Speaker 1welcome to the synopsis a business and investing podcast i'm joined with none other than drew cohen and we are talking we've got a lot of good topics we're doing a pivot last week we talked about meta and we got some comments about us being meta shills working for mark zuckerberg you know i wish we were getting some meta money for this podcast i'd stop complaining to drew but we are doing a quick pivot we're going to talk about melly and warren buffett we're going to talk about some of andrew has a great youtube video about again kind of some of the conflicts of interest inside the investment advisory world that you should be cognizant of we're going to kind of push that back because honestly i want to talk a little melly i like more business discussions you're not like more business discussions and i think the youtube video does a good job and we can kind of come back around to that if there's interest but before we get into that we did want to do some comment shout outs which i think are kind of funny and you know we like your guys's feedback even if some of it's mean try not to be too mean you know i've sent i my feelings get hurt easily but drew shields me he only sends me the nice comments so i like that it's part of my incentive strategy it's part of my it's that yeah yeah there you go the incentive strategy but i will i'll give drew and i some feedback we were pretty i was pretty nice to meta and i did like to do some disclaimers where there's no right answers here you know you i mean again you can have some evidence-based research that we do and you come to different conclusions and that's what makes investing so fun and some people are wrong and some people are right and if you're more often right than you are wrong you usually will make a you know a dollar or two and so that's that's kind of the bet so we'll see how this all plays out in the totality of time and the truth always reveals itself that's a beautiful thing but why don't we get into some of the
Speaker 2comments we had i think yeah so some funny stuff yeah so this one is from wall two who said there's a lot a lot of cop here on meta hurts to listen to the grace you two are giving this company is more than i think you have to literally any other rein it in guys you're better than this all right here's
Speaker 1my thing fair i'm just gonna say right off the bat fair i mean i i am an unapologetic i don't want to say meta bull but i i have a lot of respect for mark zuckerberg you can say as a ceo and as a person has he addicted a new generation into doom scrolling and things of that nature you can take a moral stance against against it which i'm completely reasonable with and i feel like i'm on your side in that but from a business operator executive standpoint i think he's done quite an exceptional job there's counters there's always counters to everything but i'll say i think he's done an exceptional job especially we followed that att year of efficiency very closely and i think that demonstrated and it's not just the att year of efficiency he has constantly been against the back we talk about the feed adjusting to the iphone we talk about you know the myspace meta we talk about a lot of different things that he's had to overcome the decline of the internet and the decline of the facebook the purchase of instagram he's made a lot of good decisions i'm not gonna i'm not gonna argue with people and people want to argue about that that andrew's gonna argue with me and that's
Speaker 2a whole nother comment let's go what do you got i'm not gonna argue with you i'm gonna say that alex's response to this comment is no he's gonna continue to unapologetically support meta i'm
Speaker 1gonna continue to apologize but i respect different opinions and you can come up with that and clearly the market to an extent you know agrees that hey they're not giving him a lot of leeway i i'm not gonna argue with you i'm not gonna argue with you i'm not gonna argue with you my argument is he deserves a little leeway i mean the guy's been at it for you know 20 years now and he's done pretty good job i would say you know and you know and let's move on from this i don't want to get too caught up and worked up over meta and get into you know disagreement here but i have one comment that i really appreciated and i think this guy really understands and it comes from you know a spotify user with some numbers after his name i already forgot them drew told me but it goes drew don't sack alex we love him you may end up killing each other though i like the first of all and i think it's true you know and i don't and i want to clarify something drew won't ever sack me it's you know will the desire to come to the synopsis overcome my desire for free time that's what it's going to come down to but right now i have to say i enjoy the synopsis i'm not going anywhere drew and i have a verbal agreement like we spoke about last week we're doing once a week if i have a my tie and a taco in my hand it's getting done i'm finding i'm finding the time to reply to drew but um we may end up killing each other that's true i like this one too
Speaker 2this is from matthias uh mailer who said perfect dynamic it's hilarious sometimes
Speaker 1i i think we can't be beggars out here because honestly the fact that anyone finds this funny is i'm grateful i'm grateful for that so we'll take it we'll take sometimes this one's actually
Speaker 2my personal favorite it's from uh daniel d alessandro who says drew definitely has a lot of patience with this guy and there he goes those are the comments they're supposed to
Speaker 1shield from me drew i don't want to hear about that you know i i'm glad someone noticed yeah someone noticed now i do require a lot of patience because you know someone's got to push back on drew you can't just let him run wild with his ideas and theories you got to have a little foil and sometimes we got to dumb it down i'm going to be honest you know drew's going off on a 40 minute rant i lost him well what was he talking about i'm trying to rein it back in and maybe maybe other people have you know like the 40 minute rants but i i've got a
Speaker 2that's my job that i do okay yeah okay is is definitely the right qualifier there um okay so even though you're the host i'm going to transition us now with this last comment uh from wow uh alky v vidis one eight who said after the buffett jokes you guys lost me well he's not going to like what's going to happen next because we're going to talk a lot more about buffett and i'm going to say this
Speaker 1which is i made some buffett jokes i'm like at a post-game press conference right now i said some things i said some things do i love buffett of course i've read every investor letter i've read every book about buffett i've read every book about buffett i've read every book about buffett i've listened to every annual meeting having said that i think i am clear-eyed enough to say at 95 he doesn't have it like he used to it's not an insult the guy is 95 he's been at it for a long time we love the guy but i'm not listening to buffett interviews with the hanging on his every word like we used to i don't think it's i just don't think it's reasonable for the guy to keep spitting out gold every year i mean what what do you want from him he's been doing it for 70 years
Speaker 280 years how much longer do you want from him yeah well the thing is most of the time people still don't actually understand some of buffett's key lessons which is what my last
Speaker 1youtube video was about actually i'm gonna i'm gonna counter myself and say one thing here the charlie munger interview he did before he died was still pretty compelling so i don't know
Speaker 2maybe i'm just and he was 99 in that one i think he was 99 in that one and he was kind of still
Speaker 1spitting out some really great wisdom i i really enjoyed it so uh let's say hey buffett still got some time i i don't know right now like we spoke about you have to listen to three times speed buffett buffett fans take it take what you want you want to listen to my one-time speed that's on
Speaker 2you that's all i'm gonna say okay so even though i was doing a good job hosting and setting us up for the next section alex kind of took us back there so where do you want to go from here alex
Speaker 1where do you want to go from here let's talk about drew's youtube video which is another buffett video where we are going to i think we're going to hype him up it's three lessons that are misunderstood from buffett that's right um so tell us about rattle off the three first just the topic so people can kind of have an idea of where they're going to go and what they're going to do and what
