beyond description. So they had a stand that was the same size as the BMW stand next door. They've got one prototype car sitting there and they've got a bunch of, you know, people on the stand who are clearly models who have been recruited for the day, who know nothing about the product. There's nobody that knows anything about the product on the stand. You know, so I'm there. So tell me, you're really interested in the electric car. You know, can you tell me a bit about it? Oh, he may be able to help you and no, he didn't

know anything. It's funny, because when you get into the real world and start asking real world questions like that, you then very quickly identify what's a real opportunity and what's not. So for listeners who aren't aware, NIO is, you know, it's been described as the, as China's Tesla and the stock prices, what, probably a 20x so far this year, I would say. And, no, 10x so far this year, kind of 20x from the dexterous of March. And Steve, there's no way you could know this. But my last podcast was with Jeremy Raper, who had been a NIO short previously. And we mentioned Nio briefly for five seconds.

And now I am on multiple Twitter threads getting yelled at by Nio Longs for calling Nio, for talking to someone who had called Nio a borderline fraudulent company at some point. So you can look forward to being on those angry Twitter threads with me in the very near future. Hey, Andrew, you know, funny thing about Twitter is that the vast majority of people are really nice and give you help and give you help. information. I mean, I must say, you know, shout out to all those people when I was launching the book. You know, we did a big promotion the weekend before the launch. And, you know, loads of people retweeted that, you know, I had the book on special offer for the first day

and really, really kind comments. And, you know, you're so grateful for all that stuff. But the people that are nasty and difficult, and they just take the pleasure at your day. hey, why do they do that? I don't, I really don't understand. I had one guy where I tweet, made the mistake of tweeting something about MMT. And, you know, I think MMT is nonsense. And I mean, the lady's book, Stephanie Kelton,

her book will sell a thousand times as many books as mine will sell. Mine will be actually useful to people. Hers will cause havoc in global economies if people actually think of adopting these policies. But I had one guy, you know, come on and explain to me that I didn't know what I was talking about. And I now have stopped myself responding to these people because, you know, there's just no point. But these people, you know, often these people are absolutely. clueless. They just do not know the first thing that they're talking about. And seeing quite a lot of this in terms of valuation, where people are telling you that valuation doesn't matter.

It's a good business. I want to own it for the next five years. The valuation, not relevant. And I can barely believe that somebody would make that comment in public. This particular, the last time, I saw this with somebody who's got a business, he's got a subscription service. So you sign up to subscription service and he gives you stock ideas. Well, how can anybody purport to be a financial advisor or journalist or stock tipper if they don't think valuation is relevant? I don't understand. You know, I don't disagree, though. I do think, look, the biggest winners over the past 10 years have been the Amazon, Facebooks, Googles. And I do think one thing that investors have over the past 10 years, I think one thing

we've learned is, look, the trailing financials, you know, all of us have stories of passing on Microsoft when it traded for 10 times earnings, right? Now, part of that is Microsoft today and Microsoft eight years ago were very different businesses, but I do think one thing that we underestimated is 50 years ago for Walmart to expand their network was very expensive, right? There was no doubt they had a moat, but they had to go. build actual physical new stores. And today, if you think Amazon is a great business run by a legendary CEO and they trade at 200 times earnings, it might not matter because the next set of

earnings might cost them a penny to go get. Right. So 200 can become four extremely fast. So I don't disagree. And I do think all things take it too far. And I think people have learned some really bad lessons from the past five years. But that is one thing that I've been struck by like, you do need to divorce yourself from, oh, it trades at 200 times earnings. You need to be able to look five years in the future and say, oh, it's 200 times earnings, but they can go devour this, this market, and it's going to cost them nothing to do so because, you know, the internet skills near infinitely. I think that's probably not the case for Amazon. They're investing, well, much more of their investments going into much more capital intensive areas. So,

you know, they're investing in planes and trucks and vans. Perhaps Amazon wasn't the right part. no high return business. Perhaps Amazon wasn't the right example, but you know, like something like AWS, you know, 2006, the bold case for Amazon was retailer, and then AWS, this global category killer of cloud computing comes along, and nobody had that in their bullcase, but they leveraged that off of, A, the demand for computing from the retailer, and B, having one of the best CEOs of all time. let's real quick uh a lot of your background is running special situations uh you know there

there are a lot of i my my fund is an event fund lots of special situations what is the what is the special situation that you find kind of most lucrative that you find most other event investors under rate or kind of don't pay enough attention to well i'm not an event driven person at all and you know special situation to me is just something that's not quite in the ordinary run-in-the-mill sort of area so special situation to me is something that's got a lot of upside and not much downside or for a short a lot of downside and not much upside and it's not you know it can be anything really but the the thing that's special about it is there is generally something that's been overlooked by the stock market.

