Interview. Sidecar Investor on Giving a Great Manager the Wheel

(upbeat music) - Hello and welcome to the Synopsis, a speed well research podcast. I'm Drew Cohen and this week on the podcast, we have a very special guest. We have Sidecar Investor from Twitter as you might know him. He tweets a lot about various businesses. He has his own investment philosophy that he's honed over the years and really just, I've gained a lot of insights personally following him and we thought it'd be really interesting to have him on the podcast. This is his first ever podcast appearance, so we welcome Sidecar. - Yeah, thanks Drew. It's a pleasure to be here, a big fan of the work you all are doing at Speedwell and excited about the conversation. - Awesome, we really do appreciate that. And just to kind of get us kick started here, we wanted to talk about your investment philosophy and the origins of what you call the Sidecar approach. - Yeah, absolutely and I guess going back pretty early have always been comfortable betting on people more than betting on the economy or an industry or even a business model in some ways. And it's meant to fair amount of time and fund management and an institutional asset management and that experience really led me to hone in and zero in on how important the people are really when making any investment. But after admitted, it's not an original term. I have to give credit to Richard Zakhauser who's a professor at Harvard University years ago as at a conference where he was presenting on a paper called Investing in the Unknown and the Unknowable that had a lot of really great ideas. But the one that resonated is that out there in the world there are people who are really skilled real estate developers who are really skilled technology executives or they might be really skilled at finding only like gas at a really cheap cost. And as an investor, you don't have to have those skills yourself. You can partner with them and as long as you do so on terms that are fair, ride their coat tails. So it's a bit of a combination of just what feels natural to me for my personality and temperament. But I think there's good reason to believe that it works well in public markets as well. - So was your kind of development as an investor, you read this paper and you had an aha moment or was it more of a kind of slow development where maybe you had some fun bowls and realize that it's not really worth investing alongside businesses where managers aren't exceptional? - Yeah, it was a slow evolution of tightening things up over time. I don't know that there was a specific aha moment. And early on my approach was probably pretty common, some version of good business, good price, good people. And I feel like I made investments that had those characteristics. But what I soon learned was I wasn't being exceptional at anything. The investments I was making were just okay across the board. And the results reflected that. They were okay, but not exceptional. So I took some time and really thought, okay, well, where can you zero in and if I was to optimize one of those things? And my opinion, it's partnering with exceptional people is what gets the job done. They're on the inside of the company, we're on the outside. They have access to incredible amounts of information that we don't have access to or someone at their back and call being a passive outside minority shareholder. So it really came from putting the effort into optimizing either evaluation or the quality of the business or the people and for me optimizing the quality of the people is what's led to much better results. - Was there an early experience or maybe what was your first investment that you saw where you realized how much of a difference it is when you're investing alongside an exceptional manager as opposed to one of these more kind of average businesses that you were describing? - Yeah, I would give two examples. And none of these are available to public investors anymore in the same shape or form. But one was Lucadia National is run by Incoming and Joseph Steinberg really through the 70s, 80s, and 90s into the 2000s. And they did 25% a year for many decades and just had an exceptional track record. But the caveat was they were pretty, pretty press shy. There were stories about them hanging up on people that would call in and try to have investor relation type conversations. A lot of people didn't even know what they looked like. Again, this is back when the internet was in its infancy. But they're track record and the soundness of their approach was just incredible. So Lucadia National was one where it really started to feel right. And then the second, there was a guy named Ken Peek who operated an oil and gas company out of Houston and unfortunately Ken passed away a number of years ago. But he basically bootstrapped from nothing. If my memory is right, he started with some credit card debt and went out to search for oil and gas and built an organization with hundreds of millions of dollars. They had five employees. And again, the clarity of Ken's thought, the clarity of how much he cared about optimizing per share value, which is really important, was very clear. And then, an important one, unfortunately, his life was cut a little bit short. But I think he's left a big mark on a number of people in the industry. That's really interesting. And it brings up kind of two questions in my head immediately. And the first one is, how do you kind of balance the fact that a lot of these great operators tend to be press shy with the fact that you need to have confidence in what they're doing? And I know we both have talked a little bit about Dreamfinders' home. And there's Patrick Sapiliski there who has these great investor letters. But that's also the full extent of everything you will be able to find out about him or these couple of letters in the last one that haven't even posted for this year yet. So it is kind of tough where you're trying to balance, you know, respect for the fact that they're just focused on their business. And that's what you want them to be doing. But at the same time, how do you have confidence if they're not actually communicating what they're doing? - You're right. And if you take somebody like Mark Leonard, who gets a lot of press, right? He hasn't no conference calls, no earnings guidance, hasn't issued a shareholder letter since February 15th of 2021. And that's a very minimal information. But to me, both the people and companies give themselves away in terms of the shareholders they're trying to attract. And I do place a lot of emphasis on their track record. There are a lot of people who say the right things and they might sound really good on an earnings conference call, but then you'll get the track record. And it's just kind of average. So I would much rather have an exceptional track record with a little communication than somebody who might be viewed as promotional or maybe spending too much time on investor relations. - Yeah, and I always kind of answer that question similarly, which is that you kind of don't know until they actually do it. Whether or not you could trust that they could do it. And maybe that does mean we select for some different sorts of companies that are less these kind of open-ended moonshot ideas. I'm guessing you're not probably trusting Elon Musk circa 2015. But once someone has kind of a proven record, then that does kind of change the equation. And it's also interesting because you just mentioned Ken Peak who was invested in the oil and gas industry. And typically this is kind of an industry a lot of investors shy away because of the fact that commodity prices and markets are so volatile and you can't really control that. And so it's interesting that you still kind of partnered alongside him because it kind of speaks to the fact that when someone has a track record and you trust him so much, you kind of become industry agnostic. - Yeah, I think that's fair. And there's a quote that was written about Henry Singleton Forbes wrote it years ago, and I do push it out on Twitter every once in a while. And it's along the lines of what a company makes or sells is less important than the style of the man or a woman who runs it. And I think that's really an insightful line. You could have the same set of assets or the same company and put it into the hands of two different management teams and just get dramatically different results as they make small decisions over time. I do think the industry matters. And in Ken's case, he was really dialed in on finding oil and gas at a very cheap price. And that's the only differentiation in oil and gas. He wasn't gonna be able to sell it for more than somebody else. He wasn't gonna be able to transport it better than somebody else. But he was really zeroed in on that moment when the company creates value, which he called turning the drill bit to the right and discovering oil and gas. And it goes from an undiscovered