Speaker 2we're going what are the yeah so there's a lot of times where you hear people talk about buffett and one of my biggest pet peeves is they would kind of put value investing at odds with growth investing and buffett is quite clear that if you are valuing a business growth is a very important part of that valuation and so the first lesson is really just clarifying what value investing is which all it means is that you're valuing a stock's intrinsic value and you're buying it below price that's all it means you can value that the dcf is fully capable of including growth rates far out into the future high growth rates low growth rates now whether or not you're going to assume a higher or low growth rate actually doesn't have to do with whether or not you're value investing it has to do with this second lesson which is the margin of safety and this is an another thing that kind of gets misunderstood because and this is partly not buffett's fault this is because in intelligent investor by benjamin graham when he's talking about the margin of safety he's very often applying it to a balance sheet and when he applies it to the balance sheet he's saying hey i'm going to look at this asset value and i'm going to haircut it 30 so i've seen a lot of investors literally run a dcf and then their output they'll haircut it 30 and say this is what my margin of safety is i don't think that that is a good idea because what you are essentially doing when you're doing that is you are lowering the it's mathematically the equivalent of lowering all of your growth assumptions and so if you have you know a dcf you're projecting out you have the growth rate say you're doing a 15 growth rate and then at the very end of it you're doing this 30 margin of safety what you did was the equivalent of just cut that growth rate and so what i think makes much more sense is to just be up front in cutting that growth rate at the beginning so you know what the assumptions are implied in your dcf and so all of this has to do with the second lesson which we'll go more into which is the margin of safety now the third one has to do with circle of competence the way i interpret circle of competence to be is competency in what you could actually uh project about the future what are you actually comfortable in estimating about the future it's not just about i need to avoid these certain industries it's true that certain industries are harder to predict than others but a lot of times people think oh buffett doesn't invest in technology stocks i i think that's wrong i think a better way or a more precise way to understand it is he doesn't invest in stocks where he's not certain about their future and he wouldn't consider those to be in a circle of competency and so this kind of slight formulation difference i think gives you more permission to look at all sorts of different businesses businesses in different industries that you may not understand, but you may believe if you actually study them, you will be able to have some comfort in at least a relatively high confidence prediction on the future. And I just don't like this idea where they're using Buffett as sort of a reason to say that you shouldn't learn about new industries when very clearly Buffett's learned
Speaker 1about all sorts of new industries across his life. Wow, there's a lot to unpack there. So let's take a deeper dive. It was a good roadmap, good dense roadmap here. First thing, I'm just going to say my pet peeve right now. When I talk to someone in the investing community, and I go, oh, you know, like, what kind of investing are you into? And it's difficult to frame it. But when they say, oh, yeah, kind of like Buffett value investing, I just go right there. I go, you haven't read Buffett at all. Because the term value investing, he hated he hated that term. Because again, his concept is there's no type of value investors, no type of growth investing, you're investing, presumably, to meet a certain return. And you have, you know, you're just trying to make money with the money you have.
Speaker 2I mean, that's investing, right? There's no time to clarify your point. To prevent someone from leaving a nasty comment. You're saying that there's no difference between value investing and investing. It's just investing. It's just investing. And I understand where
Speaker 1some people may focus on growth or value or and quality has been this kind of new term that I feel like people use. And even I use it because I'm not exactly sure how to say but really, what I want to say is, our investing style is trying to take money and make more money with it by investing in good companies. I don't you know, whether it's a growth company, a dying company, whatever it is, it's not a it's just we're using money to make more money. I don't know how that's investing to me. And everyone is trying to do that, right?
Speaker 2Yeah, I kind of get you do have to be careful because there are clearly more speculative activities that shouldn't be counted as investing. I will say though, the more we've talked about this and argued about it, it's very hard to actually decide what is investing versus speculating. Because what could be speculating for one person could be investing for another person. So I'm trying to not take a strong opinion on that. But there are times when someone is like, okay, if you just pull up a stock, you never looked at once and you're just looking at the stock price chart. And you're saying I think it's going to go up, I threw a bunch of money at it. That to me, you're speculating, you're not investing in that case. But if someone really wants to say they're investing, it's, it's hard to actually ground that argument. Because what ends up happening is then you're kind of stuck in a situation where you're not investing in that case. You're stuck trying to define like what investing is with an actual process. And everyone's process is going to be very different. And so I do think you have to have some level of research. But maybe that person says, Oh, I do have research, I looked at the trend lines and the 13 moving averages. And it doesn't really matter, in my opinion, having all these conversations, it's not going to be so helpful to you. But what I think could be helpful to you is understanding that there really isn't as much of a delineation between, you know, so called growth investing, and what people consider value investing to be. So I think it's really important to understand that there really isn't as much of a delineation between who can absolutely be done by the same sort of investor.
Speaker 1The investment advisory business kind of productizes things, which is, and this comes to a whole rant, I could go on, but essentially, they're saying, Oh, we have, you know, value type companies, quote, unquote, value and Buffett's, for not the people who've, you know, hang on Buffett's every word, he had a problem with that, for the sense that, like I alluded to, there's no value, I'm buying a company at a reasonable price, with the hope of, you know, a reasonable, reasonable return and taking reasonable risk, right? That's, that's what he considered investing, there's no delineation between quote, unquote, value, which people now denote with buying low multiple companies. Normally, they're somewhat cyclical,
Speaker 2but they're exceedingly cheap, right? I would say it a little simpler, I would say, when you're investing is as Buffett is, you're basically just buying when price is lower than the intrinsic value you perceive. You think of price as being perception, it's a perception of value, but it is separate from the value itself. So price is perception of value, and price is value, value is separate from the value itself. And you do not necessarily believe that the price is reflective of value. And so that is like a very kind of classic value investing principle, which is, I think, true for basically all investing. If you're buying something, you know, you have to kind of see something in it. If you're buying like a stock, you have to kind of see something in it that the person who's selling it doesn't. And so that's kind of you taking a different opinion on what the intrinsic value of that stock is. Now I'm going to confuse you a little bit about this one too, which is that when you do buy a stock below its intrinsic value, but that intrinsic value is being calculated as essentially discounted cash flows, which is anytime you use a multiple, it's the same thing as a discounted cash flow. Embedded in that discounted cash flow is a discount rate. That discount rate actually becomes your return. And so if you're buying at a discount from price relative to value, then what that means is that you're getting an intrinsic value of the value that you think the valuation is of the business. Let's say it's 10%. But if there's a discount to price, then that, let's say it's a 30% discount. So let's say you think the intrinsic value of the business is, you know, $100 and the price is $70. Then there's this $30 gap basically. And that gap is actually also a source of return. So you're getting two of these sources of return, one from the discount rate embedded in the intrinsic value you're calculating. The second is from the discount. And this kind of confuses me a little bit because what this gets to is basically a conclusion on what the quote unquote right return is or should be for a certain security. And that's kind of what an equity risk premium discussion is. It's people arguing about what should the equity risk premium be on a stock. And that's kind of another way you could
Speaker 1think about investing. And then that's a whole nother situation, which is, is the margin of safety, do you conservatively estimate the cash flows? Do you use a higher discount rate? Do you, you know, once you get to your value, do you knock 20% off of it, which we're going to get into. But what would you, I want to ask you this question. If someone said, Drew, what type of investing do you do? How do you answer that question? It's a little complicated. I know it is. I don't like
Speaker 2any of the answers I give, to be honest, because it just, all of them feel very superficial. And it could be the same thing someone would say who does something very different than what I do.
