Tobias Carlisle  01:34

Of course! Yeah, I love getting mine out of the way, so I can drop bombs on everybody else’s. (Kidding!) No, it’s been an uneventful quarter, as I’m sure you guys know. After the seemingly endless first quarter ended with the market bottoming on March 23, things have just been going straight up except for value stocks. Value stocks started running and then fell back asleep. A lot of the value stocks have now gotten back close to where they were on March 23. That includes Berkshire, which I know Hari’s going to talk about, and Markel, which is my pick.

02:10

Markel is well-known in the value community, but it’s probably not as well known outside it because it’s an insurer. I think people get nervous when they hear insurance because they’re somewhat a black box, but the key to investing in insurance being very comfortable with management.

The key is to like the management and trust that they know what they’re doing. That’s one of the nice things about Markel. It’s run by a gentleman by the name of Tom Gaynor. He’s 58 years old, and a Warren Buffett-style investor and operator. He’s built Markel to be something like a miniature Berkshire, in the sense that it’s an insurance company that has an investment arm with a very Berkshire-like process. Its returns have been extraordinary since it listed in 1986. It’s done about 15% a year. Over the last decade, it’s been a little bit higher, reaching about 35% a year.

Markel is still quite a small business. While Berkshire is a $420 billion market capitalization company, Markel is smaller, not as good, but still a very good business, and is nowhere near as it is only an $11 billion or $12 billion market capitalization company. It’s got a much longer runway ahead of it.

On any measure, it’s very, very cheap. For whatever reason, all of these companies have a little bit of a conglomerate or insurance discount. For some reason, all of these are pretty beaten up. If you look back at the history of Markel, it’s only been as cheap as this on a price-to-book basis on a handful of occasions, one of which was in 2009. It got cheap again in 2011 when it undertook an acquisition, but, basically, it hasn’t been this cheap, almost ever. It was cheap on March 23 and is now a little bit more expensive than it was then, but it’s phenomenally good value as it is. It has a bulletproof balance sheet run by a high-integrity high-performance manager with a very good set of assets. It has a very long runway for growth, so I think that if we go into another market breakdown, you would want to be invested in it. And if the market rockets from here, again, this is the stock that you want to be invested in. I feel very comfortable with Markel (MKL). That’s my pick for today.

Hari Ramachandra  04:34

I would support your pick this time. Markel is a lesser-known company even though it is are well-run. For me, another point of confidence goes to Markel as my dear friend, Saurabh Madaan, joined one and a half years ago. Also, I’ve seen Tom Gaynor operate after having attended multiple annual meetings. I think they are probably “Baby Berkshire”, as they’re well-known as. The only concern I have is that they have been trying to get into wholly-owned subsidiaries, instead of just investing in equities. How are they doing there, Toby? And what are their chances of becoming like Berkshire? I haven’t seen them having their “See’s Candy moment” yet, so what are their chances?

Tobias Carlisle  05:25

First, let’s talk about Saurabh Madaan a little bit. I met him only virtually, unfortunately. When he was at Google, Saurabh was getting a lot of the value investors to come and talk about the books that they had written at Authors at Google. I was part of that group, and I went there in 2014, along with Guy Spier, Mohnish Pabrai, and a group of other guys. Unfortunately, Saurabh was out the day that I was there, so I didn’t get to meet him.

Now, he’s left Google and has gone to Markel. I understand that he’s there to help with an initiative involving more techie acquisitions. I think that they’ve moved in the right direction to try and find somebody like him who’s able to assess those opportunities when they come in. Although, they’re always going to be very rare and unusual, and anybody who follows that part of the market knows that it’s extremely expensive at the moment.

06:14

Now, I don’t know if this bear market is over. We just rocketed brand new highs, and everybody ignores what’s happened. I find it a little bit difficult to believe given the kind of destruction that’s gone on in the real economy, but the stock market is its own animal. It can be completely divorced from reality for a long period of time.