asset to a discovered asset. And I guess that kind of brings up a corollary point, which is that if you do have a business that is run by a great manager, to what extent really do you think competitive modes important? Because the way I kind of always conceived of it was that the better the competitive modes, the less the manager mattered. But at the same time over any sort of long period of time, the manager could destroy the business. And so it sounds like I had to ask you that question, which you would prefer the manager versus a company with really strong modes. You would gravitate more towards the managers, that right? - Yeah, certainly with the business to have the potential to have really extraordinary economics. And that could be an existing mode. That could be an existing mode that's getting wider. Certainly don't want a mode that's deteriorating. It could be high quality assets, irreplaceable assets that aren't really earning much right now, but have the potential to earn money. a lot in the future, but it's over time I've leaned more towards investing when the vote is being built so that you have this exceptional management team. They're building a company that in its in-state has the potential to have some really good economics and have a big vote, but it may not be readily apparent to investors yet. The numbers might be messy for one reason or another. They might be investing through the income statement, like a lot of technology companies do. The story might just be messy, but it does feel like in the 20 plus years I've been investing that the market appreciates these companies earlier in their life cycle, relative to 10 or 20 years ago, and so it has been really helpful to go earlier and try to invest when that mode is being built. Can you maybe give an example of that that you think helps exemplify that idea? I'm going to talk a little broadly because the few I'm invested in are pretty small. These are sub-hundred million dollar companies, and so I want to be careful about the liquidity, but I would say generally speaking what they have in common is a massively overqualified management team. A historical example would have been Brian Jellison being hired by Roper when Roper was this tiny industrial company. He had come from a giant industrial conglomerate and was just incredibly overqualified to manage that business and as a result he steered it to creating tremendous shoulder value over many decades. So the one thing they have in common is overqualified management teams and then the second thing which is a little nuanced and I don't invest in turnarounds, but they tend to be situations where you call management's pruning the tree. The prior management team may have overt diversified or made some investments that don't have good economics and the new management team has really a blank slate. They could come in and sell them on core assets. They can divest subsidiaries that aren't pulling their own weight and really refocus the organization's capital on a solid profitable core business. Those are the two things they usually have in common. Overqualified management and this really refocusing of the organization around something I think can create a tremendous amount of value. When you say overqualified, are you basing that off of their track record that they had somewhere else and now maybe they're at a much smaller company or how are you looking at that? Yeah. So an example would be and this is not a commentary on this company's valuation. It's strictly on the overqualified. You look at somebody like Thomas Taylor at Foreign Decor. He was a superstar at Home Depot, rose through the ranks, skipped college and was managing 2,200 or 2,300 stores and then he gets tapped to go run a foreign decor when they're privately owned when they had 29 and now they've done 10X that. So that's a good example of again, somebody who worked in a larger organization has seen a business scale, knew what it took to build something similar and was hired into a company that was much smaller and he seems to be at it again. Yeah. You could also say that that could be an example if you're rewinding a decade ago of a company that was in its process of building its modes because they did have this unique warehouse model that perhaps didn't give them the pricing power and the scale and the leverage they would eventually have but you could kind of see some of it beginning. So it is interesting that that example also ties back to that. Absolutely. I think it was 29 or 30 stores when he joined another at 250 and they could double or triple that. They could have a thousand stores. We'll see time I'll tell but it's a heck of a business model. And you also make this distinction between a skilled operator versus someone who operates more as an owner operator. What is the distinction you're making there and how do you see that kind of manifest in your different investing strategies? The key there really in the owner operator approach has become pretty popular over the past 10 or so years especially since Tharnnite's book The Outsiders came out. But to me my my root goal is to invest with really talented people and they may be the founder of a business. They may not be the founder of a business but the root goal is somebody that's very talented and is steering an organization and building a business that could be many times of its current size. So yes owner operator I think it's a great a great framework but to me it's incomplete because you can't end up with situations where the owner owns a business because it was passed down through his family, his or her family or maybe they did by shares on the open market and they are an owner but they not be as talented as somebody else. So I'm just trying not to lose sight of the goal of partnering with extraordinarily talented operators and many times they're big owners but sometimes they're sometimes they're not. I was wondering what do you think of the idea that owner operator companies increases the distribution of potential outcomes because if I think of some of the best companies that have done very well over time you know we could pull up all the fang most of those are owner operated at least until pretty recently whereas at the same time some of the most spectacular failures like we work comes to mind that was an owner operated company as well and I think part of that has to do with the fact that when you are an owner of a company you have so much more leeway as to the direction of that company which can be both to the right direction what comes to mind is I don't know if you've ever looked at Axon but the CEO of Axon and the founder Rick Smith there's multiple times in that company's history they started as tasers he transitioned them later into body cams then he transitioned them into a whole digital evidence software and then a whole software platform thereafter and along the way there was always a lot of resistance to doing that but he was able to do it because of this you know quote unquote founders authority that same sort of founders authority though you could say oh well Adam Newman had that and that ended up the way that ended up and so I'm just kind of curious what do you see as some of the downsides as having the founder operator screen or filter yeah I like the way you you framed that and I could see it definitely being a double edged sword and if you said card investing is the inverse of activist investing because I'm not going to have any say in how these businesses are managed and if I don't trust management I shouldn't invest in the first place it's just other people I think have learned it's very hard to really affect meaningful change from the outside it can be done but it takes a lot of time and effort so I hear you I do can see it could be a a double edged sword an example would be when when google went public they they got a lot of negative press about the share structure that they chose that gave them a lot of control you mentioned Patrick Zalopski at dream finders homes he has economic and voting control over that company and doesn't really have to answer to anybody but himself and I can I could see it cutting both ways the other wrinkle also could be is that sometimes and this might be counterintuitive but an owner operator might be more conservative than we would like they may be hesitant to take the types of measured and calculated risks that me as someone looking to to build our family's wealth is taking they may be in the 730 thinninger their career and just be really happy living off the dividends and generating a mid single digit return so I think you're really onto something and that it can definitely cut both ways yeah that that is interesting to think about it and something else you just said that I want to point a little bit more you're talking about trusting management right and this is kind of fresh in my head I would see in specific to restoration hardware our age there's a lot of people commenting