Speaker 1And that's, that is the problem, which is value investing. I wish it represented what I think you and I understand as investing. But I understand why Buffett also had a problem with it, because he goes, that's a repetitive
Speaker 2statement. It is. And then there's also the fact that it got caught up in this idea of, oh, I'm just going to buy like cigar butts, basically, because that's how Buffett originally invested, or I'm just going to buy companies that are selling below their asset value, because that's how Benjamin Graham invested. And as a result of this, value investing got this sort of idea that it's going to be very, not almost like future focused, you end up with like a lot of these antiquated legacy businesses, because again, this is how they both kind of originally invested. And if you say you're value investing, you know, it means you're looking at a balance sheet trying to find net nets or something like that, which is a company that trades below its net current assets. And so all of that is like still true. And it's just, this is just marketing almost. It's like people taking different words, assuming they mean different things over time. And it gets very confused. And so it is very hard to say what kind of investor you are. I feel like quality investor, that's kind of why I'm here. I feel like quality investor, that's kind of why I'm here. That became a little bit more popular, because it doesn't have the connotation there that you're, you know, buying a company just because it trades at a really cheap multiple, even though it might be shrinking or something like that.
Speaker 1But to me, it's funny, because if you know, oh, I'm a quality investor, it's almost, you know, like political parties, we're the freedom party or something. It's kind of like, oh, what are they? Is that party not about being free or something? You know, it's kind of the notion that we invest in quality companies. And oh, that growth company, that's not really a quality company, right? You know, and that's the problem with that. terminology, too. So I do think, in the industry, I get it, there are different strategies. And these have been denoted as certain, you know, growth is you're going to be, you know, these high multiple, high, you know, whatever high growth companies, but they could be in a quality company. And they could be in a portfolio that someone quote, unquote, you know, like Drew, who's a, you know, I don't want to say quality investor, whatever box, we need to come up with a new phrase. But you could have a high growth company if, like you said, the intrinsic value is below the price, and there's a discrepancy there. And you feel that there's a good risk reward, and the return is worth it, right? I mean, you can own a very high growth company
Speaker 2as a file, right? You could you could be a value investor in Palantir. And I know that might seem like a wild thing to hear for many people. But all that basically means is that you just assume that they're going to continue to grow for a very long period of time. And when you did your math on that, you know, you were saying that, oh, the market's only pricing them growing 40%. And they're really growing 90. And I think they're going to continue to grow that fast for a couple more years than everyone else. And I think that's a good thing. That's the same thing as investing, because the intrinsic value you will calculate will be higher than the price in the market today. Now, there's other sort of pillars, though, that get tied up in value investing, one of them is the margin of safety. And so very often, it would be said that, well, you know, if you're assuming that high of a growth rate, is there really a margin of safety there? This is actually a more interesting point to make, though, because Buffett himself provides the argument to say that you can actually invest in a company, without the discount being a price. And so he does this when he talks about See's Candy, which I believe he bought in 1972. Everyone knows the story. Once he bought that, he starts saying, I would rather own a great company at a good price than a good company at a great price. And so what that means to me is basically, instead of taking these discounts by buying something at a cheaper price, the real sort of protection in investment comes in the quality of it or the moat. And what does the moat really do for a business? If you think about it, it is more likely to be a good company at a good price. And so what does the moat really do for a business? to ensure earnings are stable to growing in the future. If a company has a strong competitive moat, what that usually translates to financially is that the returns you get on your investment are stable and more consistently growing. And so if we're looking at See's Candy, for example, they would say, you know, their moat is in their very well-known brand and people love their chocolate and there's a habit around it. There's all these psychological associations and that's the moat that keeps other, you know, chocolate brands from competing against them. That shows up in the numbers in the form of more earnings predictability over time. Now, if you're doing a DCF though, and you're trying to think, how does that show up in terms of valuation? What that basically shows up as is I can be more comfortable assuming a higher growth rate. So my margin of safety has moved from being a discount on the price I buy to having higher confidence in the growth rate I assume. That is what I think. A key lesson that not everyone picks up on the margin of safety.
Speaker 1Great point. And one thing about the margin of safety, which is, it's another thing, right? And you alluded to this. People get bottled up. Well, what is the margin of safety? I mean, there's the famous analogy, oh, if I'm driving my truck across a bridge and it's a thousand pound truck and the bridge can hold a thousand and five pounds, I probably don't want to drive my truck across it. That's the concept. But how does that manifest, right? Well, do you think this company can actually grow, you know, 20%? But I'm going to say, I'm going to put a 10% growth on my cash. I'm going to put a 10% growth on my cash. I'm going to put a 10% growth on my cash. Flows and see if it makes sense. I'm going to use a higher discount rate. Am I going to come, like you mentioned, have a billion dollar valuation at the end and just slash, you know, 30% off of it and see what the market's trading at. And that's my value. So the concept is pretty simple, which is you don't want to have something priced to perfection. However, you want to think about that. You don't want to make a bunch of assumptions that, Hey, this company has to execute a very challenging or complicated plan that I'm not, I don't have a lot of confidence in. And my return isn't really going to be worth at the end, even if they hit that. And so how people think about that. Is too rigid. I believe, I mean, you need to just have a understanding of what works the best for you. I mean, I know drew, for example, you'll kind of make, I think, realistic assumptions, use your reverse DCF and say, Hey, if I have some like pretty realistic assumptions here, am I getting, what, what am I backing into? Is this a 7% return? It's a 9% return. And that's how, kind of how you think about it. And so if you're okay with X return and then reverse DCF spits out something that's a little higher than that seems pretty reasonable. Or if your expectations, and I know sometimes you go different scenarios. Okay. Hey, my base case scenario, my growth assumptions are this. I'm pretty confident that's going to happen. This is, you know, some upside of things work out really well. And you kind of triangulate what you're comfortable with. But I think that this notion of come up to a one pinpoint number, cut it off and see where the market is. I don't know. I think it's a little too rigid in your thinking about the margin of
Speaker 2safety. I tend to agree with that. I, you can do it. Certainly, you know, people are free to do whatever they want and layer in as much conservatism as they want. I think the, the other side of that is though, is if you're conservative in your growth rates and then you also take a discount at the end of your DCF to that, call it a margin of safety, then you're double layering conservatism. You're going to be missing opportunities because you're effectively raising your hurdle rate much higher than maybe you realize. Maybe your DCF was spitting out 12% and then you took your margin of safety to make sure you made that 12%. But that really meant that your hurdle rate was like effectively increasing to 15% or 16. And you're just going to be missing opportunities as a result. Again, you're free to set that margin of safety. You're going to be whatever you want and do it however you want. I just think that the key is, is being aware of what the implications are of the math that you are relying on. To me, the, this margin of safety
Speaker 1discussion, and it's kind of a broader Buffett discussion, which is the notion that people will almost print out what he said or listen to his rules in their gospel. And they go, I will never sell a quality company because I'm going to let it compound, or I don't invest in it. If you actually look closely, Buffett's Donald, he's regretted not selling companies because of the astronomical valuations. And he wish he took advantage of them, or he did sell a quality
Speaker 2company too early, or he did buy a commodity. I think he's bought Petro China early in the 2000s.
Speaker 1He's owned silver outright directly. He owned TSMC. He was like, Oh, China's a risk. I mean, you know, yeah, it's been there. That's been a big risk for Taiwan. And again, he was right. If he held that TSMC when he bought it, he would have done quite well. Right. So he actually got that right. And then sold. So he didn't listen to himself. And so, but what I think Buffett has done is he's given people an outline. And at this point, you need to take the outline, take the learnings and have some pattern recognition and have the freedom and confidence to understand nuanced situations and know that you're not always going to be right. And this is a good discussion with Chris Meyer, right? Where you guys were talking about back and forth of how he handles it and how he struggles with this rule or that rule. And whatever you do and you're wrong, you feel like, Oh man, I should have that rule or I shouldn't listen to that rule. So you just have to have conviction about the situation and the research. And when something changes or the price changes and you feel like it's, it's not what it was, you change your mind. I, you're right. I mean, I just think people get too caught up in these steadfast rules from Buffett. That's my, a little sidebar, but that's, that's one gripe I have.
