[00:03:09] Tobias Carlisle: The event that most immediately precedes the recession, though, is not the inversion, it’s the normalization when it goes back to normal, which is usually because the Fed has achieved its end. The economy has cooled down, and so they drop rates at that point, but the lag is like two years, so the lag is so long, that it’s that two years that follow that normalization when the rates go back down, that you see all of the effects of that inversion flow through the economy, and so we just haven’t seen any of those effects yet, we still are inverted, there was, it looked like we were normalizing last year, but that was, this is really insane, nobody needs to know any of this stuff, but that, This is because the tenure was rallying, and they call that a ball steepened, which is a good thing, but then it fell back down again, so now we’re deeply inverted.

[00:03:57] Tobias Carlisle: The upshot of all of that is that the macro picture is incredibly confusing to very bearish. And you add on top of that, that there’s a, an election for the president this year. So the news cycle is going to be an absolute nightmare until that happens. And so for my own sanity, and I had to look at what happened over that.

[00:04:17] Tobias Carlisle: So last year, I actually had a pretty good year in the market. Deep value had a pretty good year. I had a pretty good year, outperformed the market. returned pretty well, despite the fact that everything was so negative. And I was bearish all year long and I thought it’s probably, it’s not, I need to explain the way that I invest, which is that I’m fully invested all the time.

[00:04:34] Tobias Carlisle: I’ve got half of my investment life or more in front of me. I’ve got half of my life and probably 80 percent of my investment life in front of me. I think that if you don’t know what’s happening, which is the position that really, I am in, then the best way to do that is you just, I just buy the cheapest stuff and just let that kind of take care of itself.

[00:04:52] Tobias Carlisle: Cause there are examples where the early two thousands, the macro was terrible, the stock market crash, but value stocks did very well. And it would be. It would have been a disaster if you were following the macro in the market and you were out of value because it did so well when the market didn’t do very well. And so I think there’s a reasonable chance that happens again, but I don’t know.

[00:05:11] Hari Ramachandra: Yeah, great point, Toby. But one of the things that I see in the market today is like back in say 2001, a lot of stocks were down. The overall P ratios on the index were down. We don’t see none of those at the index level, at least, and maybe that is cued by the magnificent seven and few stocks.

[00:05:31] Hari Ramachandra: So I think that’s probably the point where people like you who are stock pickers probably will be able to find stocks that are reasonably priced rather than just buying the index at this point of time. So it’s a very interesting time and also your comments reminded me of what Stanley Druckenmiller said in a talk, a year back, I guess. He said, recently none of my gauges work anymore because of the Fed trying to manipulate the market now the government has also joined in with their fiscal stimulus and stuff like that. So I’m pretty sure Stanley Druckenmiller will be even more frustrated.

[00:06:13] Tobias Carlisle: Well, that’s right. It’s also the federal government running deficits of like eight to 10 percent a year. So you’ve got an incredibly confusing picture and I can’t unpick it.

[00:06:24] Stig Brodersen: But you know, it’s terrible, you know, I, cause I, I feel the same way as you guys. Being raised at the church of Buffett and Munger, we’re supposed not to talk about macro, think about macro, and then whenever we meet up and we just start talking about macro, you know, it’s just, this is very difficult not to, and, you know, Ray Dalio has this wonderful quote where he talks about that he has made more money from what he doesn’t know than what he does know, which I think is also a testament to what Toby said before about, you know, if you don’t really know what’s going to happen, and let’s be honest, we don’t know what’s going to happen.

[00:06:55] Stig Brodersen: Well, it’s just, you know, it’s, it goes back to the whole thing. It’s time in the market, not timing the market. So whatever your approach is, whether it’s Toby’s approach with finding stocks with the lowest multiples and then time in the market, or perhaps it’s a bit more like Hari and I, who are picking more individual stocks and not using the basket approach, like the principles in that case are still the same.

[00:07:15] Stig Brodersen: Hari, we were drawing straws before we started the episode, and please go ahead and present your stock pick here for today.

[00:07:23] Hari Ramachandra: Yeah, thank you, Stig. Yeah, thank you for getting us back to the track and my pick today is Disney. I believe I might have pitched it in the show sometime in the past, but I was tempted to bring it back in because of the recent events in the past one year.

[00:07:41] Hari Ramachandra: Disney is one of those talks that I have been following for a long time because I have two kids and we go to Disneyland at least once a year. So it’s almost like a scuttlebutt. investment for me because I see their product. My kids are watching Disney Plus channel most of the time. It’s one streaming service.

[00:08:03] Hari Ramachandra: It’s almost like a ransomware for me. I can’t cancel it for the peace of mind. So I thought it might be a good pick from the perspective of the recent changes. Bob Iger is back for people who are not following Disney from a stock perspective. Disney went through a lot of turmoil, especially during the COVID.

[00:08:25] Hari Ramachandra: That’s around the point when Bob Iger decided to retire and pass it on to a new CEO Chapek and Covid hit their parks, took a hit obviously, because nobody was going anywhere. We had shutdowns everywhere. They had to shut down their parks, so their revenues kind of stopped flowing suddenly. At the same time, movie theaters were closing down because of Covid.

[00:08:53] Hari Ramachandra: So business businesses like mainly three or four pillars, as you can see, one is their entertainment business, which is the studio businesses, which churn out movies or episodes. animation, as well as full feature movies. Then they have their theme parks and experiences, as they call it, which is their cruise, their theme parks, and their hotels.

[00:09:20] Hari Ramachandra: And then they have their television business, the cable television business. And then now they’re investing a lot in their new streaming direct to consumer business. So they’re like four pillars. And during COVID, except for their television and direct to consumer business, everything else was pretty much shut down.

[00:09:40] Hari Ramachandra: So what happened was, as a result, in 2020, their cash flows, and then their revenue, everything took a hit to the point where their cash flow, where pre cash flow went down from six or seven billion dollars a year to one billion dollars. So they were really down and out. On top of that, things had already been set in motion to grow the streaming direct to consumer business.

[00:10:10] Hari Ramachandra: So they were spending a lot of money producing content for Disney Plus, but the way it was priced was that it was not making money for them. So they were bleeding cash and, in that aspect, as well. Now adding to this injury, Was their battle with the Florida governor. A lot of other issues that they were facing, both internally within the employees, outside with agencies, that caused a lot of distraction.

[00:10:38] Hari Ramachandra: And on top of that, within the organization, there were decisions made where they tried to centralize some of the decision makers. So, which disenfranchised a lot of creative executives running each of the individual groups, especially in the studio. And this caused a lot of churn within the organization.

[00:11:01] Hari Ramachandra: I believe the CFO went to the board asking for the CEO to be ousted and Bob Iger to be brought back in. And then finally the board decided to bring Bob Iger back. So, that’s kind of a short. History or recap of what has happened in the last three years or so. So, this is a classic case where many things have gone wrong for a company with a strong moat.

[00:11:32] Hari Ramachandra: But why do I say it still has a strong moat? Because they have certain businesses like their theme park business. that even if you have billions of dollars, it’s really hard to recreate the experience. I and Stig were just talking before the show. Stig and his family traveled all the way to Paris to go to Disneyland.

[00:11:53] Hari Ramachandra: A lot of people here in the US make the trek to either Florida or to the Los Angeles Disneyland or Disney World at least once a year. So it’s kind of a family tradition for many.

[00:12:07] Stig Brodersen: To your point about the strength of the brand, we booked tickets just before COVID, obviously everything got cancelled, we lost all our money, and we are still rebooking to go there, so, I mean, that’s how much you want to please, you know, the kids and the family, and so, to your point before, Hari, about strength, like, I have a hard time seeing, and this is probably just anecdotal, I have a hard time seeing which other amusement parks that have that power, And actually the way this came about, this is not even for, you know, my own kids.

[00:12:40] Stig Brodersen: I don’t have any kids. These are for my nieces. And how this went about was that whenever they were born, they had a book that everyone could write in. And I apparently, cause, cause I unfortunately saw it later was that I wrote in that whenever you’re old enough, I’m going to take you to Disneyland, which my sister of course reminded me whenever they were that age where we could go to Disneyland with them.

[00:13:00] Stig Brodersen: But it’s like completely forgotten, you know, it is what it is. And I made a promise. Of course we’re going to go. And perhaps it’s just because I have all these warm, fuzzy feelings for Disney, I don’t know what the reason is, but I just couldn’t, I couldn’t think of any other brand I would, or in this category of amusement parks that I would do that with. So, Hari, I feel your pain.

[00:13:21] Tobias Carlisle: Could I just throw a, play devil’s advocate for a moment, because I have a 10 year old girl, and she read all the Harry Potter books, and then read them all again, and because she loved them so much, she was desperate to go to Harry Potter World. And Harry Potter World lives at Universal Studios and there’s one in Los Angeles and there’s one in Miami.