on their debt load on you know what's going on with their accounts payable and all that and you know the fact that it's been elevated over the past couple quarters and from my perspective if I'm investing with a manager who's been running you know a retail operation nearly pulled it out of bankruptcy has grown it from a negative equity value to you know several billion multiple transformations and it's been able to overcome all of that who am I to question that he doesn't know how to manage his accounts payable and so on one hand it's it would kind of suggest that you shouldn't be invested in that company if you trust management so little a retailer nevertheless that can't manage their accounts payable but I could also see it at the other end that it is kind of your job as an investor and analyst to stay on top of the company to understand what's happening and to foresee potential problems before they actually format and so I was wondering as someone who you know very much trust all of their managers how do you at the same time also kind of keep an eye on them and how much are you really critical of the way they run their business how it shows up in financials or do they really just have an open leash once you have invested with them yes it's definitely a trust but verify type situation in the investments that I make and and your point about restoration hardware which I'm only casually familiar with you think about that management team they're they're making every day small decisions that will impact the long-term value of that company they're making big decisions that will impact the value of that company such as when they did a a large repurchase a few years ago they're making small decisions that may turn out to be really big decisions but the point being they're on the inside and we're trapped on the outside and I do think if you don't trust a management team as a shareholder you're likely to bail at the wrong time and then it's probably just not not the greatest investment for Yeah, that makes sense and also kind of back to what you were earlier. you're said, you know, we also wouldn't want to take really kind of an activist position. And when you are analyzing a company and you're saying, even if you're not being vocal about it to the company or the outside world, but you're saying, oh, you don't know how to manage your accounts payable, this inventory is too high, you are kind of taking the position of an activist in a way in that you believe you know what's better for the company than the company knows themselves. >> Yeah, absolutely. And I find myself doing this as well as that the environment is really important. So if a company's not performing well, it's really easy to get picky over some smaller or trivial things, whereas if a company's doing well in the share prices is marching higher, some of the same things could be interpreted favorably. And that's a really difficult, difficult position to be in. >> Yeah, and I think it's very interesting too, because there are, of course, people that made of career as being these activist investor types and one of them in specific because we've covered Etsy before we see Paul Singer's firm was making all sorts of recommendations on Etsy. And the way I saw it was that they're talking about capital allocation and kind of these decisions, whereas at then the day, the problem with Etsy that I see is that people just don't care about homemade items that much, and that's not a solvable problem by any sort of capital allocation decision. And so I think this also kind of ties a little bit back to what you were saying earlier about turnarounds, where you were saying that you weren't interested in a turnaround where it wasn't like the core business, wasn't working, but rather it was kind of management distraction in a way, because they had all these other assets grouped together, but the core business itself was working. And I think that's an important distinction, because when a core business isn't working, it is very rare, of course, that a manager is able to come in there and turn it around. >> Absolutely, and I'm glad you picked up on that distinction with the turnarounds. And a lot of these companies, by the time an outside shareholder realizes that the company's falling apart, sometimes it's just going to be too late. These management teams are really, oftentimes really strong communicators, and when their mode is deteriorating, it just may not be apparent until it's too late. But the other thing that is really important, and I do think it's somewhat of a binary test, is how that team thinks about shareholders and what is their attitude around delusion. And if they're really zeroed in on per share value, if they may be really skilled and they may double the value of the business in five years, but if the shares are outstanding go at 50%, I'm not going to get a good return out of that. And the way that they communicate with their shareholders, whether they're treating them as partners, did they treat the shares like gold? And if they do, and they're very careful about that per share value, that tends to be a sign that what's going on on the inside is also good for shareholders. Yeah, and I think that's an important point to make. I don't know if you've ever looked at TransDime, but they put out this investor presentation, and for those that don't know, they usually have this picture of them discussing why they would do MMA. And it's kind of like this cartoon, I tweeted it out a week or so ago. But they have all these reasons listed, oh, I want to manage a larger company, I want to grow my revenues, you know, synergies, all sorts of things that people usually think of as being these virtues when you are making an acquisition, and they said all of those are wrong. The only thing that matters is increasing value per share. And so it is important, of course, to think about dilution in that equation and not getting lost in what really the purpose is there. And kind of as we're talking about these businesses that maybe aren't on the right track and all of that, I was wondering how you think about kind of investing in what you would call these stable variables. Because I'm assuming you're kind of thinking that if you're investing in these end markets or consumer preferences or assumptions that you have to make that don't really change over time, then it makes it a lot easier. Yeah, absolutely, and there's an old saying and I don't know the source of it, but it's along the lines of the cash made from a gas station is just as green as that that's from a high technology company. And I have found that a lot of these operators, there are reasons they're drawn to industrial distribution or building products or retail concepts that do have pretty stable end demand. And again, when they're trying to optimize per share value, it's helpful to be operating in an environment where the products are essential. Maybe they don't cost a whole lot, they're a part of the economy and the business might grow at GDP plus a couple percent. But when a manager is confident that 80 or 90 percent of this year's revenue is going to come back next year, they could do things like leverage the balance sheet appropriately. The effort they put into optimizing their manufacturing facilities will play off over a longer period of time. And so I don't think it's a coincidence that some of these businesses that have created tremendous wealth over decades, somebody like a fastinal or a CH Robinson, that they're operating in these seemingly mundane industries that are crucial to the functioning of the economy, and they're never the most exciting investment to make, but overall, on periods of time, they can just compound it at a very acceptable rate. And is this why you focus more on resiliency rather than diversification? Yeah, that's a good point, and maybe we'll get into portfolio construction at some point. But diversification, again, I don't think it's a complete term. It's directionally correct, but you could be diversified by owning just a bunch of different companies or different stocks or different types of securities. Or again, the root goal to me is resiliency. It's surviving the difficult times while also exposing yourself to an upside that has the potential to really change your life from an investment return. So I do think individually the businesses need to be resilient on their own, and then when you put them together, the portfolio becomes even more resilient. But I don't think you need to own 30 or 40 or 50 of them to be diversified. Do you think you can have more of a focus on just resiliency rather than diversification because ultimately your investments you only answer to yourself. You don't really have to worry about any outside allocator looking over your shoulder. 