Speaker 2I think that's true. I, but if you're thinking of like the reason why I made the YouTube video, it was more specifically misconceptions. And so the first one we talked about is people not really understanding value investing. And I think that's true. And I think that's true. And I think having this weird idea of what it is, that's more antiquated. The second one was this like lop up the margin of safety at the end of your valuation. Uh, the third one is I don't like this idea where people think that are you transitioning? Let me tell you, I just added a fourth one. And
Speaker 1the fourth one is people take Buffett's word for gospel. They need to understand that he has changed his mind many a times and anything he says, it's a, it's a framework to be applied to situation. You're trying to, you're trying to amend the video right now. I'm trying to amend the I think is arguably more important than the three because it's so fun to read and listen. And I think you graduate, like, I think you, you know, listen and you read Buffett and you have the fundamental understanding. It's kind of like the crash course in investing. And then I think you grow up a little bit from that and you go, okay, this was the foundation. And now I need to go out and fly on my own and kind of understand a situation and a circumstance and a company. And how can I apply these foundations? It's like foundational calculus. And now you're trying to build something on it. You need to have a little application of what you've learned. That's
Speaker 2my only thing. I can, is that fair? Or I think that's fully fair because a lot of times, whenever you have a lesson, even when you hear anything, it's going to be very tied up to your own perception of it. So the things that are being said, aren't always going to be the things that are being heard. And so, and this is also kind of in theme with the issue, the things you would say is not the things people are receiving. And so within that, I think there's room for flexibility and figuring out your own style of how you actually want to apply the rules and invest in really first principle thinkings to you. what he says as guidelines to get you close to the mark. But if what makes sense is slightly different than what he's saying, like that's fine. He may himself not listen to his own rules.
Speaker 1He often doesn't. And that's, that's the thing that I think people, you know, we can still say something and that'll be clipped or that'll be the lesson. And then I'll never forget the first earth shattering moment I had with this was when you read every Buffett letter and he talks about how dumb commodities are. And then an investor at one of the annual letters, he goes, Hey, you bought a hundred million of silver. Why did you do that? He was like, Oh, I think it's going to be higher. Like next quarter. You're like, what, what just happened? And you're just kind of understanding of, yeah, he's not going to put a big position in it, but he also, you know, he he's, if he saw an opportunity, he's going to take it. I mean, he's not so rigid in the fact that if there's an opportunity that presents itself or a price that's too, you know, the
Speaker 2Godfather price, that's too high. Right. He, he, and the other thing that I really wish we had more insight on is he has his own personal account and we don't know much. About that. But there's like rumors that he used to like would trade copper derivatives sometimes in there and like, be like doing a lot of other stuff. I think that was actually in one of the biographies. It was like, he was short on cash and want to generate a little bit more. So we started trading like copper derivatives. Someone can, can point out in the comments that exact story did, but he's done stuff like that before. And that's not to say like, that means don't have like an investment philosophy or everything he says is not like very well founded and very well thought out, but there's going to be exceptions. And especially as, uh, the world develops over time, there's going to be different ways to think about businesses. And, uh, this is two separate points. So one is there's going to be different ways to think about things. The second point is that you may be misinterpreting the things he's saying. So my video was more about, you are probably misinterpreting some of the lessons, or at least people are, whereas Alex is trying to point out that you have to be more flexible than what the lessons may suggest. And here's a great
Speaker 1example. Look at me segwaying hosting. Great example. Look at me segwaying hosting. Look at me example of the circle of competency as something that people take a little too intensely. And to
Speaker 2me, this is a very simple concept, which is okay. So I was going to transition us there. And then he purposely derailed the conversation in a different direction to take back the hosting
Speaker 1to this. So go ahead. I have to, I have to take the wheel, you know, you drove for a second. I didn't like it at all. I like, I like the control and I go on a tangent. It's cool, you know, but you only go on Alex sanction tangents. Okay. But anyway, back to the circle of competency and you alluded to it. To me, this is a very simple one, which is actually, it's not that simple now that I think about it, but in my own mind, it's very simple, which is for example, if, and I like think biotech investing is one of the most simple ways to do this, which is, you know, people are taking these positions on whether a drug is going to get FDA approval or it's, you know, how are these clinical trials and studying the data, uh, of a specific disease or something of that nature. I find if you're going to play in that game and you don't really have a lot of knowledge about how to read clinical trials or how many people have that disease or what the probability it's going to get there. fda and you don't specialize in that that seems like something i wouldn't want to dabble in lightly right it seems like you're either aware of that space pretty acutely or you're not but we always get back to do you need to know that what's in the big mac sauce to invest in mcdonald's right what's the level of competency you have to have and i think that that's you know what your video talks about kind of
Speaker 2so i'm trying to hit on a different point in your analogy of of the biotech it's a good point though that you made that is a very valid point um within your your biotech example though i don't like this idea that the suggestion is if you don't know anything about biotech you should never like invest in a biotech stock i think you are fully capable if you really are committed to learning a lot about pharmaceuticals how the body can work all sorts of different things about molecular biology and so on and so forth and i think that's a good point i think that's a good how the drug works if you're really committed to that and you want to do it and i did this in my own version when i really started learning a lot about semiconductors i feel like i actually understand how semiconductors work better than you know by far the average investor that owns those stocks but then the question of circle of competency for me had more to do with whether or not you are competent enough to predict kind of where the business will go in the future and so that's a little more clear in your biotech example because it's kind of cut and dry does the drug fail does it succeed but if you're thinking about you know semiconductor revenues amd can continue to you know be one of the leading cpus they could continue to do better than intel in some in some regard uh and you could be right about all sorts of different predictions on that but then the question ultimately is do you feel that it's within your circle of competency to make the predictions on the earnings growth rate for the long period of time which ties to the shipping volumes the shipping volumes is going to tie to you know industry demand and supply cycles it's going to tie to competition that to me is more the the part i want to focus on which is the prediction aspect of it and less the like don't even bother trying to learn because buffett has learned about all sorts of different industries and occasionally he will invest in them but he would for instance understand google and he understood google for decades and he just never invested in it and this analogy is kind of annoying to make now because he decided to buy it in the last month but uh he would talk about google in annual meetings over a decade ago and say how geico was one of uh that was one of their most important sales channels and he understood very well how uh the search ads were working for the business the return on ad spend he understood that aspect of the business and so it's not like he didn't understand the business what he felt was not in a circle of competency was specific to the predictions of the future of how google search would unfold in the future what would happen with that business 20 years from now that is more about what the circle of competency is is at least as i see it which is it's about future predictions far out into the future how the business develops it's not about understanding the business today everyone can understand like the business today and work at it but if you do that that's not sufficient in and of itself to be able to predict the future the circle
Speaker 1of competency and i'm going to go a little off topic maybe but the circle of competency in the two hard pile are very close to me they're very similar concepts which is how many industries and this is where the situation is it would you had a great qualifier for my biotech example which is if you want to spend the time and hours i think that any human with some base level of education and understanding can learn anything about any industry it's not like you know people who are in the semiconductors i mean maybe some of the engineers in the semiconductor working for asml are actually exceedingly more intelligent than the average human but i think on the baseline you can understand anything about any industry it takes time energy and you have to keep up with it and so how many industries can you realize realistically do that how large can your circle of competency be to me this is where the two hard pile concept comes it's not that you know semiconductors or something of that nature can you spend the time and understand them to me it's almost in my two hard pile right which is is nvidia going to be and our people this is a hot topic so i don't want to get too much into this i just don't have a good answer for this so it's not something that i'm going to make a big bet on but isn't the video going to be the ai chip for the next 25 years a lot of people would like to not see that right they're making outsized returns a lot of people are making investments into trying to displace them can they be displaced can these other companies there's a lot to me that i don't find that i have enough confidence in so to me it's too hard now some people might spend thousands of hours trying to understand that question and maybe they get to it but it seems like your point is at a certain point you know how much do you really need to know right that's another argument and that's where i got to the big mac sauce it's yeah that was your initial one