[00:13:40] Tobias Carlisle: Oh, there’s one in Florida. Sorry. I don’t know where it is in Florida. And so she doesn’t have a Disney princess who she loves because the last one that came out that she sort of connected to was Elsa, which was which she regards sort of being something that was, that happened when she was very young and it’s not anything she’s connected with.

[00:13:57] Tobias Carlisle: So I think that there is genuine competition out there in the form of Universal, not so much in Europe, but certainly over here. And it sort of speaks a little bit to the how important the IP is. If you connect to the IP, then you’ve got a customer for life. And if you don’t and it misses you, then, you know, they’ll connect to something else. And in this case, it’s a Harry Potter.

[00:14:19] Hari Ramachandra: Yeah, I think no doubt that any mode is dynamic in the sense it’s either building or it’s eroding. And Toby actually brings up a very good point and that’s one of the things that I was just mentioning earlier that in the past three to four years, things that happen in the company, especially in the organization now, centralizing some of the chain of commands, not giving enough freedom to the creative executives.

[00:14:47] Hari Ramachandra: Has caused Disney in terms of churning out new product and the to add to the bear case that Toby just made Mickey the original Mickey recently lost its IP The Disney lost its IP for the real original Mickey Mouse Not the one that we are all familiar with but the first one which is the black and white Mickey Mouse that was created by Walt Disney So, they do need to continuously bring in new characters and continue to invest in their existing characters.

[00:15:18] Hari Ramachandra: So, definitely granted but at the same time, what I’ve seen is, between age 1 and 7, it’s almost like a default setting for most parents, that they just take their kids to Disneyland. Because the kids haven’t really formed clear opinions. But by the time they come to teenager, anyway, they won’t listen to you.

[00:15:42] Hari Ramachandra: So, that’s a different issue. But up to six, you get to do whatever you want. So, you just take them to the Disneyland. But at the same time, a lot of us have grown up with Disney characters. I think our generation, as just Stig was mentioning, it’s almost like Apple’s strategy of giving out Apple laptops to schools for cheap or free so they catch them in the ring.

[00:16:04] Hari Ramachandra: I think that’s another thing that is going for Disney. But nonetheless, like even if you look at revenues, I think Disney theme parks made around 23 24 billion dollars last, this year, in 2023 last year. Whereas Universal Studios made around 8 billion. So definitely Disney still is leading the pack, but there are risks that slowly that can erode if they don’t continue to invest.

[00:16:29] Hari Ramachandra: So I agree with that. So that’s one, one part. The other part is they are in a, the way I look at it is that, is this a company that is in a short term or a temporary turmoil? Is it a value trap where it’s gradually eroding its mode? Almost like IBM, right? Like it’s on a decline. And my sense is I go back to Buffett when he talked about Disney a long time back and why he would, and I’m, by the way, but Buffett hasn’t bought Disney, so that doesn’t really support my case.

[00:17:04] Hari Ramachandra: But still, I think he was a big fan of Disney. But my point is, in case of consumer businesses, to erode the mindshare takes a lot of effort by the management in the negative sense. And I’m assuming that, you know, Disney, by the change of management and the change of strategy, is setting up itself. for the future where they can actually have the best leverage.

[00:17:29] Hari Ramachandra: If I think about Disney, how they’re setting themselves up today, their cable business is a dead weight for them. So I’m hearing news that they’re going to get rid of most of it, become lean, but their streaming business plus their theme park business is a unique combination where they can establish direct consumer relationship, have data, even offer deals for their customers, bring them to the theme park and form that vicious cycle and then sell merchandise through their streaming platforms or their online presence. And in theme park, that’s a model I see, which none of the other businesses, whether it is universal studio or Netflix, they cannot replicate that because they don’t have this two components to it, but they had to invest a lot of money initially and sink a lot of money.

[00:18:22] Hari Ramachandra: In fact, to bring up Disney Plus, scale it up, I think today, Disney Plus fares as number three, with 16 percent of share, with Netflix 24 percent and Prime as 21%. So they’re up there among the top. And they have a pretty big international presence, which they didn’t have before. So now they can capture more hearts and minds.

[00:18:48] Hari Ramachandra: And in many countries across the world, the soft core of the United States, one of the visible presence, apart from Coca Cola, is Disney. That’s how people connect, basically. And they can really leverage that in expanding. Putting in a lot of money, I believe, like, every year, three to four billion dollars for the next few years they’re planning to spend on expanding their theme parks.

[00:19:15] Hari Ramachandra: And at the same time, if they can bring back that mojo into their studios and be more effective and more creative and not just go on with sequels after sequels of the same characters. I think they have a chance to really turn around and all they have to do is today their free cash flow is 4 billion, 4.8 billion or so.

[00:19:40] Hari Ramachandra: If they can get back to what they were in 20 14, 20 15 of around $7 billion, which is pre covid with the investments and streaming, stabilizing. With the theme park business coming back up online with their experience business coming up back online and also, they are cutting down fat. They have already started stated and started.

[00:20:05] Hari Ramachandra: I believe their EPS used to be. around four-six. Four to six. Actually, back in 2018, they were at 6.26 dollars. If they get there, their P ratio will be like 18 to 20, which is a reasonable P ratio, even via zero moderate growth for them to pay. And that would mean it’ll be one third of the P ratio today. So almost like, you know.

[00:20:42] Hari Ramachandra: At least two, two and a half times the stock price today. So today they’re selling it around two times revenue. So all these factors makes me feel that one, a company that will fade away in the future, my answer is most likely no, because there are at least based on my experience and as Stig was mentioning, based on his experience, we still see this one to 10 year olds are still hooked onto Disney streaming service. They’re still hooked on to Mickey Mouse and other characters of Disney. And to Toby’s point, for example, my daughter is hooked to Doc McStuffins, which is another Disney character. So they are churning out new characters too. So I believe that they can be a very attractive takeover target at 170 billion to 180 billion market cap today.

[00:21:42] Hari Ramachandra: Or they’re going to be making really hard changes in the next couple of years and coming out of it more efficient and lean with improved earnings in terms of EPS that stock market will reward them. And of course that cut their dividends. So once they are in a better health, I’m assuming they’ll reinstate or recover their dividends as well, which will make them more attractive.

[00:22:09] Hari Ramachandra: So from my holding periods are usually five years or more for a stock. So one of my tests when I’m deciding on whether to buy a stock is, am I comfortable holding it for five years? In this case, based on all the factors I said, I’m borderline comfortable because there is a factor of uncertainty that some of these bets might not work out.

[00:22:35] Hari Ramachandra: But based on the model I said, the direct to consumer streaming, theme park, merchandise, and experience. forming like a flywheel and creating that relationship. It’s almost like Amazon Prime with their video as well as their membership service. They form a flywheel. I don’t see Netflix or any other HBO Max having that kind of a relationship with their customers.

[00:23:00] Hari Ramachandra: So that gives me a bit more confidence on Disney compared to other streaming providers. So that is my pick, but now I want to hear more about from you guys, from a financials perspective and a valuation perspective, do you think it’s cheap or if it’s a value trap?

[00:23:17] Stig Brodersen: In terms of valuation, I think it’s important to, and I’m looking here at the numbers, which I know it’s, it doesn’t bode for a good podcast, but whenever you’re talking about.

[00:23:25] Stig Brodersen: you know, going back to an EPS of like five or six dollars pre COVID. And right now it’s trading at 93 at the time of recording. And so I don’t think that’s the goal. I don’t think that’s the, like, if you want to believe in the bull case of Disney, I think you might want to see it a bit different. So one of the things that happened during COVID was that they issued more shares.

[00:23:48] Stig Brodersen: So there used to be like around 1. billion shares. Now it’s like 1. 8. Also they did an issue at a good time for obvious reason, the Disney stock was punished severely during COVID, but also like, if you look at 2023 revenue, you have revenues of 89 billion, the numbers you were quoting before here we had revenues of 55 million.

[00:24:10] Stig Brodersen: So it’s a different company that you’re looking at now. And if you are looking, for example, at streaming. They have a lot of revenue for obvious reasons, but they don’t really make any money. And so a big part of your thesis also has to go to, do we think that Disney Plus can be profitable and how profitable can it be?

[00:24:30] Stig Brodersen: And if you’re looking at Nelson Pels the activist investor who have taken a stake, and you know, you mentioned that at the top of your pitch and it’s going back and forth and they’re still like doing a proxy battle. And it’s like, there’s going to be a big annual meeting.

[00:24:43] Stig Brodersen: So he has in his company, 3 billion in Disney right now. [Inaudible] was in 70 like you mentioned before. [Inaudible] so they have a lot of debt, that’s another issue that they are struggling with. So generally, whenever you have an activist and you’re a shareholder or you’re considering being a shareholder, it’s typically a good thing.