100% and this may be an unpopular opinion in some circles, but I really think the biggest advantage of a small investor has is not having to explain their investments to other people, whether it be the portfolio manager or a chief investment officer or clients, and sometimes having other people involved can help enforce discipline on your own process. But ultimately investing, I feel like when Dunwell is a very personal adventure and you need to have an approach that really fits your own personality and temperament and even history and relationship with money. And so I do think that being able to make decisions quickly and not having to answer to boards or clients is a huge advantage, although we'll say if the investments don't go well or dinner table conversations are going to be pretty uncomfortable with my life. Yeah. No, that definitely makes sense. And I think about too on the diversification point that a lot of people kind of don't focus on the actual factors that would cause the cash flows to vary or the correlations between the cash flows in businesses. And so the example I could give is that you can invest in Snapchat, Meta, and Pinterest and think that you're being diversified, but of course, ATT, the app tracking transparency app are rolled out, impacted all of them in the same type period. And so when you do think about diversification, it's not diversifying across different companies or assets, but it's really across different risks. And the risk aspect is ultimately what I would want to hone in on most. And it's interesting you're talking about not wanting to have to justify your decisions to other people because ultimately, the way I see it is that all investments have some level of risk. And when you get into a conversation with someone about the various risk and investment, let's say you're investing in Apple and they're trying to say, well, aren't you worried about China? It's their whole supply chain. It's 20% plus of their revenue, and so there's a lot of concentration there. And ultimately, you can't really argue against that. You just kind of have to say, yeah, that's a risk. That's there. And I accept that. And so I think that's one of the reasons why when you're in an investment committee, it doesn't tend to lead to great outcomes because it's hard to have a conversation where you say, that risk exists and you are correct. And if that happened, it'd be really bad, but I want to invest in it anyway. Yeah, absolutely. And I do think it's important to have people in your life and friends who invest that will push back and part of some groups on Twitter that are dedicated to specific companies. And occasionally, I'll float something out there just trying to get people to tell me how I'm wrong and to poke holes in what I'm thinking. And I do think it's really important to have people again that are going to provide you with a different perspective, be really candid with their opinions. But ultimately, look back over generations. The best investment track records were not generally made by teams or by committees. They were individuals and individuals whose names most people in this, who were listening to this podcast, would recognize. Yeah. And as much as I would really like to know why Warren Buffett invested in Paramount. I don't think we're ever going to get that answer. You know, he has that quote that. He says every day when I wake up, I look in the mirror and that's the end of all of the people who have their say. And so he's very much on board with you there. Yeah, absolutely. Since we're talking about decisions, if I may ask, what are perhaps some poor investment decisions you've made and what do you feel like you've learned from those? The one that that really bites me is there's a company win mark that owns a franchising, a bunch of retail operations. And I invested in it back, call it 15 years ago and wind up selling it in 2011 at 30 or $35 a share. And now the stock is something like $375. And it's not even that the stock made that kind of a move that causes me to get upset about missing that one. It's that John Morgan was starting a second act of his career. He had already built the one business and sold it for a huge exit. Essentially some friends asked him to come in and manage win mark. And I think I was right about partnering with with John. But the mistake was I just got too cute with valuation and thought, oh, it's a little extended here. The stock's gone on a good run. I could always get back into it if I need to, but of course that never happens. And so that's the one that I really looked back on and think I shouldn't have made that mistake. Yeah. And I could definitely say I've had similar experiences looking at a company where, especially in the valuation aspect, it gets really hard to justify. And then you kind of on the other hand say, oh, well, it's an exceptional company and exceptional companies do things you don't expect. But then if you start expecting them to do things that you previously didn't expect them to do, then it kind of gets more and more frothy. And so it is definitely tricky on that front. But since you mentioned valuation, how do you approach valuation? Yeah. And I like the way you teed that up because it is hard. It's hard. And if you go look at a lot of investors that have been really successful over time, even somebody like Lucemson at Geico said his number one mistake was selling a good company too early. Peter Lynch has said that. And you just hear it over and over and over again. And even being aware of that, it's hard not to bail on something. But what works for me, and I don't know if this will work for others, is I don't buy or sell outright based solely on valuation. If something is getting a little extended and I think the price has gone from fair to maybe a little overextended or the stock price is pulling forward too much of the future. Then I'll trim the position and recycle that capital into what I think are more attractive opportunities. But I'm not a big fan of selling just because the valuation has become a little stretched. Nor am I a fan of buying something at 50 times just because it's an incredible business. I don't know that either of those things is likely to lead to good results. If you are kind of moving in and out of positions, do you include taxes in that calculation or do you find that if you consider taxes that leads to worse decision-making? I struggle with it because again, the math is that unrealized gain is money that is still working for you and money that's not going to the government yet. But it's something I do struggle with. I have a good friend. We talk about it a lot where the stock looks extended and maybe it's grown into a 10 or 12% position for me. And that tax bill, it is in the back of my mind. I know I'm trying to avoid it. So I don't know that I have a great technique or answer for that other than being aware of it. And making sure that if I am going to sell something or trim it, it's really going into an opportunity that's exceptional and not just exceptional by a little bit, but better than what I'm selling by a wide margin. Yeah. And I kind of think about it the way you kicked off that answer, which is that the government is giving you sort of an interest-free loan on your deferred gain. And so to the extent that now you have a little bit of leverage in your position, you can essentially accept a slightly lower expected return because you have more money working for you. And so you could kind of do the math on how much your return would be lowered and all that. Having said that, you know, I've definitely heard many investors talk about how when they do start considering taxes in their investment analysis and when to sell, it usually leads to poor decisions because usually that's kind of like the end of that discussion you're having with yourself is what about taxes, whereas that discussion came up in the first place because you were probably itching to sell for some other reason. Yeah, absolutely. And I know the industry is littered with stories. And back when I worked in wealth management and a great financial crisis, I saw people do this, right? They rode some of these financial stocks essentially down to zero because they were afraid of taking a capital gain. Again, it's a difficult conversation just trying to balance again that long-term tax-free loan from the government with what's doing what's right and trying to be measured with any changes that I'm making. What about position sizing? If a position gets really big, is that a reason in and of itself to trim or would it have to be because of some other variable? The general framework that I use and the math that plugs into this is going to be different for everybody is that big but don't bet the farm. I never want a position to be so large that I'm not going to sleep well. That's really the litmus test. If I'm losing sleep over it and for one business that might be seven or eight percent, but a business that has different characteristics and a different management team, it might be fifteen percent. But I want each investment to be big enough to be able to make