Speaker 2yeah so what i would say is that if you just lock down for three months to learn in i think you could say that nvidia is a company you understand very well and you understand all of the key aspects but then whether or not you will be the right person to predict what the gpu future holds 10 years from now is still it may not be in your circle of competency so it's less about understanding the business as it exists today and more about predicting the future i'm making that delineation maybe you find it pedantic but that's kind of what i want to call is different because the the reason why i'm making this decision is because i'm not going to be able to make a distinction is you're not going to know ahead of time whether or not that prediction is within your circle of competence because before you study a business you don't know what kind of assumptions you need to make about the future and so that's why i think that you can't make that decision before you're actually researching the business that's a good that's a nuanced point i respect that how can you say it's too hard if you don't if you don't know about it right and too hard piles it's like a time allocation thing too which is fine like you're allowed to do whatever you want i do that all the time as well there's certain companies i i never look at biotech companies because i don't have that time to decide that i want to learn about how biology works at that kind of uh level of granularity that to understand drug pathways something like that
Speaker 1and that's fine and and you know that is the thing which is it's also you can have very basic companies that are exceedingly difficult to predict to predict right that's just the competitive environments it's not complicated you know i think airline industries some you know airline companies it's not complicated you know as a business all right i'm picking people up and i'm dropping them off on an airplane i think it's difficult to delineate where those industries are going i think auto companies right we talked about how hard it is and the returns for an auto company is ford going to have a great year next year that's actually a very hard question even though the simple answer is they sell cars to people anyone can understand that right and so it's a very interesting concept but i agree don't limit yourself you know if you put your mind to it anything can happen that's true's
Speaker 2to say something or because i was going to transition and i don't want to get in trouble
Speaker 1for that no you could take it you know yeah i just i wanted to let you know you're an inspirational speaker out here in this youtube video thank you you're right any i and i agree he won't kill me anyone can learn any industry if they try hard enough for the most part it's a question of where do you want to divvy up your time which is also the hall look at all of this love being shared why do why do people think it's a contentious but don't you think that's the hallmark also where do you want to divvy up your time you know where do you want to put attention to what industries what businesses i mean that's a whole very yeah conscious decision of course yeah time time allocation industries right i mean that i don't know people passively make that decision they start picking up companies and just looking at different things making youtube videos but have they decided what industry they want to get into yeah we're getting too caught yeah we're back to the contentious side all right but anyway let's let's get into that melly here which is an almost i just want to ask you something in a vacuum which is and i'm i don't want to get into this melly real quick why don't we just give a state of the union on melly there are two business lines real quick because i don't want to start talking and people are confused about what we're talking
Speaker 2about so real quick mercato libre uh south america e-commerce and fintech company reported earnings the big story with what's going on with melly right now is they've basically consciously decided to invest more into the business to defend themselves against potential competition or existing competition mostly from c limited shoppy in brazil but also because they see a bigger opportunity in expanding their fintech business to a much wider audience and in that expansion of the fintech business they're seeing really good uh retention basically and sort of a flywheel spinning between the fintech and the e-commerce business and so in this last quarter revenues grew 50 percent uh year over year gross merchandise value grew 44 percent year over year active buyers were up 26 percent purchase frequency was up 14 percent and customers who purchased across multiple categories increased 10 points year over year this is a similar theme as we saw with coupon which is that as you roll out more categories and you get more customers to buy across more categories it increases retention it becomes a better customer now if we get to this ecosystem idea uh these ecosystem users uh purchase 55 percent more items year over year credit card holders are two to three times more likely to buy more items than three times more likely to stay locked into the ecosystem also meli plus which is their equivalent of amazon prime uh grew 72 percent and we also saw that ad revenue surge 62 percent year over year and now meli captures 10 percent of the digital ad market if we're going over the fintech business total payment volume grew 56 percent year over year hit 101 billion uh in total uh payment volume and total credit book grew quite high 75 percent year over year and so once again to just kind of overview of this business is you have meli consciously deciding to take margins down margins are now down to 6.7 percent that's down 5.5 percent year over year or 550 bips year over year. And so their margins used to be much higher. They're lower now. That's because they're investing in free shipping to spawn a lot more commerce activity, get more of these lower end buyers that were kind of being soaked up by sea, get them into the Melly ecosystem. Now using a lot of credits, credit cards, other sort of fintech pushes to get more users into their ecosystem, because they've seen that once a user, you know, I gave you that stat on the credit card, they're much more likely to stay in the ecosystem. Once they have a Melly branded credit card, they're much more likely to spend on the e-commerce site. And so the idea is to kind of do this dual prong attack where they're using fintech to get more people on the platform. When they're in the ecosystem, they spend more money on commerce. You're spending more money on commerce. You're getting more data, which actually helps the fintech offering become better because they can figure out how much credit to extend, who to extend it to, et cetera. Also that purchase history is proprietary data for them to figure out more. For their algorithms. So those are kind of the two aspects there, but then you also get more commerce activity and more data from the fintech side. It improves the advertising business because you have more data to better target ads. Then when the ecosystem gets stronger, the value prop behind Melly plus their subscription is also stronger as well. That helps incentivize more people to subscribe. And if you're going to subscribe to that, you're also more likely to stay in the ecosystem, increase your usage across both things. And so this is kind of what they've been doing. Again, this is, I would say, a very, very good idea. And I think it's a really good idea because it's not entirely on their own volition. I think a lot of people who are big Melly bulls, they're like, this is the classic Amazon playbook. And it is with the exception that Amazon's hands were never forced to do this. Melly's hands were kind of forced because C Limited became bigger in number of shipping items sold in Brazil. And right now it's actually growing faster, at least according to C in Brazil, than Melly is on the e-commerce side. And so that's a good idea. This is defensive. A lot of this is defensive. They took down the seller commission rates on their commerce platform for a bunch of categories. That's because C was just cheaper. And so I think that if you're saying, oh, they're going to invest and then eventually they'll be able to take their margins up again lately. I don't think that's going to come from being able to increase their seller take rates again. I don't think those are going back up. I think they operated it in an environment that for a period of time just didn't have very intense competition and they were able to earn more profit as a result of that. So I think that's a good idea. Now, they really had to double down and really increase their competitive moats in order to become a better business against C Limited and then to a certain extent, NewBank on the fintech side as well. And so that's kind of painting the stage, but it wasn't entirely that their hand was forced. It still was their decision to move to the free shipping. It was their decision to push out all the credit and it's working, which is the important thing. Now, I think what we're going to see is that margins are going to be depressed for a while. And the improvement in margin is going to come because now you're getting better scale, better efficiency, you know, more packages through the system, more buyers and all of that. That's going to bring in new operating leverage. So that's going to be one aspect of it. The other aspect of it is I think going to come from advertising. I think once you get all of this data and higher usage, you're in a better position to monetize the advertising side. And because that's not directly monetizing the seller the same way, it monetizes a single sale and can like prove that sale happened. It's a better way to kind of defacto increase the take rate on the seller without actually having to do it through the sales commission. And so that's kind of what I expect for them to happen over time. I think that, you know, the introduction of C-Limited to South America was not a net positive for them. But having said that, they're responding very well to it.