[00:25:04] Stig Brodersen: Not always, there are a ton of exceptions, that’s not the case, but it’s typically a good thing. One of the things that he came in starting to talk about was, to your point before, cutting costs. And now they’re cutting costs, what, roughly 7. 5 billion, which was 2 billion more than the original target. One of the things that he talked about that he wanted to do, was he wanted to get streaming to have a 15 to 20 percent profit margin in 2027, which is roughly what Netflix has right now.

[00:25:34] Stig Brodersen: And so is that feasible? I honestly don’t know. I think that there are a few, there are different ways to look at this. I completely agree with you, Hari, that it’s an advantage that they can monetize what they have on Disney Plus in the parks. And the way that shows up in the financial statements are just separated, so you don’t really see it the same way.

[00:25:53] Stig Brodersen: I also think that there’s something to be said about companies who have a core focus, which I’m going back to later for my pick. But can they be as good as Netflix whenever that is what Netflix is doing and has always been doing? I don’t know. And I generally think that the competition in streaming is.

[00:26:10] Stig Brodersen: Terrible. Like you’re competing with the best companies out there. And it’s very difficult. No, it’s not difficult. It’s very expensive to produce the content and you continue to need new content. And it’s expensive to produce and you’re competing with others who are doing the same things. It goes back to, you know, the argument that Charlie Munger has where he talks about like, if you have a textile mill and there’s new piece of equipment and you’re supposed to get it because it will pay for itself.

[00:26:37] Stig Brodersen: And that it’s all well and true, but all the other textile mills are buying the same technology. So all the savings goes to the consumer and not to those with the textile mills. And so I can’t, I, for me right now it’s a bit in the too hard pile. If I try to extrapolate the next five years, like are the big players just driving down margins because they’re trying to trump each other with, you know, more and more expensive content.

[00:26:57] Stig Brodersen: I don’t know about that. The parks are definitely fantastic. And of course I have my own biases that we already talked about. It comes with a lot of Capex, but I still think that there is like, this is such a valuable brand. You have millennials who are now starting to have more money, they have kids, now taking their family to Disneyland and head on for some time.

[00:27:16] Stig Brodersen: You have Gen Z’s, where obviously not everyone has kids, but it’s a generation that will soon significantly more have kids. And there’s also a trend of kidulting, which I’ve just learned recently. It’s called kidulting, which is adults doing stuff for kids. And so I think there’s something to be said about that.

[00:27:33] Stig Brodersen: Now, at the same time, with all the wonderful things that we can say about Disney, there are some bad things too. We already talked about the debt that they had. We see problems with succession. And, you know, Marvel, the first generation of Marvel just seems to be, like, brilliant move by Iger whenever he bought it, and probably was, like, the second generation you’re seeing now.

[00:27:54] Stig Brodersen: People just don’t watch that to the same extent anymore, and they’re not as excited about it, and they tried hitting a new target audience, and it seems like whenever you look at some of the numbers, that they lost some of their core audience, or perhaps their original audience were just more excited about Iron Man, and Thor, the Black Widow, whatever, and so, I’m not really sure how to read that, but if you look at the Marvel movies, it’s not going in the right direction, so, Like I mentioned there at the very start, I said, I don’t know.

[00:28:25] Stig Brodersen: And then we got to talk for like five to 10 still don’t know. But I can say is that the retention rate for Disney plus is 78 percent and 72 percent for Netflix. So I’m not saying it’s a bad business per se, but whether or not they can’t be as profitable as Netflix, it’s still left to be seen. So those are my two cents.

[00:28:44] Tobias Carlisle: I think that Warren Buffett once said about Disney that it was something like an oil well that just infinitely renewed itself, and so you get this royalty stream, and that’s a very attractive business model. And then Disney has created this infrastructure to really maximize the return from its IP, where it has the streaming service, it has the movies, it has the theme parks, it has all of the merchandising, it has generations of people who have watched all of this stuff, and who have very good feelings about Disney, who introduced their kids to it, start the new generation, that’s that infinitely renewing oil well.

[00:29:22] Tobias Carlisle: And so, Disney has an incredibly valuable franchise that would be almost impossible to kill. Having said that, I think they’re trying their very hardest to kill, and I think that the real issue for Disney is that they have waded into the culture wars. And you’re immediately excluding half of your audience, which I just, as a business decision, it’s a terrible one, whether it does something to improve society or not, I think is moot, but the business decision is a terrible one, and I would prefer if they went back to producing stuff that appealed to little kids so they could continue to renew this.

[00:29:56] Tobias Carlisle: I don’t think it’s fatal for them at all. I think this is a short term problem that is currently being resolved. And at some point, in the future, it will go back to being an absolutely invincible, high flying company, however, it’s not there at the moment, it’s stumbling at the moment, and they’ve gone.

[00:30:12] Tobias Carlisle: They’ve sort of tripped over their own feet again and again here, probably for about a decade here, with, you know, they’ve got incredible properties in Pixar, which gave them the ability to produce all of the computer animated stuff, which is just table stakes these days, but it was an innovation when it first came out.

[00:30:28] Tobias Carlisle: And they’ve got the Marvel movies, which is great IP, which connects to a lot of people. You know, it’s easy to show your kids those movies because you know, there’s not going to be any blood, they don’t like the debt, you know, it’s good stuff to show the kids and they’ve got other properties that are worthwhile.

[00:30:41] Tobias Carlisle: The problem that they have is they haven’t had anything that cuts through and connects with kids for a very long period of time, but you know, it’s an incredible machine for producing that stuff and all it would take would be one more movie that actually did cut through and connect with a new generation, and then they’d be back to where they were before.

[00:30:57] Tobias Carlisle: Because they’ve got those issues, though, I would want a big discount to sort of a quantitative valuation before I would consider doing it. And when I look at it, they’re pretty stretched on all of those multiples. And I think that the fact that they’re stretched is just a recognition that it is kind of an incredible property.

[00:31:12] Tobias Carlisle: But it’s not kind of living up to its promise at the moment. It’s a little bit underexploited. And it’s just poor management. I would absolutely buy Disney at some price, but not this one, and I would want to see more progression towards them getting back to what has been their bread and butter for good.

[00:31:31] Tobias Carlisle: You know, generations before, or a very cheap price. And I don’t think you’re getting either of those here. I think if we went back to the first time Harry pitched this, I think I said exactly the same thing. The price is down a lot since we sort of discussed it last.

[00:31:46] Hari Ramachandra: Yeah, I think those were really good points. Thank you, Stig and Toby. I really appreciate it. I think I was noting down a couple of points you made. I think Toby said it’s like an oil well that Buffett said that keeps giving. And that reminds me of the Content that never expires that they have on Disney Plus channel, like whether it’s Mickey Mouse or Doc McStuffins, a lot of these shows.

[00:32:11] Hari Ramachandra: The kids want to watch over and over again the same thing. You can’t say the same thing about the shows that Netflix, for example, produces. They kind of become stale after a while. Adults don’t like to watch the same serial again and again for weeks. And trust me, kids want, like, you know, they will watch the same episode days on end.

[00:32:36] Hari Ramachandra: And that is the magical power of Disney, and as you pointed out, Stig, that’s why their attrition rate is lower than Our retention is higher than Netflix is because many of us parents don’t see it as a luxury, but as more like necessity. It’s almost like internet or electricity that you need it for your kids.

[00:32:58] Hari Ramachandra: That’s it. You don’t even care once you have it. And the second thing they’re doing is they’re coming up with models, as you said, like, you know, are they making money out of this? They’re coming up with models with ad supported, they’re increasing their subscription fees. They’re mixing Hulu and Disney and they’re making bundles.

[00:33:14] Hari Ramachandra: So I think That’s the other one. And then the final one is Toby was mentioning like that went through this period of 10 years of lull, reminds me of Microsoft during the bomber days, right? Like they’re really gone through this 10 year spell and I feel activist investors entering the stock is a good thing.

[00:33:36] Hari Ramachandra: For this talk, because the management was kind of complacent and they not having a dual class of shares makes them vulnerable and they know it, which I’m hoping will lead to an action. So this might be a catalyst, but I think this is one franchise I would love to own for the long term.

[00:33:56] Stig Brodersen: Well said, Hari. And I also think there is something to be said about your point about a potential acquisition target. I don’t think it’s in the cards at all. And there’s probably a lot to be said about whether or not they want to be bought up, which most companies do not, or at least not the type of companies like Disney.

[00:34:14] Stig Brodersen: But of course, like you can make the argument that perhaps not at this price, but at a lower price, you have a certain amount of. I don’t know if insurance is the right word, but because the brand is worth so much that someone is going to come and put a cover on the market cap, because I think it’s the least well known secret in the world that the Disney brand is strong and all the franchises, they have are just very strong.

[00:34:36] Stig Brodersen: So that’s another way to look at it. More about Disney before we move on to the next pick.