a meaningful impact on the portfolio. But not so large that if something goes terribly wrong, it's going to make a difference in our lifestyle. So generally, starter positions are call it two to three to four percent. But if I don't have the confidence to take that up to the high single digits, I'm generally going to move on to something else because the goal is to have a small number of stalwart positions call them eight, ten, fifteen percent, maybe even a little bit larger that are driving the returns of the portfolio. Yeah, and that makes sense that you're ultimately tying the position sizing back to the risk UC is being inherent in the investment rather than some stultified rule that is don't go higher than eight percent, which is pretty common in a lot of investment management business. They'll set a limit and it won't be on the basis of what the business does. And to me, it makes sense that the limit of how much Microsoft or Constellation you might be willing to hold would be different than how much of a smaller microcap and kind of a more volatile industry. Yeah, and I think the first time I came across this was probably ten or twenty years ago with Joel Greenblatt where he talked about his largest positions being those where he could lose the least. And I don't know that I fully appreciated that again when I was younger in my investing journey, but absolutely those largest positions should not be the ones with the biggest upside. It shouldn't be swinging for the fences. They may have a range of outcomes that is much narrower than some of the other investments, but if it's a good company being stewarded by a very capable management team and there isn't a lot of downside, I found that good things tend to happen as well. And you kind of also have tweeted a few times before different stock price charts and you want to point it out when you do that, just the amount of drawdowns that have been there along the way. And then you make the point that successful investing doesn't really feel the way that people think it does. It doesn't feel like this straight upward slope. There's a lot more involved on that. Yeah, and usually when I put something out there like that, it's a reminder to myself because there's a situation that's causing me to revisit that idea, but I do think if you'll get the experience of owning something like a Berkshire over the decades or an Amazon or even a company like Brown and Brown, the compounding always it feels linear. It doesn't feel non-linear. And tomorrow will feel a lot like today and then today feels a lot like yesterday. Unfortunately, even in the greatest businesses, the stocks are always going to be off of their highs by some amount, probably 10 or 20%. So then you're kicking yourself or not selling or trimming because the stock price was higher. But ultimately, I do think it comes down to compounding, just doesn't feel the way that we think it should. The wealth builds gradually and slowly, and then that is occasionally interrupted by a huge drawdown either because there's something going on in the market, like COVID or the financial crisis in 2007 or 2008, or it could be something company specific. But I really try to hammer it into my own mind that even investing well is going to feel uncomfortable. It's always going to be uncomfortable. And it's not easy and it just doesn't feel as rosy as looking at a stock price chart 20 years after the fact would lead you to believe. Yeah, it is kind of funny that even I could catch myself doing this where you could look retrospectively and you'd say, oh, well, of course, I would have held that that whole journey and never would have been itching to sell it at any point. And then of course, that is not your actual experience of the businesses you do really hold in. So it is kind of funny that you can see that cognitive of dissonance even currently within myself. I'm sure people have similar experiences. - Yeah, and just being aware of that, and this is a real example, I'd rather not say who that company is, but there's a CEO, I think's building a really incredible organization. He's been at it for six years, and he's compounded at 24% a year. So it's probably a number most people would be happy with. The stock was $17 on the day he took over, and the ride has been $17 to $34 to $11, to $86 to $33 to $43 to $21, and now it's around $60. So again, 24%, 25% a year for six years is an incredible return, but that ride has been very difficult. And if you truly don't believe in the management team, and they're long-term vision and what they're building, you're gonna get shaken off the horse at the wrong time. - Yeah, and that also kind of demonstrates nicely that a lot of times these higher returning opportunities do tend to come with a lot more volatility over time. And so, in a way, you're quote unquote, paying for that return with all of the emotional pain alongside that ride. - Absolutely, yeah, absolutely. There's an old hedge fund guy, Andy Kessler, and one of his line was markets trade for maximum pain, and it's absolutely true, it's absolutely true. - Yeah, and we were talking a little bit about decision quality, and when you sell, will you ever allow kind of macro indicators or your thoughts on the economy to influence that decision, or is that just kind of the way I think of it, sometimes is that you're trading off something you maybe have high confidence in, which is what the business does for something you have low confidence in, which is what the economy may do in the future. - Yeah, ignoring the economy is a lot easier said than done, especially when so much of the information that is really thrown at investors every day on CNBC, or in the Wall Street Journal, or in the local news, or even what they're experiencing in their personal lives is related to the economy. I can't say that I've ever made a decision based on an economic projection, but where I have made a decision is really when it gets down to the industry level. I want the company to be operating an environment where it has some tailwinds, long-term tailwinds, or maybe short-term tailwinds due to macrofactors, but really thinking about, does the company have the wind at its back? Did the company's competitors have the wind at their back? Because maybe they'll be a little less aggressive about going after each other's profits when they're in a more favorable economic environment. - And maybe if I can ask what might sound like a silly question, what counts as macro indicators that maybe you're not looking at that much, but that kind of could potentially influence your investment. And I guess I'm asking this question because every business you invest in, they all have these insuptions embedded in them. And if you're parsing out enough of these assumptions, they're tying in some way back to the background economy. And if we go too far and we're getting to interest rate assumptions, it's kind of hard to know, but maybe for something like demographics, that could be an important element in a company. And so we've looked at Kupong and one of the pushbacks we get a lot of times is that the Korean population isn't growing, it could be slightly shrinking. And so that's gonna be a headway for a long time. And so I don't know if that's strictly speaking counts as macro or not, but I was curious what your opinions are on all that. - Yeah, where I feel like it's tangible enough to make a difference is at the level of something like housing inventory. You could cut the numbers in a dozen different ways, but in the magnitude of our housing shortage could be debated till we're all booing the face, but it's pretty hard to look at the economy and look at the number of houses that are being built and to look at the household formation and household ownership rates and to think we're gonna need fewer houses five years from now or 10 years from now than we do now. So investing in a company that's selling into that market is likely to have a long term tailwind at their back. Another example in the investment industry would be something like alternative investments in a company like Brookfield asset management. I don't know for sure, but I'm pretty confident that in the future investors are gonna be allocating more of their portfolio to non-traditional assets than they are today, and that Brookfield and some of the competitors are gonna take share of wallet. And so those are the types of long term trends that I think you could bank on a little bit and that again provide those tailwinds for these businesses. - Yeah, and I'm glad you brought up housing 'cause I actually had that same sort of debate with myself internally 'cause on the one hand, you can point to the things you pointed to, household formation, a number of houses being built, what inventory is, and then on the other hand, though ultimately, it's really just affordability because as long as you can't afford the house, it doesn't matter how many are being built or how much of a