Speaker 1Yeah, it's an interesting, you know, e-commerce dynamic. And it is funny how, I mean, Melly, I'm thinking 2021, Melly and C on top of the world, I mean, taking over just the of, I don't know what we, what are historians going to call the 2021 post-COVID boom? I'm not sure what that time is. Zerp era tech bubble or something. I don't know. We'll say post-stimulus era, you know, the inflationary post-stimulus region. But one thing that I look at and in the e-commerce side of this is interesting and there are a lot of dynamics going on, but I know you did a video on C and Melly and there seems to be this, these loan books growing at tremendous paces. You know, their Melly's loan book was growing, I think 50% year over year or 40% year over year on average. Their net interest margins are somewhere in the 20%. And, you know, I know you're a banking guy for Goldman Sachs. So, you know, the average net interest margin is usually much lower than that. And maybe we can take on just, let's explain this, this business a little more in depth. So what is a net interest real quick? And why is it so insane that Melly and C and all these people are earning multiples? I mean, what's the difference between the net interest margin of a bank and a traditional bank?
Speaker 2Sure. So what a net interest margin is, is it's going to be NII on the top net interest income, which is just going to be interest income from all of the loans. And then you subtract out the interest expense. So how they're funding all of that, that gets you net interest income. And then on the bottom, you divide by basically the loan portfolio or more technically average earning assets. And so that together is what's going to get you what's called a net interest margin or NIM is the name of that acronym. And so this is a very good way of to just get a rough sense of how much money their lending activity is generating before any credit losses. And so they actually have their own version of this metric. They call NIM all, which is NIM and then AL because it's net interest margin after losses. And so this includes their loss estimates, basically. So that's a little bit better, in my opinion, to look at. And this in the last quarter was 20.7%. So that's a little bit better, in my opinion, to look at. And this in the last quarter was 18.7%, which was up quarter of a quarter from 18.7%, but down a little bit year over year from 23%. So there's a few reasons why this fluctuates. Some of it has to do with the type of loans, personal loans, merchant loans, they're a lot more profitable, they have a much higher net interest margin on those. Whereas credit cards, which is where they mostly been focusing on, have not only tend to have lower interest rates, but they also initially because of something called CECL, where you're booking a lot of losses up front, you're going to have a lot of losses up front, and you're going to have a lot of losses up front, you don't need to worry about why. But as a result of that, that actually initially shows up as a negative nimble. And so in this last quarter, credit cards had a negative nimble of negative 2.5% versus 0% last year. And so this is, you know, you're issuing a credit card, when you issue it, it's a new credit card user, you don't have them accumulating much of a balance, you don't get much in the way of interest income, because they're pretty fresh to it. And on top of that, you may not exactly know fully who you should be lending to or not. So you should be you might be lending to some people you shouldn't be to that increases losses. And then the other side of that is this CECL accounting rule, which makes you provision up front any of the expected losses for the card. Because of all of that kind of accounting, when you issue a bunch of cards, and you're growing very quickly, like they are right now, they just issued 2.6 million credit cards, this is going to reduce the nimble basically. And so this is not like a steady state of what economics of the business what it will look like. But this is what it looks like today. Again, primarily because you don't have these credit cards earning interest today. And then you have the full accounting burden of the CECL provision losses.
Speaker 1So with me, and again, I'll caveat this with I didn't do you know, banking at Goldman Sachs. And I also am not quite familiar with the personal loan space. So two big caveats. But when I look at that, is this in your circle of competence? I don't know. I don't think it's in my circle of competence. I you know, I know a little about Mellie. But this is actually definitely this lending business, I think has both CECL and Mellie are getting into C holdings definitely is a little not confusing. But I mean, I think that there's some questions that I have, which is, first of all, you have a loan book growing very quickly. And now loan books growing very quickly can be good or bad. Often, I would consider it a concern, right? When you have a lending going very quickly, you can get concerned, it's not that hard to hand a bunch of money out to people, right? That's very easy. Question is, is it's hard to hand out money to the right people and get your return on it. So that's one thing loan book growth concerns. The second thing is, is net interest margin to me. It's a little bit of a double edged sword, because you're saying, oh, we have to charge as high on a rate of a personal loan and personal loans are higher. And we do that because there's a higher rated credit default. Then they have this slide that says, oh, no one ever defaults. It's a great loan book. So I'm confused about what what's true here. And then the overarching concern is, is are the defaults just lingering and lagging? Or is this are they kind of over earning? Because if you keep keep lending, you're going to get a lot of debt. And then you're going to get a lot of debt. 20% interest rates or 25% interest rates, and nobody's defaulting, who the hell wants to borrow money in 25%. And I know that these are developing, you know, countries, and there are not a lot of loan infrastructure. But to me, that's not a sustainable business. Because you would, I mean, if no one defaults, I'd come in and loan at 18%. I mean, sounds like a good idea.