So my favorite situations are nothing to do with valuation. I don't really spend a huge amount of time in valuation. I mean, obviously, in the book and in the courses, you have to spend time in valuation because that's a big component of the process of many, many investors, and it would be foolish and dangerous to overlook it. But my particular thing is I try to just very, very, very, simple. I say in the book, the start of the book, you know, there's three ways you can make

money in stocks. And the way that I prefer to do it is to find something where the market has misunderstood the profit opportunity. And so my particular speciality is try and find something where I believe and have a strong conviction that the company is going to make X in two years time and the stock market thinks it's going to make half X or 75% of X. And so there's a big gap between what I think the earnings potential is and what the stock market consensus is estimating. And I found that to be a very consistent way of making money, because if you beat earnings by a large amount, the stock invariably goes up. I mean, I can't remember the last time I saw a company that had, you know, over an 18-month period was consistently beating

earnings that didn't do really, really well. And so that's why I spend my time. looking at. Perfect. Any particular examples you can give in the market currently that you kind of that you like right now? Well, you know, I'm no longer running professional funds. So I'm only running my own money and doing some stuff with, you know, some of my clients. Obviously, the client stuff, I'm not liberty to divulge. And, you know, from my personal account, I've been, the one, the biggest mistake I've made this year is not being more aggressive.

And so I've made a big mistake with one particular situation where I've been trying to be cheap and trying to buy, you know, because stocks in the summer were trading in ranges. And this is, this particular situation is a travel related situation. And so I was trying to buy it at the lower end of its trading range. rather than the upper end of its trading range. And the vaccine came and the stock is up 60% in the last couple of weeks. And I'm slightly annoyed with myself because I've only got a half waiting in the position. But I've really been devoting my energies to the travel area where travel, leisure, and hospitality, where there has been a stock where it doesn't have the balance sheet risk.

risk. So obviously, a lot of these companies have got the risk of will they be around. But I'm attracted to those sorts of situations. So an example in the US would be the casual dining sector, where if you think about what's happening with COVID, a large number of mum and pop businesses have been put under pressure. So it's particularly prevalent in the UK because we've had a much more stringent period of lockdown and a much more stringent period affecting the restaurant sector. So we're allowed now to go out as a family in London to a restaurant, but you and I couldn't go out to a restaurant if we were friends, because that's forbidden. Outside the household, yeah. Outside the household. I don't know the, I mean, I don't even understand the situation in the United Kingdom

because it depends where you are because different cities are in different tiers and the system is incredibly complicated and it's quite hard to understand. You can go out for a meal with a business colleague so you can try and sell to your customers, but you can't go out for a drink in the pub with your friends.

So the distinction between that is quite bizarre. But those sorts of things, you know, we're seeing in the UK the casual dining sector being decimated because of this. And you know, it's a sector in which there's a lot of mum and pop units. So, you know, they won't survive. There's a lot of private equity-owned units. So a lot of the brands are private equity-owned, and they tend to have debt, so they won't survive. So the people that are left standing are going to be in a very

strong position. And that's the sort of thing that I'm looking for. It was brought home to me, because I was having a Zoom call with one of my friends, instead of going to the pub, of us are having a Zoom call. We all have a glass of wine at home for a beer and have a chat. And this friend of mine has got a chain of menswear shops in the UK. And he's the biggest retailer of suits in the UK. And he, you know, he's barely selling any suits because there's no weddings. Hardly anybody's allowed to go to a funeral. I'm just wearing these shoes every day. Yeah. And everybody's at home. They're not going, they're not going to the office. So if they're at home, they might wear a shirt and tie, but they got tracksuit bottoms. So he said,

it couldn't be, I mean, it couldn't be worse for his business. But he happens to have a lot of cash because he's a privately owned company and he's very conservative. And his competitors are falling by the wayside, left, right and center. And when he emerges from this, when he emerges from it, you know, he offered voluntary redundancy to his staff because he needed to take his staff numbers down. And obviously the government payments aren't as high as their salaries used to be. So he's reduced his head can quite significantly. So he knows that when we get to the other side of this, his business will be more or less back to normal, not quite because we'll have an impaired economy and people won't have as much money to spend. But where are they going to

go? Because his competitors aren't going to be around. And so he's going to increase his market share and his margins are going to improve simply because he's got less staff. So those are the sorts of characteristics that I'm looking for now. No, it's a good, you know, it's something I've been wondering, so I've told a lot of people recently, I've been obsessed with like the cruise lines and stuff because this has been just, you think about a cruise line and you say, oh, they haven't run for approaching the year at this point. Those ships, you know, they sit in saltwater and those really depreciate while they're sitting in salt water. So these companies are burning hundreds of millions in cash to kind of keep their equipment operating while they're waiting for demand to come