gap there is between home formation and the number of homes that exist. As long as it's not affordable, you'll never be able to buy the home and so I could see it both ways in a way because if you are looking at someone like a home builder, what ultimately gets someone to buy a home is that they can afford it. And so that's been something where I've kind of had a little bit of an internal dialogue there because I don't know if you're looking at household formation, it ever is gonna actually tell you whether or not a home is gonna be sold. And we can all just kind of assume that people would prefer to live in homes than live in apartments and that's a fair assumption to make, but again, doesn't it just ultimately come back to affordability? - Yeah, I think it does in a lot of a sudden this situation where our barrage is at two and three quarters or something, right? And so the probability of us moving into something else in your terms pretty low. Well, say it's really interesting to see how markets and people adapt. One thing that's really common today that I've seen a number of times is parents giving their children money so that they could afford their first home and they could afford that down payment. And that was something that at least how I grew up was unheard of 20 or 30 years ago. It's just I can't ever recall that happening, but it seems to be very common. So people do adapt and adjust and some of those things are really unpredictable. We're just doing the best that we can to try to play in a good sandbox. - Maybe shifting gears a little bit. How do you think about kind of the capital light approach to investing because that's kind of been a very popular way for people to screen for what they would assume to be these high ROIC companies is they'd say, oh, it's capital light and they're kind of suggesting when they say that it's a high quality company. And so I'm kind of curious your thoughts on whether or not there's really any information in it. - Yeah, I'll approach it from two angles. One, the investment angle and then second, the business angle. I do think it pays to just be skeptical when a lot of investors are rhyming with one another and pursuing a very similar approach. Each market cycle since I've been investing has always had a factor or a style or an approach that paid off disproportionately, relative to other approaches. And the people that were aligned with it think they found the holy grail of investing. And this certainly happened to me earlier in my career. I think you're really susceptible to it if you're younger and just learning how to invest. And these capital light companies, many of them have been rewarded with really high multiples and that multiple expansion has led to some great returns. But I do think it pays just to be a little cautious about the approach. And that ties into the business angle which is being capital light when your business is based on intangible assets or based on goodwill, it does improve the company's ability to grow in scale and to become profitable very quickly. And to really generate those outsized economic returns. But I do think there are two sides of the coin and maybe we haven't seen the other side of the coin yet which is that some of these businesses, not all of them, some of them may be more susceptible to competitors coming out of left field. Things we haven't even thought of yet. And when the value of your business isn't underpinned by tangible assets, like a railroad or high quality office buildings, I do think there's just a risk that something we're not anticipating could come and displace them just as quickly as they could. So again, there are certainly advantages to investing in capital light businesses. But I've become a little cautious when I hear a lot of people talking that way. And again, would be a little skeptical of taking a broad-paced approach. I would rather take an approach that's a little more balanced than includes that is just one part of it. - Yeah. I think that makes sense because if you think of some of the capital light companies historically, you could have looked at my space, maybe even Alibaba, and you could look at these and say, oh, they're social media. That they're one's an e-commerce marketplace. They don't have a lot of capital tied into it. And because of that, they're very high margins or they're able to throw off a lot of cash. But at the same time, it also, they didn't have a lot of moats that turned out. It's not necessarily because they didn't have tangible assets invested, but the two do sometimes tend to correlate where it was very easy for people to leave my space and go elsewhere. It was very easy for Zuckerberg to spin up Facebook. It didn't take a lot of initial capital to do that. And similarly, in China, for the competitors against Alibaba, they were also able to move people to their own e-commerce sites. And so in contrast, you could say someone like Amazon who, once they kind of had their marketplace built out, they had their website people were going to, they did the really expensive thing of building out a logistics network. And now when you see a threat like Timo come and try to pressure Amazon, they're like we have 150 billion plus of logistics expenses that you have to replicate before you could get anywhere near us on one day shipping before even all the other advantages. And so it does seem that I agree with you where people focus too much on kind of the capital that is invested in the company rather than the return on that capital. I think the corollary point there too is that actually you want them to have the ability to invest a lot of capital in their business because you as a shareholder want to continue to benefit from having your capital reinvested at a high rate of return and not being forced to reinvest it yourself. Yeah absolutely and there's an old story from early in Amazon's days and they were actually think about pairing up with eBay and the eBay executive said why would we want to own all of these assets pointing at Amazon's logistics network and fulfillment space they had. And of course what they have now is just an incredible footprint here we we have a little game to see how fast packages come to our house and occasion I'll post them on Twitter but sometimes it's two to three hours from click to doorstep for you know a consumer good which is which is just incredible and I can't think of anybody who's even remotely close to that and they are really creative in thinking about how to leverage that physical footprint. And gosh anybody who tries to duplicate that is just going to have to spend hundreds of billions of dollars in today's dollars right which are more expensive than yesterday's dollars given the inflation that we've seen which again with all the focus on capital like company something like Amazon's logistics network is is just an incredible asset. And maybe switching gears a little bit I'm curious because it sounds like you're invested in a variety of different companies so how do you source different investment opportunities. This is an area where my approach has changed a lot over the years and I used to spend a lot of time running screens and actively looking for the next great investment but for me I found that it led to more unforced errors I would find that I'd spend a lot of time researching something and then in the back of your mind it's I don't want that to be wasted and maybe I buy something that I that I shouldn't have but it really shifted to just trying to stay alert talking to interesting people I might be investigating one company and that leads to another but I'm personally don't spend a lot of time just turning over rocks to turn up for the sake of turning over rocks. And it's just staying aware and waiting for something to to stand out and for something to really really kind of smack you in the face as while this management team is is exceptional or they experience in another area that can be really valuable for this new company that they're at. But there are years where I do very little and there are months where I might have two or three new positions and it's it's really unpredictable the pace at which they arrive. But I think the key point is just trying not to force it sometimes when you try too hard it leads to at least unforced errors and for me that wasn't very helpful. And I'll say people people like you the work that you're doing at speed well other people on Twitter I've gotten some incredible ideas from that network really life changing ideas and just talking to interesting people tends to surface a lot of good investment opportunities. Yeah well we do appreciate that I am curious you said it when an investment kind of smacks you in the face and I was curious what kind of defines being smacked in the face by an investment because I can say personally if I looked at or read let's say you know dream finders homes Patrick's loop skis shareholder letter that was a very interesting