Speaker 2So a couple things, one that they'll loan, some loans are much, much, much higher than that, because that's the NIM you're looking at, not the interest that's actually charged. Oh, great point. Yeah. Yeah. And the main reason why the interest rates are what they are is there's just not a lot of people that want to lend to these cohorts. So one of the key risks I flagged in the video is that, you know, over time, could there be competition here? And that brings that down potentially. I don't think that's going to happen for a while, though. Essentially, a lot of traditional banks that have exist in Latin America, they never wanted to lend to this. So there's been a lot of people that are unbanked and underbanked. These fintechs, New Bank and Mercado Pago kind of stepped in. And they're really the main ones that are lending to this category. And there still are like a high number of losses. And in addition to that, inflation is also kind of a big concern there. That's another aspect that keeps these interest rates up high. And those two factors together kind of just resulted in interest rates generally being pretty high. It's just normal. That's what the interest rates are in these economies. And so to your point, you know, could someone else step in and do that over time? Yes. You still need a lot of data, though, to figure out who to lend to and not. And one of the reasons why Mellie is able to do this at scale is because they have a lot of information on a lot of buyers across the entire continent, basically. Because when you're buying stuff on Mellie, that provides them proprietary data, and they actually use this data in their lending model to say that if someone's buying, you know, supplements, it turns out they're less of a lending risk than if it's someone who's buying, I don't know, potato chips or whatever like that. And so all of these data points go into their model. Are there going to be other competitors? People try to do this eventually? Sure, sure, sure. I think eventually you will see these rates competed down. I just don't think it'll happen for a long time. It's still pretty early in these markets. They're still growing very quickly in all of these respects. Growing loan book concerning? Yes. This is another key risk I flagged in the video. But the concern is that you're growing imprudently, basically. Now, one thing that's different and worth pointing out about their loans is they're shorter term loans. This is not like someone loaning a mortgage for 30 years. And so you don't really, you know, it's a long time before you're getting paid back. These are much shorter term loans, usually under a year, you know, maybe under two years. And so when there's a shorter loan term period, that means that you find out whether or not your models are working much quicker. And so they've been doing this now for years. And so they're finding out if their models are working on a lot quicker time horizon. Same thing for credit cards, right? If someone doesn't pay their balance after a month, you're not lending them more money. You figured out that they're not paying their balance. And so you're going to cut down on their credit limit. And so all of these kind of adjustments are different things they can do. Is there credit risk in this business? Absolutely. That is a risk. And so you're probably the number one key risk. Ultimately, if you are investing in them, you're confident that management is properly doing these underwriting risk models. If you're not confident in that, and you don't trust them in that, and you think they're making mistakes, then you're not going to want to invest in the business. What I will say is that so far, if you're looking at like the existing NPLs, non-performing loans and where they're trending, there's really not a lot you could say that looks that problematic. There's going to be a little bit of variation, you know, up and down. So if you're looking up the 90-day NPL, it's 18.7%. If you looked at what it was last year, it was 18.5%. Okay, it went up 20 bips, like sure, wrong direction, but that's a pretty small difference. Can it fluctuate quarter to quarter a little bit more? Yes, and it did. But this is not enough of a difference for you could really say that this strategy isn't working.
Speaker 1First of all, Drew, I'm going to say this. It sounds like you're parroting some great investor relation points about this loan book. It just almost sounds like you're management on some of this. Are you trying to get ahead of someone dropping a comment like that? But now I can hear it. I can hear it. I can hear why they didn't like my meta analysis. You're right. I was drinking the Kool-Aid too much. And me as someone who's being a little more skeptical about it, and I agree. And as you were saying all that, I was kind of like, oh, you're right. What am I worried about? This makes a lot of sense. But then I'm thinking about every lending issue that's ever happened in the history of lending, which is management doesn't ever really see it or they don't disclose it well. I don't think usually when lending businesses go badly because they're growing too quickly or something of that nature, I feel like it's not easily discerned. And then when it is determined that it's a problem, it feels like it unravels quite quickly.
Speaker 2100%. And I made that point in the video. I said, if there is a problem, you're not going to see it coming. Like you could try to monitor the NPLs and the regulatory filings and all that, but it's going to happen so quick and the stock's going to react so quick in response to that, that I just think there's very little chance that you're going to be able
Speaker 1to see it coming. Maybe there's certain alternative data sets, but I don't know about that. Oh, good. I like that you agreed with me. I actually don't remember you saying that from your video. So maybe I've subliminally watched this in an hour pirating your points as my own, which I frequently do. But the last thing I want to say about this portion- I like how you said pirating instead of parroting. That's pretty perfect. No, I'm stealing. I'm stealing. I want people to think they're mine. Now, the second kind of concern I have with this loan book is it just convolutes the financials as well, right? When you get into the banking and as someone, and I can't emphasize this enough, banking is a whole nother accounting nightmare that you have to have, I think, specialized training to look at. And you, for many years, all you did was look at banking statements. And even you- Not too many, but yeah. Not too many, but for years, you've looked at only banking statements. And so it makes things complicated and it's hard to determine. I guess, one concern would be how reliant they are on this loan book and the net interest margin they're making on it, right? Are they generating a lot of cashflow on a high margin basis that's supporting perhaps the e-commerce business that is under more pressure than we think? Because it's hard
Speaker 2to tell. That would be a secondary concern I have. So first, yeah, if you're looking at a bank, for those that don't know, what ends up happening is loans, instead of it being a liability, it's an asset. And then people giving you money becomes a liability because that's what a deposit is. And so it kind of flips the balance sheet. Then if you're thinking the cashflow statement, the loans do show up in different places. They're not showing up in the financing segment because they're kind of operating activities. So it is kind of confusing and blurring these lines. If you are originating a loan that's for quick resale, it could be in the operating segment of the cashflow statement. If you're holding it for investment, as Mellie typically does, it could be in the investing part of the cashflow statement. And so it does really mess up the cashflow statement. And so if you're holding it for investment, I'll say two things. One, Mellie provides their own cashflow reconciliation to kind of adjust these things out. So you could see like the core cashflow of the business, which is actually pretty helpful. The second thing is I think NIML is a pretty good metric to focus on. And so if you're looking at that, that does give you a pretty good sense of the underlying profitability after losses of the loans. Yes, there's always a risk that the next quarter there's this huge blow up, and so it didn't fully capture it. But generally speaking, I think it still is a pretty good
Speaker 1metric. And so if you're holding it for investment, it could be in the investing segment of the cashflow statement. It doesn't seem like you could be a killer for the company necessarily.
Speaker 2I don't think there's any scenario where you're getting 100% loss on it. Right. I agree. Yeah, that's not going to happen. And the loans you're looking at, that's already net of the provisions. So when you're looking at net loans outstanding, that's net of whatever the loan loss provisions are going to be. So they're already assuming they lose money on a bunch of loans. So that's already embedded in there. So then your question is, are they wrong on their provisioning? And are they going to lose much more money than they predict? Okay, well, how much? Is it going to be twice as bad? Do they lose 10% more, so a billion, 20% more, around 3 billion? Okay. I mean, that would be pretty bad if that ended up happening, but they would be able to fund some of that from cash on hand, short-term investments and operating cashflow. But no doubt there's some risk if things get truly, truly terrible to a level maybe we haven't seen in a very long time that, yeah, it could potentially sink the company. So there is that very, very small tail risk. I don't think that's likely unless you're really gearing for a scenario close to like a Great Depression. I think in almost all scenarios, they continue to survive as a business. I think there's some risk that, you know, it could impair them for a period of time. But at the end of the day, a lot of these loans, they pay back pretty quickly. They roll off. Once they see an issue, they dynamically pull back the credit limits on that, and they stop lending so much credit. They can make other adjustments in the business to conserve cash and get through it. And so I get it, because even after a lot of these loans, they're still going to lose money. And so I get it, because even after a lot of these loans, they're still going to lose money. And so I get it, because even even after a lot of these loans, they're still going to lose money. And so I get it, because even this conversation, the fact that you have to defend this makes people nervous. And that's why, you know, people don't like banks, right? This is exactly why. And I think that's fair. Very often, I don't like banks either. I think the exception here is that it's not just like a bank for its own bank economic reasons, but it's really more about the flywheel and the way it plays into everything else Melly is trying to do. You know, the credit helps improve people actually using Mercado Pago as a payment method. It improves the e-wallet business. It's more likely that people are going to be able to use it. And so I think that's why I think it's fair. Use them for asset management, other financial products, more likely they get the credit card, they get the credit card, more likely they're spending more money on Melly, spending more money on the Melly marketplace, more likely that they're going to become a Melly Plus subscriber. And so all of these things work together. And that to me is, you know, the better business case than just the strict economics of the lending business. Although as you're pointing out, the lending business itself has pretty strong economics. But there's that little tail risk that everyone that I can never argue against, I can never say it's not going to happen. You just have to accept it. And I think that's a really good point. And I think that's a really good point.