back. And they're raising super expensive financing, issuing shares like crazy. And you look at it and their enterprise values today are actually pretty much the same as they entered the year with, the same enterprise value they entered the year with. The stock price is a little lower because they diluted themselves like crazy, but the enterprise value is the same. And you say, how is this possible? They're burning so much money. It's going to be months before they even begin approaching to running ships again. And I do wonder if the market's forecasting, hey, you know, two years from now, demand is going to be there. And actually, they're going to be huge beneficiaries because a lot of the alternatives to cruising have gone bankrupt,

on a way. And they're not going to be back for another four or five years while the mom and pops who used to do them kind of rebuild. So the cruises are actually going to see kind of a super cycle. Or similar to what you're saying, a Chipotle is going to see a super cycle of demand for a long time, not just during the pandemic, because the mom and pop talk Korea down the street has gone bankrupt because it's been shut down for the past six months. You know, I used to do the transport sector when I was in the south side. And unusually for a UK analyst, I used to follow the U.S. cruise cruise lines. And it's never been a very good business to me. I just had a lot of growth and, you know, it's popular. But, you know, the assets are very expensive. And yeah, I mean,

you might be right that they might be able to charge a bit more for their holidays, for their vacations. But how much more, you know? And look, the US is slightly different situation. And obviously we haven't yet got to the other side of all this and worked out. I mean, we've got two groups of people. We've got the people that have been disadvantaged and we've got the people that haven't been disadvantaged. So if you're sitting in New York working at a hedge fund and you've been doing well through the markets this year,

then you haven't been able to go out. You haven't been able to go on holiday. You haven't been able to spend money. So you feel quite a lot richer and you're going to be out there spending money more positively, perhaps, than you were in the past. There are going to be vast swaths of people in the Midwest who are out of a job or working for a bankrupt retailer who really won't have that propensity to spend. So I would question to what degree an industry like the cruise industry

would be able to raise its prices because the hotels haven't gone away. The competition, the capacity hasn't diminished. And I don't. don't know that many, I don't know the volumes, but I don't know how many births will have gone out of market, but I suspect it's not that many. So you don't have a sufficient diminution in supply, and you'll have some impact in demand. So your ability to price up when you emerge from this, I don't know the answer, because I've not studied it, but I would wonder whether there would be, you know, the opportunity to sell that $1,000, 10-day cruise for $2,000. I think that's highly unlikely.

So, yeah, they may be able to get a tweak, and obviously the tweet will do a big, have a big impact on their margins. But the equation doesn't seem that, it doesn't seem a blindingly obvious opportunity to me. I don't disagree. And, I mean, the reason I mentioned the cruise lines in, you know, AMC theaters and I meant long-time listeners will know I mentioned these all. the time. It's because I'm obsessed with what the market is pricing in where they're basically saying no value destruction through the pandemic for any of these things if you look at enterprise value. I mean, I don't disagree. I don't think they're going to sell a thousand dollar cruises for $2,000. But if they sell $1,000 cruises for $1,000, and then because me as a consumer, I haven't been out the house for a year and I go on this cruise and I buy four extra drinks a day because I've got a little extra money and I'm just excited to be back and it's the roaring 20s all over again. all that flows through to their bottom line in a very positive way.

Again, I don't know. I don't know. I'm just very interested in what the market is forecasting for these things. Anyway, I think we're kind of running up on our hour. So any last thoughts here, Steve? No, I just want to say thank you enormously for having me on. It's been great fun, enjoyed the conversation, enjoyed the chat. unusual to have somebody who's an investment practitioner doing a podcast. So it's been quite fun,

like Tobias as well. It's getting more and more usual than you think. You know, Tobias obviously runs a fun. He's acquired pod. Bill Brewster, my buddy just started a good podcast up. More and more investment professionals. It's great marketing and it's a lot of fun to talk to other investors on it. So anyway, Steve Clapham, I'll put a link to the book. I'll put a link to the book in the description. And, you know, I enjoyed it, especially if you're an intermediate looking to push the next step. I think I'd really recommend it. So Steve, thanks for coming on and we'll chat soon. Thank you very much indeed for having me, Andrew. I just tell people that you can find me on Twitter at Steve Clapham. And my website is behind the balance sheet.com. Thank you very much.

I'll put links to those in the show notes too for everyone. Thanks a lot. Have a good one.