[00:34:42] Hari Ramachandra: I guess that’s all from my side. Thank you. This was really good feedback. I really appreciate it. Nothing or all. What I conclude is that it’s definitely something that I would like to own for the long term, but the returns I’m going to make at this price is still not very certain. Like, you know, would it be market beating returns or not is still up in the air.

[00:35:05] Stig Brodersen: So my pick for today is Spotify and a full disclaimer. This is a stock I own and bought back in December 2022. I also have some questions for Hari at the end of my pitch about Spotify and. I have no shame. So now that, I borrowed a bit of a hardest time and he knows a lot more about tech than me.

[00:35:24] Stig Brodersen: I wanted to be my biggest critic and pitch some of the ball the bare thesis from a technical perspective. That’s way above my pay grade. But the easiest way to think about Spotify is and the investment thesis is to think about can they get to a billion users, which is a goal that the public stated.

[00:35:41] Stig Brodersen: They’re at 574 million right now. And then how many of them will pay for a premium subscription? And the latest numbers are 226 million. And perhaps I should have started by saying, and I probably just assumed here that everyone knows what Spotify are doing. Perhaps that’s not the case, but it’s a company that has three verticals.

[00:36:01] Stig Brodersen: They have music, podcasts, and audio books. And you would typically listen through your phone. And you can also use your desktop and smart speakers, whatever. But then, and you can consume the content like that. And so if you are a premium subscriber, you have access to more content. You also generally don’t hear ads.

[00:36:19] Stig Brodersen: You actually will on this podcast. You also right now have access to 15 hours of audiobooks in some markets. And that’s going to be rolled out here probably as we speak. The bull thesis right now, and this is for a company that’s a 40 billion market cap. The bull thesis here is, do you believe that they’re going to hit a billion users?

[00:36:37] Stig Brodersen: So far, so good. They’re at 574. I would encourage everyone to go in and look at the growth of monthly active users. It’s just up and to the right. It has grown very fast, but then they also have a goal of hitting a hundred euros in annual revenue per user. And that’s very ambitious. Right now we’re between four and five euros.

[00:36:58] Stig Brodersen: Speaker 1 And you might be laughing and saying, how on earth are they going to 20, 25 X that? And I think it’s going to be quite challenging. Also, I would say that they’re probably still going, like, even if they don’t hit it a hundred euros, they’re probably still going to do quite well on the stock price.

[00:37:14] Stig Brodersen: Even if they’re halfway there. I would also say, don’t count Out Daniel Ek, the co-founder and the current CEO. Everyone ridiculed him whenever he said that he wanted to take on iTunes. And, you know, he had no labels, he had no cash whenever he said that and here, we are. He has the biggest platform on the market, so do not rule him out.

[00:37:33] Stig Brodersen: So, the market that Spotify is competing in is Absolutely terrible. And I do understand the irony of me telling Hari just before that. Oh my God, like they’re competing with Amazon and, you know, with. With Apple, to some extent, even though it’s a much smaller platform, like they’re competing with the big tech companies.

[00:37:51] Stig Brodersen: You don’t want to go into that space. Right? So then you’re looking at Spotify and they’re competing with all the big tech companies. So why am I saying that? Well, they have by far the biggest markets here. Apple Music is training them, and then you have Tencent music. I don’t really think you can say that they’re competing.

[00:38:06] Stig Brodersen: And also, they’re collaborating a bit with Tencent music and have two chairs in each other’s companies, but, and then you have Amazon and you also have YouTube slash YouTube music. So those are the competitors. There are others, but those are the main competitors. And you generally obviously don’t want to compete with the best companies.

[00:38:22] Stig Brodersen: But I do think that there’s something to be said about, imagine how successful Spotify has been that do not own the device, like, you know, like, like Google and Apple, and they also do not own the app store. They’re paying a tax to the biggest competitors. And yet still here we are with the most successful of all the apps.

[00:38:42] Stig Brodersen: And so I think there was something to be said about having an audio first, founder and controlled organization. Whereas if you look at something like Amazon or looking at something like Apple. Like those who, and there are different stories to them, but first, if you’re looking at Amazon prime and you get access to Amazon music, that’s not the reason generally why you have Amazon prime.

[00:39:05] Stig Brodersen: And you can also see that with the stats on how much people engage on Spotify compared to the other platforms, because they’re more verticals. And it’s very conscious that even though they can, whenever they get their iPhone, they can get, you know, three months, whatever campaign there you have on, on, on Apple music, whenever they have Amazon prime.

[00:39:22] Stig Brodersen: People still use Spotify, despite all of that, and it just says something about the lack of churn, and the high retention, and the engagement that Spotify has. So, whenever you are comparing the number of users, I also think it’s important to know that a user is not a user. Of course, you also have a lot of risks, so if we can talk about that.

[00:39:44] Stig Brodersen: I would probably say that of the competitors, I’m mainly concerned about Google and what they’re doing right now with YouTube music. I’m looking at it, I’m using it and I’m thinking they’re doing a really good job. I’m looking at Apple and thinking they’re not doing a good job. And why do they have Apple Podcasts and Apple Music in two different apps?

[00:40:03] Stig Brodersen: And considering that they own the tollbooth, why can’t they convert people to their service? And I think there, there’s something to be said about that. Also, one thing that we learned as value investors, aside from not talking about macro, which we did at the top of the interview still, is that you generally don’t want to compete in something that’s cool.

[00:40:24] Stig Brodersen: Like, you want to buy their landfill, right? You want to invest in a company like Toby’s going to talk about later. Like, that’s not a sexy company. Spotify, that’s pretty cool, like musicians and concerts and like all of that is cool, right? And you don’t want that. And they, Spotify spends a lot of money on being the best brand for Millennials and for Gen Z’s and Spotify currently ranks now as being more used and cooler.

[00:40:49] Stig Brodersen: Whatever that means compared to the, to, to the other services. It’s also really difficult to continue to be cool. Like that’s just like. Think of whenever, you know, we started on Facebook and we were, at least I can’t speak for you guys, but I kind of felt I was young back then and I was cool.

[00:41:05] Stig Brodersen: And then my parents, you know, started using Facebook and that was really uncool. And are we going to see the same thing with Spotify? Are our kids going to use Spotify too? Now that the parents are using Spotify, I don’t know the answer to that question. And so if you’re looking at the valuation, it’s.

[00:41:23] Stig Brodersen: I’ll be the first one to say that it’s not a cheap stock and the stock has run up a lot recently. I bought the stock at $78 and 70 cents back in December 2022. I’m doing the not so humble brag and says that it’s up hundred and 70% in 13 months, but who’s counting? And I don’t think it’s undervalued at all, if anything is probably overvalued right now.

[00:41:48] Stig Brodersen: At the same time, you know, we talked quite a lot about Buffett and Munger on radio, which we tend to do here on their episodes and Munger has this wonderful quote where he talks about. that a business, like whatever a business owns earns on their return on investor capital, that’s the return you’re going to get as a shareholder.

[00:42:05] Stig Brodersen: If that happens for a long enough period of time, it’s not so much the PE you’re buying at right now. And also Spotify, they’re still like, they’re growing really fast. So what, like, let’s just look at revenue. It’s up what six, seven X and. seven years, like it’s going really fast and it’s up and to the right still.

[00:42:23] Stig Brodersen: And so whenever you’re looking at, like, don’t look at you’re the PE, like you have to make adjustments to that. And I think I want to come about this in two different ways because you’re probably saying this is ridiculous. Stig says that he’s a value investor and he says that you have to adjust the earnings, like that’s terrible.

[00:42:42] Stig Brodersen: And I think I want to use this analogy. First of all, I’d say you’re probably right, but I want to use this analogy and saying that, and this is a chess analogy. So the novice chess player loses because he doesn’t know the value of the pieces, but the novice chess player also loses because he is so fixated on the value of the pieces.

[00:43:02] Stig Brodersen: And if you have played a bit of chess, you know that sometimes you have to sacrifice a rook for a bishop if it gains you the right position on the board. And so that’s what you’re doing whenever you’re adjusting earnings. And if you do it, and especially if you do it, doing it often, and if you trying to torture the data to make something look like an appealing investment, your head will be handed to you at the same time, if you find companies with the right quality, you’re going to get a quite decent return.

[00:43:31] Stig Brodersen: And so let me give you, let me give you an example here. Let’s look at Berkshire Hathaway. So from 1962 and 1965, Buffett bought Berkshire Hathaway at a price between 7. 50 and 15. So let’s say that you came in there as an investor and you wanted to buy Berkshire Hathaway at 100 a share. First of all, everyone would ridicule you because like you’re buying this terrible textile mill and why would you pay 100 for that per share?

[00:44:00] Stig Brodersen: But if you did that in 1965 and you held onto it, you would still have made more than 15 percent return. And so you’re very much buying the future. Now, all of that being said, this is not a new Berkshire Hathaway. I’ll be the first one to say that. So it is a bit overvalued. I’d say perhaps a lot overvalued.