Speaker 1And this is where I delineate between, you know, business, catastrophic business risk, and quote unquote, investor risk, which to me as an investor, I think the risk is more realistic. You know, you can't be thinking all the time is this company and I get some people think like this, but can this company survive the Great Depression? And we you know, when there's nuclear war in this, I understand it's hard to invest always for the catastrophic downside. I think you really shorten your universe. But what seems more realistic to me and on a higher distribution is that you're kind of over earning from the loan book. That's showing that's kind of creating better
Speaker 2economics. I don't think they're over earning. To be clear, I think, eventually, in a long enough time frame, you could get more competitors into this business. But there's no one else is really competing that much to bring these interest rates down a lot. This is kind of what the interest rates in the market are at this current time in these economies. Again, a lot of it does have to do with the fact that people, a lot of banks, traditional banks are not so comfortable lending to these Latin American countries. There's a big inflation risk. That's part of it. There's not just the credit risk, but there's also the fact that a lot of these banks don't have great information on the average consumer profile. And so that's why these neobanks like NewBank, and you could call Mercado Pago that as well, that's why they're taking over and stepping into this lending field. I think eventually as it gets more mature, then sure, you do see some competition on that side. But there's also some geopolitical risk of investing in these areas too that could keep these interest rates high for some period of time. And so I think eventually it makes sense to me that it's, I get it, you're looking at a high return, you're saying how sustainable is this, but I don't see any reason why it's immediately pressured.
Speaker 1I have more faith in capitalism than you do, I guess, which is, you know, you've seen a loan book that's 5x from $3 billion in June 23 to $16 billion in June 26. That's a three-year, you know, 5 whatever x of the loan book. If you see that there's no losses and the net interest margin, or not material losses, and the net interest margin is that high, I mean, I'm excited. I want to go loan to some people and to some people. I understand there's barriers and people are going to say MercadoLibre has data and they're making more strategic loans, but they 5x their loan book. So how strategic are, is the data that they, you know, people buy like toilet paper and consistent products from them, so they must have some stream of income? Perhaps that's some relevant data, but you would think that as a basic lender, I could get some, you know, some income statements, some information about the customer that could get me maybe not as close to a Mellie model, but over time, it doesn't seem like an, it's not easy, but it doesn't seem like a competitive advantage that Warren Buffett would like. And so that's my concern. And I could be wrong. I mean,
Speaker 2obviously, well, let me, let me push back to you because, you know, Buffett invests in a lot of banks and what would you say their competitive advantages are like Bank of America or Wells
Speaker 1Fargo? Great point. I mean, he loved Wells Fargo, I guess the management, I think that would probably
Speaker 2be his competitive advantage that he's Wells Fargo management. Really? That was the competitive advantage there. Okay. Um, well, when he invested a long time ago, if you look at the return on equity for a lot of these banks, you could see like a mid teens return on equity, which is, you know, you could say that's too high. Sometimes it's high teens, sometimes 20%. So that's just kind of where the market is set. Some industries just naturally have higher rates of return than other industries and different geographies have different rates of return than others. And that doesn't mean it can't change over time. But if I don't see like a force to actually come in and bring that down, like then I just, I don't see how that's really happening. Even, even sees, you know, lending rates are pretty high as well. Now maybe they get much more aggressive, but they're also worried about losing money too, because if you're lowering those interest rates too much and it's a new business, and then you're really playing a game with whether or not you're correct in the provisioning, you're losing a lot of your slack. And so I think, especially in these economies, it makes sense that these lending businesses are a little bit more conservative and how are you conservative? You charge a higher interest rate. Wouldn't surprise me if over time it goes down, it wouldn't. How much of a risk would that be to Melly? Well, it certainly would be a hit to their, their credit, um, revenues and earnings and all that, but they would still have, you know, the payments business, they would still have the ability to cross sell, uh, other financial products and they'd still have the commerce business. So, you know, they, they would could definitely survive that. And it's not like it's going to drop from 20 to five, but I don't know, could it drop like 25%, maybe over a
Speaker 1decade, 50%. That doesn't seem crazy to me. My scenario is a lot less draconian than their loan book blows up to me. It's just whatever, you know, maybe the interest rates drop or they're long on their provisioning and it, and the high, cause it seems like a very high margin, but not seems it is a very high margin business. E-commerce is a very low margin business. So is the high margin business supporting a lot of this competition defense that when it goes away, if it goes away or is challenged in some way is now their ability to defend e-commerce a little more, is it a little more difficult, right? And are they getting into a cash issue that, that, that's a scenario that I think is more realistic than, you know, oh, the loan book blows up, right? That they're over, not over, maybe over reliant in that cashflow is funding a lot of the e-commerce business. Is that a reasonable argument in any way? I don't know that
Speaker 2it's funding a lot of the e-commerce business cause they were profitable in that e-commerce business before and they're taking margins down. Having said that, if you're stressed as a company, if you have less cash coming in, yeah, of course that's going to mean you have less flexibility with where to invest. So if, if for some reason, you know, interest rates are dropping a lot, the credit book is making a lot less money then, okay, do you cut back on some fulfillment centers? I don't know, probably not. Cause that's, that's the business that's working instead. You're probably not extending your lending book as much.
Speaker 1Good counter. I like, I like this discussion. I think, you know, I was kind of going back and forth because you had me convinced that I'd come up with another, I'm not sure where I land on it. I need, I need more information. I need to expand my circle of competency, but I wanted to kind of touch on the loan business because we've talked a lot about e-commerce and, you know, I think it's a pretty straightforward business. You're delivering people and, you know, so I like this loan book discussion. It's an interesting concept with, you know, C expending their loan book, Melly expanding their loan book. It's, it's becoming a big story for them and it's not something we've really fleshed out before. So I kind of want to end on that note. I think it's a pretty straightforward I kind of want to end the Melly update on that. I mean, you kind of gave the update, but I wanted to just really dive into the loan book here and we can kind of have a, maybe a broader e-commerce discussion, you know, with all these companies later, but this is more of an update. Any kind of closing points on Melly? I know I derailed just the lending discussion for a while, but I found it to be quite interesting.
Speaker 2Yeah. I, I think you're right to identify that as the risk and I'm not trying to say it's not going to happen. I'm trying to contain it a little bit as a risk, but it, you know, that's just something you accept if you invest in the business. In my opinion, that that's kind of, you know, you could say that's a reason why the stock is sold off is because of that. And then, you know, the e-commerce competition is the second side. I'm less worried about that because their response seems to be pretty good so far, even if the economics have been kind of worse in that market. They don't need to make that much money on e-commerce to kind of make the numbers work. So that's, that's kind of where I'll leave all that
Speaker 1there. A very compelling discussion. And I'm sure, you know, the audience will let us know if it wasn't there. They're very vocal. So. I guess. Yeah, that's right. If they didn't enjoy it, they stayed 80 minutes in. Yeah. They stayed 80 minutes in. Yeah. For out of spite. And well, I guess we'll end it there. I'm not sure what our next topic is going to be. Drew and I will have to figure that out. So, you know, stay tuned, but until next time. Until next time.
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