shareholder letter to me and if I looked at maybe a company like copart just learning a little bit about their notes it's a very interesting industry that also would make me really interested in it. Whereas in contrast I could just look at metas financials depending on what period and you just say wow and it would really be the financials I could do it in that case and so I know there's probably it depends but what really to you is being smacked in the face by an investment. Two things stand out and one I'll use in as an example there's a guy named Jay Henneck up in Canada and he controls two companies now first service and colors international and if you look at Jay's story and I first came across him almost 20 years ago he started with a thousand dollars in high school and he created a lifeguarding business where he'd hire his buddies and farm them up to different pools and then he went into pool maintenance and property management and ultimately into commercial property brokerage but you look at somebody like Jay who started with literally a thousand dollars and is created to multi billion dollar organizations along the way he beat cancer twice that's the type of person I want to partner with and there aren't any signs of him really slowing down. So that's one looking at at their track record petrises up ski as a similar story right the guy started with with negative equity alone from a small commercial bank couldn't even afford to buy the lots that they built their first homes on until after they they sold the homes and he's built an organization that from a scratch start that I'll close eight thousand or so homes this year the companies were three billion dollars he's personally a billionaire. So again looking where somebody started and where they've wound up is really helpful the second softer thing and it comes back to management's track record is what gets me really kind of uncontrollably excited is when I find a management team that has demonstrated the ability to pull multiple levers and creating value per share. They know how to operate a business very well they know how to acquire they know how to leverage the balance sheet. The approach they have to share repurchases is generally episodic and very opportunistic they may not pay a regular dividend but they pay a special dividend. When I find a management team that they could pull I have confidence can pull all of those levers that gives me a lot of confidence in their ability to navigate a future that's really uncertain and can navigate different economic environments and can navigate different different competitive threats and frankly change change the business based on whatever circumstances are present at the time so. A lot of it does come back to again there are a lot of great operators out there there are a lot of people that could raise money there are a lot of investors or operators that could that could acquire but I find very few management teams can do. All of those things and doing all of them well is what I think will generate the exceptional returns over all periods of time yeah and I think your answer just gave a lot of credence to why we spend so much time focusing on the history in the background story. When we do write a company up because if you read you know a typical sell side analyst report they're talking about end markets and tams and a hundred graphs whereas we'll just start similar to kind of what you were saying about some of these entrepreneurs here's how they started the business and kind of just going to that story because I agree that that tells so much more about the business. It is a little harder though because that's not something that shows up in the annual report typically you do kind of have to search for that a little bit more. Yeah you do and you have to go through the history and again something like a company's share repurchase program right the kind of the least attractive program is somebody who's doing it to offset. Off set the options solution right a neutral approach is somebody who does it kind of consistently over all periods of time with our excess cash flow whereas you know an approach that would that would lead me to believe they're being a little bit more systematic about it is the stock price gets hit really hard because it concerns about the economy. And they ramp up a big stock buyback and they buy back a huge percentage of the float and then when the stock rebounds they peel off of it again these behaviors tend to be somewhat unpredictable and dependent on the environment that they're operating in but I think they're all signs of a management team that's zeroed in on per share value which is ultimately what's going to drive the returns for for shareholders. And we've talked a bit about how you gain confidence in the management teams you've talked about the importance of the track record you know in the story kind of underlying these different entrepreneurial endeavors my question is have you ever lost confidence in a management team. Yeah and I generally find that it happens gradually and then suddenly and every year I might kind of buy one or two things and sell one or two things and but yeah I generally always confidence but I find that if I'm having that debate with myself that it that itself is a sign that maybe it's a company I shouldn't own and oftentimes it's not it's not one big thing that has happened it's it's a bunch of small things that have added up. But they're just for public market investors especially smaller investors who do have the ability to invest in microcapped companies and small companies that institutions can't touch they're just too many opportunities out there to waste time and energy and money on an idea that that is just kind of average. Do you have an example and you don't need to say the name of the company if you don't want but I'm just curious what were the things that you were seeing that made you lose confidence. Yes so there was one and it was a stock I probably own for five or six years and it wasn't a terrible investment but it did pretty much just tread water while the market rose so the opportunity cost was really high but I'll say management was really explicit with meeting with investors and saying the NAV over their company was twice the stock price and the market misunderstood it for these reasons and they tried to improve their reporting to close that gap. But then they went out and bought a bunch of land and embarked on this project that was going to take decades to execute on and consume tremendous amounts of capital. And they just couldn't go along with it. Again, if you truly believe that your stock is trading at half its value and have high confidence in that estimate, you should just be buying back the stock counterver fist. Not tying up capital in long-term projects that have maybe questionable returns or certainly more uncertain returns. Another would be there's a small company and I was just really confident that this management team wasn't going to dilute shareholders and there was an offering that I didn't expect. Of course the reason for doing it sounds okay and the investments are going to make with it. But I just lost confidence that they were really zeroed in on per share value and that my stake wasn't going to get diluted to an uneconomic place in the future. I'm curious on that first example you gave. You were talking about how the management team was going out and they were talking about NAV and how undervalued it is kind of looping back to earlier in our discussion where we talked about how a lot of these managers tend to be press shy. You consider that to be a red flag in and of itself if a company is very obsessed with how the market is valuing their stock. I think it can be but what gets under my skin more is when their actions don't align. Again, if you could try to jawbone the stock higher all you want and give all the investor presentations all day alone but if you truly believe the stock is trading the huge discount and you have the cash flow or the capital available you should just be buying it back hand over fist. So it's a situation where the actions to me mean ten times more than the words and if those two things are saying different things I'm going to rely on the actions all day long. How focused are you on sort of quarterly earnings and reading into what management says on a quarter to quarter basis versus if something doesn't look like it's really developing the way you expect it to giving them the leash and the leeway and maybe this kind of goes back to what you're saying how you're losing confidence slowly and then quickly or all of a sudden how do you kind of deal with this more incremental dripping of information that may come out over time as you're kind of updating your a priori thesis on a company. So one thing that I found that works for me is that a very rarely review an earnings report or listen to the conference call immediately that afternoon or the