[00:44:18] Stig Brodersen: I’m going to hand it over to Toby here soon. And he’s probably going to tell me that it’s ridiculously overvalued. And perhaps he’s right. But before we get to that, I would like to ask you Hari about Spotify, because one of the things that popped up here recently was that Spotify has partnered with Google.

[00:44:34] Stig Brodersen: They’ve done that with multiple different things about billings and so on and so forth, but they’re also doing now more with cloud computing and having. Using Google’s algorithm for recommendations, and I couldn’t really figure out if that was a good or a bad thing. And if I can just sit and debate a bit with myself, I’m thinking that this is a 40 billion tech company.

[00:44:56] Stig Brodersen: Why do they not have enough data to figure out what people want to listen to? And they’re reliant on Google. And keep in mind, Google, or Alphabet, they own YouTube, which is one of their huge competitors. I don’t really like that, for obvious reasons. So, Hari, how do you look at this?

[00:45:15] Hari Ramachandra: Oh, thank you, Spotify is a very interesting pick because they kind of have been defying gravity in a way, in the sense that a company that doesn’t control its own distribution, a company that doesn’t produce or own its own content, they rely on others to produce the content and they pay for it.

[00:45:36] Hari Ramachandra: And as you just mentioned, they’re also relying on others for like Google on technology platforms as well. So they’re more like a broker in between, and I think their strength is the ability to identify the right talent, invest in them early on, and then reap the benefits later. So they’re almost like the value investors in entertainment, like they catch the talent early enough so that they probably pay a little lesser price than they would make.

[00:46:07] Hari Ramachandra: I think that is also reflected in their financial statement, when you see in the past 8 years or 10 years, they have never made profit. They’re always negative. And that is what concerns me is that they’re growing, as you said, impressive MAU growth, impressive revenue growth. Everything has kind of doubled in the last 5 years.

[00:46:28] Hari Ramachandra: But they’re not able to monetize it to the point where they’re profitable. That means there is this game they’re playing where the value they’re getting from the customer and the value they’re playing to the three aspects, the content creators, the distributors and the technology providers. In between, they are left with nothing right now, basically.

[00:46:52] Hari Ramachandra: How long can they sustain? The second thing is, like, for example, Amazon has built a mode where most of the people now, if they’re searching for a product to buy, they don’t even go to Google, they go directly to Amazon. So they have made themselves as THE provider. 90 percent plus market share. Has Spotify been able to do that?

[00:47:15] Hari Ramachandra: Things like YouTube and there are other competitors. And what tells me they’re still not like a monopolistic toll bridge is that they’re not able to churn out profits. And that would be my main concern is that their dependence on outsider factors. So they are their future is dependent on a lot of things outside and how long is this sustainable? And if I want to hold this up for the next five years, will that churn profits in the end? That would be my main concerns.

[00:47:51] Stig Brodersen: Yeah. All good points and I think I want to take them one by one here. So whenever you’re talking about the profitability. And this is a common strategy of these type of let’s just call them growth companies, which is not the same as it’s a good strategy, just because it’s a common strategy, because a lot of companies do not succeed in that.

[00:48:09] Stig Brodersen: If you look at the net income, it’s been negative since they listed, not so with the free cash flows. In the end, they will follow each other, but like different tax reasons and write offs and all kinds of things. They’re the reasons for that. So whenever I’m looking at a company like Spotify, the plan is to…

[00:48:25] Stig Brodersen: it’s a bit like the Silicon Valley approach where you’re going to get really big and not the same as it’s a winner takes all, even though we’re not, the winner takes a lot. And then whenever you have enough volume, you start monetizing and you also start cutting some costs. And so whenever you’re looking at why aren’t they making more money per user, they’re using a.

[00:48:47] Stig Brodersen: ton of different discounts right now. And they’re spending 13 percent of their revenue also on, on advertising. Like they have a lot of growth Capex and figuring out how much growth Capex they have is a bit more odd than science. And that’s why they’re growing so fast. And they would need multiple additional verticals to take the company to like much high revenue, which of course could potentially translate to more profits.

[00:49:11] Stig Brodersen: That being said, and you might be saying, well, what does it matter? Like, just because you have a lot of users, you don’t necessarily make money. And I think that’s a good point. But if you look at the two most important verticals right now, you’ve seen a shift. And so let’s talk about podcasting first and then perhaps music afterwards.

[00:49:30] Stig Brodersen: And I’m perhaps I’m biased. I should have probably also say for full disclaimer, like we just started recently hosting on Spotify platform. And we did that because as an insider, I can see why it’s the best. And I don’t want to be too technical why that’s the case. And anyone can send me an email if they really want to know, but the market for podcasting has changed a lot in recent years.

[00:49:53] Stig Brodersen: So first I’ll say that Spotify came out of nowhere and they took the throne from Apple podcast in like what, three years, like from 0 percent and all of a sudden, they were the biggest. And they were so much better. They bought all the best studios. They bought the best companies to do attribution for advertising.

[00:50:09] Stig Brodersen: They set up the best sales team. Like they did a bunch of like, as an insider, I remember having a conversation with someone in the industry and I’m saying like, if I could invest in the podcasting industry, I want to buy XYZ assets. And then six months later, Spotify bought all the assets. I was like, they have some really smart people behind this.

[00:50:26] Stig Brodersen: And what you’ve seen Facebook and Google do with democratizing advertising, for example, on, you know, on social media, on whenever you’re using Chrome, Spotify doing the same thing in podcasting. And I’ll probably also say music is slightly different. And they’re ramping that up now. And so if they have the best hosting platform, they also have publishers coming there and they can then sell advertising to two advertisers that are sliced and diced.

[00:50:55] Stig Brodersen: So it used to be so that in the industry, people would come to us and say, can we advertise on your podcast? Here’s 50, 000 and then they will get our entire audience. And, you know, they might have a product that’s can only be shipped in the U S or whatever that might be the case. And that’s a quite an efficient way of doing it.

[00:51:11] Stig Brodersen: So all of this is bad for publishers, but all of this are good for, you know, the Spotify’s of the world. And so instead, what they’re doing is that they’re saying, okay, we, we have 50, well, 50, 000 is not enough. The it’s a hundred thousand and up right now with Spotify and saying, we want, you know, males between 18 and 25 with these interests and in these states.

[00:51:31] Stig Brodersen: And then they’re going out and finding all of them for all the podcasts that are hosted on megaphone. And so just because you could access podcasts on your Spotify app, some of them are hosted there, some are not hosted there. And then for premium subscribers, they bought the best studios.

[00:51:46] Stig Brodersen: So some of the best content you can only find on Spotify. So that is, that does not show up right now in the financial statements, but it’s coming. And I know it’s, it might sound ridiculous whenever I say it’s not there, but it’s there. Whenever you’re looking, for example, at the gross margins, they’re there.

[00:52:03] Stig Brodersen: So in the financial statements, there are in for premiums and subscribers, they’re right now at 29%. And then they also have the free subscribers. And right now it’s 8. 3%. But you have all the podcasting, they disclosed that in some filings a long time ago. They put all of that in for the free subscribers.

[00:52:18] Stig Brodersen: And so like some of those margins that you see there, they’re artificially low. You have a lot of earnings power in podcasting. We talked about this before, podcasting is much cheaper to produce. And you still have the same scale advantage as you also have with streaming. And then with music, the power has also shifted.

[00:52:36] Stig Brodersen: There is a quite bad show about the early beginnings of Spotify. I can’t remember which streaming, where it’s hosted, but anyways, but if you do that, or if you read the book play, which is about Spotify in the early beginnings up till, I don’t know, 18, 20, whenever it was, you’ll see how it has shifted from artists or, well, I should probably say labels, having all the power and, you know, you might remember everything that happened with Napster and how, you know, this Swedish dude tried to set that up with his co-founder, no one wanted to talk to him.

[00:53:11] Stig Brodersen: And now, the platform you go to, that’s Spotify. And now the artists and I should say labels pay like they’re still paying royalties. Don’t get me wrong, but if you have concepts, if you want to sell merch, all of that stuff, they pay to get promotion on the Spotify platform, because now it’s the biggest platform.

[00:53:27] Stig Brodersen: And so you do see a reflection of that to some extent in the gross margins, but not all of it. And that’s also coming. And so the power has shifted. And then you have audio books where the operating margins are much better than, for example with music. They’re different reasons why they can’t go higher with, than with music.

[00:53:43] Stig Brodersen: The easiest ways to think about it is that you can still make them the margins wider, but it doesn’t have the same scale advantage as with podcasts, but it’s even better with audio books, I should say. Sorry, that was a long ramble. Going back to your initial point, yes. We would eventually like to see more profitability. I’m not trying to argue against that by any means. Toby?

[00:54:04] Tobias Carlisle: What Spotify has achieved is very impressive. When you look at the growth in their revenues, it is extraordinary. It marches up every year at a very good clip. The problem is that none of it falls to the bottom line. The response to that is, well, they’re reinvesting.

[00:54:19] Tobias Carlisle: For the future because this is a very competitive space and if they reinvest and they win this space Then they’ll be able to switch on all of that sort of profitability, which we’ve seen other companies do So Amazon did the same thing. The, in that instance, then you need to look at competition that they’re up against and its ferocious competition in the form of Apple and Google with YouTube and so they are very deep pocketed competitors and they’ll be able to compete for a very long time.

[00:54:50] Tobias Carlisle: They’re able to lose money in various segments because they have so much money. So, it’s not guaranteed that Spotify gets to that position. Now, the response might be, well, they have been doing very well in the vertical that they’re in, despite the fact that they have this other competition there and its sort of proof that they are able to compete and to out compete.

[00:55:10] Tobias Carlisle: And I think it’s a very good argument, and I think it’s probably likely that Spotify works out. It’s just for me personally, it’s not the way that I like to put positions on, so it’s not one for me, but I think it’s a, I think it’s a great pick, and I think it probably works out, and it’s probably one of those ones that When it’s a 40 something billion dollar company now, when it’s a 400 billion dollar company, I’ll be kicking myself.

[00:55:32] Stig Brodersen: Well, for what it’s worth, Toby I don’t remember what the market cap of Amazon was at the time. It was, it’s almost a fraction of what it is today. And still everyone knew it. Everyone used it. And I remember having done a recording with Preston. This is like back in the early days of TAP and. I was saying, how can anyone buy Amazon at this valuation?

[00:55:52] Stig Brodersen: And so, and I’ve kicked myself so many times because of that. Like there was a lot of survivor survivorship bias here, right? Like you, you mainly remember what you see today. And those are all the companies that prospered. And you thought about, I mean. I don’t know if I can speak for you, Toby, or for everyone else, but you see so many different companies and perhaps a small part of you thinks, should I be invested like thousands of times?

[00:56:15] Stig Brodersen: And then whenever you see some of them work out, you’re like, ah, I knew it. I should have invested. And then of course you forget the 996 others that you also thought the same of that would have been terrible investments.

[00:56:24] Tobias Carlisle: So, there was a paper that came out by Novi Marx, and the paper was about gross profits on total assets, which has become a very kind of fashionable way of assessing how high quality a company is.

[00:56:37] Tobias Carlisle: The more gross profits you earn on your total assets, the better you tend to do. And I read the paper and I built the little, I built a little screener that would pull up for me the best company by total profits on gross profits on total assets. And the number one pick in that screen was Amazon and that paper came out in about 2013 or 14, something like that.

[00:56:56] Tobias Carlisle: So he was right. It was a good, it was a good pick. I didn’t put it on there either, but it was interesting. Maybe I should have listened to [Inaudible].

[00:57:03] Stig Brodersen: All right, Toby thank you so much for the feedback on Spotify. Let’s go to your pick and I’ll just preface this by saying your pick is trading at a much more reasonable multiple. So please go ahead.

[00:57:15] Tobias Carlisle: Well, I think that when I give my pick, in any case, everybody’s going to know why I tend to not like the much bigger, more expensive companies where you actually have to be right about the business. So for my picks are always, and I think I always need to preface with the way that I invest, which is to say that it’s largely quantitative.

[00:57:30] Tobias Carlisle: We’re looking at the financial statements. Trying to find a business that is cheap economically, and largely we try to sort of ignore the narrative around the business, so I’m not necessarily looking for a bad business, I’m looking for a good business that is disguised, or a business that is better than, looks like It is in the market where it’s trading, but this is a company where, and I would buy a basket of 30 of these, they’re all 3.

[00:57:57] Tobias Carlisle: 3 percent each, they’re all equal weight, and then they’re rebalanced at the end of every quarter, so that’s the level of conviction that I have in this pick, you need to understand that, I’ve had it for a little while, it does always meet my criteria, I hold it, it’s still in my screen, and it still Passes all of our additional measures, the company’s name is Mueller, the ticket is MLI, it’s a 5.3 billion dollar market cap, They have 1. 1 billion dollars in cash and cash equivalents sitting on their balance sheet. The enterprise value then is about 4. 2 billion dollars because you back out the cash from the market cap. And that means that my favorite metric, which I call the acquirer’s multiple, but it’s otherwise known as just enterprise value to EBIT operating earnings.

[00:58:41] Tobias Carlisle: So EBIT operating earnings, sort of the accounting equivalent of cash flow. The cash flow statement is just reconstructed from the income statement of the balance sheet. So I just like to take the number without the reconstruction. And then I compare that to what you’re paying, which is the enterprise value.

[00:58:54] Tobias Carlisle: So it’s under five here, which is very cheap. Price to cash flow is about 8, price to earnings about 8. 5, price to book about 2. 4. The long run return on assets for this company is somewhere in the high 20s, in the low 30s. So it’s a pretty good business. When I say long run, I mean over about the last 5 years.

[00:59:15] Tobias Carlisle: So, quantitatively, this is a very cheap business. Now, the question is Why is it cheap? And I’m about to give you the answer for that. This is a company that makes copper and brass extrusion. Basically what it does is it takes metals and it turns them into piping. And then it has a whole lot of other businesses and a whole lot of other little products that sort of are complementary or ancillary to that kind of piping.

[00:59:39] Tobias Carlisle: And so the way that they think of themselves, they think of themselves as being in three segments. They call the first segment piping, and that’s sold into construction, new homes, commercial, HVAC, that’s 46 percent of their business. And the second area that they, they say that they’re in is industrial, and that can be anything from transport, heavy industry, there’s a whole, their website has a whole crazy list of all the things that they’re in, the spread of business that they’re in is pretty amazing.

[01:00:06] Tobias Carlisle: It’s from everything from like, they make the hose that attaches to the breathing apparatus for fire, they make pool fittings, if there’s some industrial application that needs to shift fluid through a metal pipe, these guys probably do it. And then the final thing that they do is climate, which is again, like that refrigeration, all of those sort of things.

[01:00:25] Tobias Carlisle: And that’s about, well, so, so industrial is about 31 percent of their business and they have this climate business. Geographically, they’re all over the world. They’re mostly in the US. They’re about 40 percent in the US, I think, but they’re geographically spread really widely over the world.

[01:00:40] Tobias Carlisle: And so that means that they’ve got, you know, incredible logistics to get from manufacturer to distribution, all that sort of thing. It’s a business that’s been around for a long time. It’s pretty stable in terms of if you look at their long run history, it’s been pretty good performer through good markets and through bad.

[01:00:55] Tobias Carlisle: The big problem. All them has been that, well, not that this is a problem, but the reason why it’s optically cheap and possibly not actually cheap is that they’ve gone through this building boom in the States where basically everything has gone about as well as it can possibly go for this company because There’s been a lot of new builds, which requires a whole lot of the stuff that they produce.

[01:01:18] Tobias Carlisle: And so that’s gone into the houses, it’s gone into all of the industry. And then at the same time, there’s been difficulty shipping things. So their products have been favored over all of their competitors. And this is the problem for them. They have this Chinese competitor who can probably produce more cheaply than they can land it in the States more cheaply.

[01:01:36] Tobias Carlisle: The question is, does that matter for the long term? Are we sort of seeing this on shoring where these sort of things are just going to be manufactured in the States and there’s going to be fewer imports from China? Or is that process going to be made more difficult? Will China in fact come back and compete again?

[01:01:52] Tobias Carlisle: with this company because they’ve had a few years now, they’ve had three years of pretty good earnings. And how sustainable is that housing boom? Now, I think that those questions are largely unanswerable. The sustainability of the housing boom, if you look at the average number of housing starts since the GFC, since the Great Recession, whatever we’re calling it these days.

[01:02:13] Tobias Carlisle: 2008, 2009, when the housing got busted, we sort of underbuilt housing for about a decade after that to about, well, I think we were building it like half. Clearly, some of that was because we overbuilt through the early 2000s, and so there was some underbuilding through the 2010 to 2020. And now we’re back into a building phase.

[01:02:33] Tobias Carlisle: I don’t know how long these building phases last. There’s some suggestion that we’re coming to the end of it now. Because the homebuilders have been, the homebuilders too, so you might remember last 2022, lumber went crazy, homebuilders got crushed, and then, when they put rates up, it made new houses sort of comparably cheap to existing houses, and so the, Where previously there’d been quite a premium for a new house, the premium disappeared because it was so hard to buy a house that the new houses were able to, they were basically able to buy down the interest rate so you paid a lower mortgage, which created this huge demand for new houses, so these guys were clearly a beneficiary of that, so they’ve been a beneficiary of the reduction in imports from China, from their main competitor, and from this sort of big building boom that’s going on.