morning that they reported like to let things settle down a little bit because I find I'm just able to evaluate it without a lot of the noise that comes immediately around those reporting periods. I will say I think there's some value in terms of following companies over really long periods of time and listening to their calls and if there's a scenario where say a management team has been playing defense a lot for one reason or another and all of a sudden you could tell they're shifting to playing offense that that could be a really valuable signal for the business. So again I try not to put too much emphasis on the quarterly returns but ultimately again 10 years returns are just a bunch of quarters strung together. So I try to approach them with realizing they're important but also being aware that it's really easy to to overreact especially when stock prices are moving so quickly these days either pre market or post market around the earnings reports. Yeah and that all makes sense or I guess two questions my first one is how do you think about kind of coming about conservative or relatively conservative assumptions when you're thinking about the valuation of a stock because you could kind of make two mistakes in evaluation. You could either assume something too ambitiously that doesn't happen or you could be too conservative and then thus miss the opportunity because you have too much of a margin of safety. So how do you kind of weigh those two when you're thinking about you know the prospects for a business? A few things and one of the pieces that you all published that I think hits on this is the piece you talked about Home Depot in the late 1990s and what was baked into the stock at the time and I've read that piece multiple times because I think it's on some really fundamental questions and what would happen if things went right and the company was able to grow at a higher rate of a longer period of time. I think where I learned this lesson though is back in fund management the fund I helped manage we owned some companies that just went on to be incredible investments over time. Companies like when Mark that I talked through earlier but we never owned them. We never harvested those results and it took me a while to figure out why and I think a key reason was that we really did value being conservative. There's no shame in coming to the table with a model that says hey this thing's going to grow at four or five percent and margins are going to level off. You're not going to get in trouble for having those kinds of assumptions but to capture big returns it do you think it's important to value being accurate over being overly conservative. And if there are reasons a company could grow at twice GDP to work through that math and what that might that might look like and so I think it's just it's valuable not to lose sight of the goal is to be right and the goal is to be accurate and while there can be some pride in being overly conservative that might lead to leading some money on the table. Yeah and I like the way you phrase that where you said it's being accurate over being conservative because what I've seen some investors do is they don't feel comfortable making an assumption so they'll haircut it and then they'll get a sort of valuation and then they'll say well I need a margin of safety so I'll haircut it again and they'll have these kind of multiple layers of conservatism baked into their valuation and it is just so far off of what reality would actually be if you're kind of seeing what the implied assumptions would be and maybe they don't ever end up losing money that way but they're also not really doing their job which is to try to of course deploy capital at attractive rates of return and so it is a good framing to kind of say you want to be accurate more than really the goal is to be conservatives of course though you still don't want to lose money. Yeah absolutely and somebody could rightfully say oh well not being conservative is something that investors say in the middle of a bull market and that's fair as well but I also think your question hits on it's interesting to think about some of these companies like again like fast and all or Simpson manufacturing or C.H. Robinson or AutoZone for that sake and say why were they misunderstood or mispriced for so long and in some case even decades and to your point I think it gets to the issue that there's always something more exciting to do than invest in an industrial distributor there's probably always ten or a hundred things more exciting to do than invest in one of these companies and as a result the companies like this traded a premium but it's really not a premium that's large enough to compensate for the durability of their growth and that results in an investment opportunity that just kind of hides in plain sight and potentially position investors to earn again it's never going to go up 50% in a year but earning 12 14 16% over 10 or 15 or 20 years can be incredibly powerful. And I think that's also a second answer to why successful investing doesn't feel the way people expect it will because it's not always investing in you know the next Google or Airbnb or some sort of exciting company that's making a transformation a lot of times it could be you know they focus on manufacturing they focus on HVAC and it's a pretty boring business but they just execute so consistently that they continue to grow per share value and so it may not feel like you're every day describing that business to people and thrilled about how they're changing the world but they are making these slow developments I compound on each other over time yeah absolutely or a company like Aon which is in the industrial HVAC space which you could about 15 or 20 years ago and just made a tremendous return but again industrial heating and air conditioning companies don't get people excited at the Christmas holiday party and this result not a lot of people not a lot of people invest in them. Yeah and kind of wrapping this up I am curious what businesses would you recommend people study that you think an analyst could kind of gain the most understanding and perhaps some sort of novel learnings that you learn from these businesses yourself when you studied them. Yeah so there's there's a reason that one of the few articles I've linked to the website is an overview on Henry Singleton and it's probably the most common answer that a lot of people are going to give is a study teladine but again somebody who demonstrated the ability to pull multiple capital allocation levers in a really rational way to create tremendous value he's the gold standard for that and that's why I read that article a couple of times a year. A case study that I think is really fascinating is we've talked a little bit about Home Depot but going back to see when they changed gears they were a growth oriented company the whole organization was really geared around growing the number of boxes that they had and they reached a point where they became oversaturated they had too many stores and then they changed gears they said we're not going to open as many stores we're going to focus on the economic return of the assets that we have in place and that change at the time was interpreted like oh they're giving up right they've they've done everything they can but the stock is up something like 15 fold since then. So that's a good example of a company that's changing its capital allocation policies to match where they are in their corporate life cycle and to match where they are from a competitive standpoint that has been really valuable as well. A third one, one that's more of a live situation, it's really interesting is there's a company distribution solutions group and this is kind of an odd duck in that it's a billion and a half dollar company that trades like a million dollars worth of shares a day because it's so closely held. But if someone's kicking themselves over missing a fast and all or a grandeur over the years, studying something like distribution solutions group that is steered by a really capable operator in my opinion and Brian King, it's kind of a live example of something where some really interesting things are going on. Great, that does sound interesting. Maybe we'll have to talk more about that on another time. But thank you so much for coming on the podcast. If you do not currently follow sidecar investors, you definitely should. We'll link to his Twitter in the show notes as well as his website and I really enjoyed this. Thank you so much. Yeah, it's been my pleasure and I always am excited when the work that you all do hits my inbox. It feels a bit like going to church because you're reinforcing the fundamental things that are really important to being a great investor over time. So thank you all for the work that you're doing and look forward to seeing what you accomplish in the future. Thank you. Really do appreciate that. Until next time. [BLANK_AUDIO]