[01:03:20] Tobias Carlisle: And the question is how sustainable is that? I don’t know, I can’t answer. I would just say that I think that the chances of this business going out of business or being a donor are very low. I think it’s still modestly priced for, if you look at its long run history, it has been quite good at surviving periods, which is one of the things that I, that’s the first thing I want to know.

[01:03:40] Tobias Carlisle: Is this a business that can survive through a tough period? And I think that this one is. And then they’ve built up all this cash on their balance sheet over the last few years. So in the event that there is some big drop in the stock price. They have the firepower there to go and do a very big buyback.

[01:03:53] Tobias Carlisle: Now, I don’t know what their likelihood of actually undertaking that buyback is. I’ve looked at the share count. The share count sort of dribbled up modestly. It’s not nothing egregious at all. It’s very modest sort of increase in the share count over the last few years, but you know, it is an increase.

[01:04:06] Tobias Carlisle: It’s not a decrease. And typically if I think a company is undervalued and it’s got a whole lot of cash on its balance sheet, I’m always a little bit suspect when they’re not doing a buyback. Because it means that management doesn’t necessarily agree with me, or management’s not necessarily, it’s priorities aren’t shareholders, and I think that this criticism could have been leveled at the last company that I bought too, I thought that it was, which was InMode INMD, they had a lot of cash on their balance sheet, they seemed to be cheap, they weren’t doing a buyback, so I sometimes think that’s a little bit of a red flag, but then, you know, any of these things can happen at any point in time, they can make the decision at the next board meeting and you can have a buyback that you didn’t expect and that is a catalyst.

[01:04:45] Tobias Carlisle: And if you’re waiting for that catalyst, when they announce it, sometimes you miss the move. So I prefer to buy with all of the conditions right for a buyback before it happens. So I think for me, this company is, it looks optically cheap. It’s very cash flow positive. It’s got a lot of cash on its balance sheet.

[01:05:00] Tobias Carlisle: It’s a pretty simple business. It’s got wide geographic distribution. It’s got distribution through lots of different business lines and all of those are positives. The negative is that they have some serious competition from China and they may have been, their financial statements may have been flattered by the fact that they’ve been through this over earning housing boom. That’s it. MLI is the ticker.

[01:05:23] Stig Brodersen: Wonderful. Thank you, Toby. So if I can just back up a bit there, whenever you talked about capital allocation, I think that’s a frustration that a lot of shareholders have. They’re seeing all of this wonderful cash on the balance sheet, but they’re looking at a very low multiple and it looks like.

[01:05:38] Stig Brodersen: Like, it would be such an obvious thing to, to buy back shares sometimes because it is all the time because perhaps it’s a cyclical stock or there might be other things there that we might not be seeing. And one of the things that I found helpful is just simply being to go through the earnings calls.

[01:05:53] Stig Brodersen: And very often the analysts even though there are sometimes some ridiculous questions that are more or less, could you please. fill out my Excel spreadsheet, like my model so I could come up with a new estimate for earnings. Sometimes I would say quite frequently, they are asking about capital allocations such as should you buy back shares, and I think you can learn a lot from those calls.

[01:06:13] Stig Brodersen: Just in how they respond, and sometimes they would give you your investor relation type of responses where they’re saying, oh, we are always looking out for opportunities and deploying the best possible way. Like something that’s like so generic because it’s just terrible to listen to. I also tuned into an earnings call and the CEO said that he would never under any circumstances.

[01:06:34] Stig Brodersen: Buybacks, yes, which makes me really worried as a shareholder. What company was that? It was a small Swedish company. And I was like no. That, that, what?

[01:06:44] Tobias Carlisle: Philosophically opposed to buybacks.

[01:06:46] Stig Brodersen: Philosophically opposed to buybacks. And I was just like, that doesn’t sound too shareholder friendly.

[01:06:50] Stig Brodersen: And so I think there are different cues you can pick up there. And, you know, time is just very expensive. And if cash is not put best to use, you know, you’re going to be penalized as an investor. Toby, I was I think I have two questions here. The first question I have is how you factor in cyclicality into your equation as a deep value investor.

[01:07:10] Stig Brodersen: Optically stocks that, that look to be very cheap. can be very expensive based on where they are in the cycle. So on a forward basis, like that multiple would be crazy. But whenever you’re looking at swelling 12 months, it looks really interesting. So how are you factoring that in since you were so quantitative in your assessment?

[01:07:29] Tobias Carlisle: There is, I have this sort of, I do have a somewhat philosophical answer for you. There’s the nihilist answer where you say, I know nothing. about what the future looks like. And if I put together a portfolio of low multiple stocks, and I put together a portfolio of high multiple stocks, if I then randomize their performance over the next 12 months, your expectation would be that the randomized portfolio of low multiple stocks randomize up to the mean of the population.

[01:08:00] Tobias Carlisle: And the randomized portfolio of expensive stocks would randomize down to the median of the population. And so if you think about what that means, it means that the cheap portfolios are getting more expensive, they’re going up. The expensive portfolios are going down, they’re getting cheaper. And it’s not knowable which of those stocks is going to do what, because I just said, definitionally, we defined in this little thought experiment, they’re all going to be randomized completely.

[01:08:24] Tobias Carlisle: Now, it’s not quite as nihilistic as that in practice, because there are some factors that we know that have some explanatory ability sort of over as many as five years. So value is the one that has the most explanatory power. There are others. And I, over a long period of time, I have built a model that includes all of these things.

[01:08:43] Tobias Carlisle: And one of them What we can look at is return on invested assets isn’t mean reverting. series, but it is a slowly mean reverting series. And so we can have, I can look at a period of years so say five years, what’s been the average return on invested capital over the last five years. And clearly in a case like this is going to be flattered because it’s done pretty well over the last three.

[01:09:05] Tobias Carlisle: And then I can use that to say that this has probably got, if the return on assets comes down a little bit, which I expect, it’s still too cheap for the multiple where it’s trading. And so what I would expect is that the return on assets comes down, but the multiple does tend to expand. And that’s basically the experience that you have if you look.

[01:09:24] Tobias Carlisle: If you did a scientific experiment and you looked at stocks, this is what tends to happen. The more expensive stocks do in fact deliver on their promise of earnings growth, but the multiple contracts. Value stocks tend to deliver on their sort of promise of being terrible businesses. And the business does tend to do a little bit worse over the holding period, but the multiple expands because the multiple is so low.

[01:09:44] Tobias Carlisle: And so the way that I capture that phenomenon in my portfolios. that I build these portfolios that sort of meet those criteria. And then I don’t interfere with it very much. And I try to do it across an entire portfolio because I know that in any given instance in say MLI, the problems for MLI, as I have described them, may be exactly what happens for MLI over the next few years that they were over earning because there was a housing boom in the States and their biggest competitor was unable to land in the US and compete with them. And when they’re able to land and compete and the building boom goes away, all of that sort of unusual profitability that they had disappears. That’s an entirely plausible scenario. But having said that every single time I put these portfolios together, I look at the stocks that are in these portfolios.

[01:10:30] Tobias Carlisle: And the good example, a great example is the one that I just gave before. And I did this in real time because I have my own podcast where I was talking about why I was buying the housing stocks in. late 2021. And knowing that, you know, we may have been going into a recession, we may have been going into this period of time where it was likely that housing was going to not do very well.

[01:10:52] Tobias Carlisle: And they all look pretty beaten up because the lumber had been so expensive. And what happened was just something that was unforeseeable that when the Federal Reserve increased interest rates, the way that they did, the home builders were massive beneficiaries of that. And I, not in a million years, but I have guessed that was the way that was going to work out.

[01:11:10] Tobias Carlisle: But it was the case and so for a period of about 18 months, the home builders have just run incredibly. And anybody who’s taken those positions off has sort of regretted it because they’re, they’ve really gone from strength to strength. That can’t go on forever, but it has gone on for much, much longer than anybody thought it could possibly go on.

[01:11:25] Tobias Carlisle: And that tends to be one of the ideas that I’ve really come to understand about the stock market is a lot of things go on for much, much longer than you think they can possibly go on for. And so I try to approach the problem is I really don’t know, I’m very open minded about what a business can do and I try to just, I pick businesses, I pick little stocks based on things that I know that have worked in the past and if the future looks like the past and there’s no guarantee, but you know, for most of my life, the future has looked a lot like the near future looks like the recent past in any case, these stocks should do pretty well and should outperform and so that’s been The experience for value investors forever, basically, is that you’re buying these companies that everybody’s like, why are you touching this thing?

[01:12:09] Tobias Carlisle: There’s good reasons not to own this thing. And that’s why it’s cheap. And for some reason, that sort of cognitive bias, that collective cognitive bias that is built into the market creates these opportunities that The only way that you can exploit is if you are prepared to buy these things that look exactly like this thing does, where we know that there are real issues out there, but it meets the criteria that I also know outperforms the market collectively, and so I follow the criteria that I know outperforms and I try to ignore the narrative.

[01:12:40] Stig Brodersen: Thank you for your response, Toby. It’s very insightful. And I wanted to shift gears here a bit and talk about another, perhaps a bit more philosophical question, and I’m going to constrain you by asking you to look away from your more quantitative basket approach and think more as a qualitative investor.

[01:12:58] Stig Brodersen: So, I was reading the financial statements of Mueller Industries and realized that I knew approximately as much about copper pipes going into the financial statements as after that. And it reminded me of a conversation I had with a friend here in the stock investing space. And I sent him a stock pick some time ago, and it was frankly, coffee that was, that I bought into.

[01:13:21] Stig Brodersen: And I, we also discussed that pick here on, on the show. And he, he said to me, Like, are you using the product yourself? And I said I’m not. And then he was completely disregarded and say, well, if you’re not using the product itself, like that was his filter. Like he would only want to hear from stock investors who also use the product because that would give them more insights.

[01:13:38] Stig Brodersen: And I, you know, I’m not the one to question that’s necessarily a bad approach. And I was thinking about that here the other day, as I was reading the financial statements of your pick. And I am probably using cover pipes, I would imagine indirectly somewhere in my life, but it’s not like, you know, I was talking about Spotify before, and I’m using it, you know, it’s also my, not just as a user using the app, but like my livelihood is depending on Spotify.

[01:14:05] Stig Brodersen: And I’m very much in the podcasting space. And so in its own way, it might give me a lot of different biases. And perhaps it also gives me some insights, who knows. And because here in the past few weeks, I’ve been looking not only into LVMH that we talked about last time, but I also looked into MS, which is just, it’s one of the best businesses that I’ve ever seen that.

[01:14:25] Stig Brodersen: And they’re probably most famous for their Birkin bags. And I would probably never ever buy any products from MS in my life, who knows, but like it was it’s a brand I’m well aware of. And whenever I look their financial statements, I got, just got so intrigued. But I’m not really looking to spend more than 10,000 for a woman’s back.

[01:14:44] Stig Brodersen: I’m probably not You’re not the target market. No, I’m probably not even going to buy any women’s bags. So, and I couldn’t really figure out if that made me more unbiased because I could more look at the numbers and I didn’t have any warm, fussy feelings about I love this brand for bags and not the other.

[01:15:02] Stig Brodersen: Like, how do you look at that as a stock investor? Like how important is it that you are a user of the product?

[01:15:09] Tobias Carlisle: Not at all. So let me give the, that’s my short answer. The long answer is that’s sort of the Peter Lynch approach where he was saying, hey, you’re drinking Starbucks coffee, go get a Starbucks.

[01:15:17] Tobias Carlisle: You’re using zoom, go invest in zoom, you know, use Microsoft, invest in Microsoft, use Gmail, invest in Google. And that clearly has been, that’s probably been not a bad way of doing it over the last few years. Except that I think that, that’s, I call that first order thinking, so Lynch would have then said go into a valuation and make sure you’re not overpaying for this thing, or make sure your assumptions are reasonable, or whatever the case may be, but I don’t think that a lot of people do the second step that Peter Lynch did.

[01:15:43] Tobias Carlisle: Also, Peter Lynch invested through the period 1982 to 1996, which was an incredible bull market, so he wasn’t a full cycle investor necessarily, and I’ve paid more attention to My filter for who I follow in the market is how long they’ve survived in the market. That’s why I like Buffett. Best returns over the longest period of time.

[01:16:00] Tobias Carlisle: Walter Schloss very respectable returns, 20 percent over 50 years. incredible returns. And he’s much more sort of, he wouldn’t have described himself as quantitative, but he was pretty quantitative, pretty big portfolio or selected on the basis of cheapness, basically. And I wrote a book called Concentrated Investing, where we went and looked at guys who invested over the very long term.

[01:16:18] Tobias Carlisle: There’s all different ways of doing it in that book. They’ve all got different approaches. There’s nothing really that I can draw from that. There’s this, there are many of these interesting sort of cognitive biases, behavioral errors that humans make. And there’s a whole body of research on this and I’ve tried to cover it in some of my books where I describe how bad we are at predicting the future, how these sort of simple little quantitative models tend to outperform the very best experts, including when the very best experts get access to the output of these models, which means that what the experts are doing is they’re taking a model output that delivers a good answer and they’re turning it into a bad answer through their own biases even at that stage, which is kind of interesting.

[01:16:58] Tobias Carlisle: One of the biases that we have is this idea that as we collect more information about something, we’re learning more about it. And we’re becoming more competent with our pick, but what in fact happens is we collect more information and we only collect information that agrees with our own preconceived conclusion about this stock that meets our biases and we ignore disconfirming evidence.

[01:17:23] Tobias Carlisle: And so what happens is we’re not in fact becoming more accurate. We’re becoming more confident about a pick that is less accurate. And so they show this two different ways. It’s kind of interesting. They had college students come in and pick which college football teams would perform the best of the course of the year.

[01:17:39] Tobias Carlisle: And then they said to them, they gave them a group of statistics and they said make your pick based on these five criteria and that whatever it was, number of tackles, the number of points, offense, defense, something like that. And then they said, here’s five more data points. Would you like to change any of your picks?

[01:17:55] Tobias Carlisle: And they did five rounds of these five data points. And what they found was that, and they randomized the data, so everybody eventually got the same data, but at the start, everybody got different bits of data. What they found was that people anchored way too much on the first data that they were given, and way too little on the last data that they were given.

[01:18:11] Tobias Carlisle: And what they should have been doing was updating the entire, you know, you would call it like a Bayesian update, where you take the information that you have, you take the new information, you factor that into the model that you have, and then your initial guess should shift. by what has been provided with that new information.

[01:18:27] Tobias Carlisle: We don’t do that. Humans are way too kind of stubborn. We just collect the first bit of information.

[01:18:32] Stig Brodersen: And the different variations of the experiment you talked about with football. It was it was similar with the perception that students had about a new college professor. And then they were asked after, I don’t know, a minute or 20 seconds. It was like, it was so short period of time you would believe it. And then they had an entire semester following that class.

[01:18:52] Stig Brodersen: And then they were asked how they felt about the college professor. And it was the same rating. Like it’s just, we were just anchored so much to that. And so. Thank you for sharing, Toby. It was quite interesting. I would love to give you a handoff to where people can learn more about you, Toby, but before I do that, anything else that we haven’t covered here in the episode?

[01:19:12] Tobias Carlisle: No, I think that was great. Again, a wide group of picks, Disney, Spotify, Mueller.

[01:19:19] Stig Brodersen: Wonderful. Well, Toby, before I let you go, where can the audience learn more about you?

[01:19:24] Tobias Carlisle: I run Acquirer’s Funds. We have two funds, Deep, which is small and micro domestic U.S. value, and Zig, which is mid and large cap domestic U.S. value. I’ve written some books that are all in Amazon under my name, and I have a website, acquirersmultiple.com, which has got some free screens and all of our blog posts and podcasts and various other things there. Thanks for having me, Stig.

[01:19:46] Stig Brodersen: Pleasure. As always, Toby. Hari, what can people learn more about you?

[01:19:50] Hari Ramachandra: Yeah, I think X or Twitter, @HariRama is my handle. Happy to continue the conversation there. I also have a blog, bitsbusiness.com So I look forward to comments, feedback, and conversations.

[01:20:04] Stig Brodersen: All right. As I’m letting Hari and Toby go, I want to mention that we have been repeatedly being asked to provide an overview of the stocks we discuss here on the show, especially for the mastermind episodes.

[01:20:15] Stig Brodersen: When We Study Billionaires turning 10 years here in 2024, it seems timely to share my track record and portfolio. Clay and I plan to record a podcast that is doing just that. It won’t be discussing all the stocks that we have discussed here in the mastermind episodes, but the stocks that I put my money into, the very intention of the mastermind episodes is not to invest in everything we discuss, but rather to get feedback and decide not to invest in the weakest investment cases.

[01:20:42] Stig Brodersen: Remember, invert, always invert. And at the time of recording, I have 10 positions, including five major stocks. And I’ve talked about every single position on the mastermind episodes throughout the years. With that said, we’re trying something new, and we want to use our website, theinvestorspodcast.com to accompany the podcast more.

[01:21:01] Stig Brodersen: So what I will do is to publish my portfolio, track record, but also links back to the specific episodes where all of these positions have been discussed. I’ll be the first to say that taking on this project was a lot more work than I originally expected it to be but I’m almost done and I’m excited to share my results with you.

[01:21:21] Stig Brodersen: So stay tuned for episode 619 and we hope to publish that March 28th and with that, I want to thank you for listening to this episode of We Study Billionaires. If you like what we do, please leave a review or tell a friend about our free content.

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