From 2007 to 2009, when we went through that bust, energy had been very strong. In the first half of that bust, energy was unaffected by it largely. Everybody thought, “This is good news because it means that the bust is probably not going to be as bad as we initially thought it was going to be,” and then the second half in 2008 took down all the energy names. This time around, I think tech is similar to energy then. Tech has been largely unaffected through the first half. It’s no surprise to me, if that is their focus, that they haven’t been able to do anything through this period.

07:10

I think, like Berkshire, which I’m sure you’ll talk about in a moment, they’re a little bit front-run by the Fed. The Fed stepped in to provide that role that Berkshire has typically done in the past. Berkshire has all of this cash, and they sit and wait for opportunities like these to deploy into pretty robust companies that need liquidity. They did that with Goldman Sachs and with a few other investment banks the last time around.

This time, tech was strong, and the federal government stepped in without giving Berkshire that opportunity, and Markel equally didn’t get to take that opportunity. So, I think there’s a very good chance that they will do something in a not too distant future. It’s no surprise to me that nothing has happened so far. Also, as these things can be rare and one-off, although you would have thought that through some weakness like that, something would have already happened, I think the reason it didn’t is because of what I’ve just said.

Stig Brodersen  07:59

I like your pick, Toby. Actually, just earlier this week, not only did I snag up more on Berkshire, we got to talk about that here shortly. I put in a new bit on Markel, too. I think the valuation is very attractive.

But I think now that we also are going to talk about Berkshire, I think that we also need to talk about some of the differences. People have been referring to Markel, as the “Baby Berkshire” for a lot of good reasons for a long time, but I also think there are some distinct differences.

You mentioned Tom Gaynor before. He’s a very interesting person, who, unfortunately, doesn’t do a lot of press because every time he talks about how he manages his equity portfolio. He has been outperforming the stock market for as long as his Markel track record. It’s always interesting to hear. Whenever I look at DATAROMA, I tend to look at just a five to seven value investors, and Tom Gaynor is always one of those that I check every quarter. He is not as concentrated as Warren Buffett. His method is a lot more cognitive, at least that’s how it seems. His two biggest holdings are A shares and B shares of Berkshire Hathaway at only 5.7% and 5.3%, respectively. He picks stocks differently. That’s one thing.

09:14

The other thing I took note of was the Markel Ventures, which Hari mentioned before. I was reading through the last annual report. It was interesting that they talked about when they started. Just to give you a few numbers, late in 2005 was the first full year of the Markel Ventures unit. They had $60 million in revenue and $5 billion in EBITDA. Here, in the fiscal year of 2019, their revenues now stand at $2.1 billion, and EBITDA at $264 billion. So, I would agree in many ways with Hari that they haven’t had their “See’s Candy moment” yet.

I think they’re just doing a very, very long play. I don’t see any amazing catalysts materializing over the next year or so. This pick just has a good track record. They’ve been underwriting with a decent profit 16 years out of the last 22 years. Although not by much, their equity portfolio has been outperforming the market, too. So, as much as the growth rate of the book value has been slowing down over the past 10-15 years compared to what it has been, some of that is just due to size and interest rates, too. But this is a significant appreciation from me already. This is a stock I like.

Preston Pysh  10:34

I love this pick. I think this is a very strong pick. I’m coming up with an IRR of around 11% at the current market price, which is difficult to find in a lot of companies based on how this market has been bid. As far as performance against the S&P 500, I think it’s going to strongly outperform it on a long-term scale.

I just want to throw it out here that Toby mentioned he did a Google Talk. We’re going to have this in our show notes, too. The first time I was introduced to who Toby is was through this Google Talk. I watched this on YouTube, and I was thoroughly impressed. I just want to share that with the audience. I know you did the talk a long time ago, but it was a really, good video for people to watch. It was about deep value investing. We’ll have a link to that in the show notes.

11:19

Now, I want to talk a little bit about Hari’s question about wholly-owned operational subsidiaries versus non-operationally-owned subsidiaries. That question has a lot of learning in there. That’s why I want to explore it a little bit. If you guys have any comments you want to add to this, please feel free to chime in.

Warren Buffett and Markel now are both trying to wholly-own companies, as opposed to owning a 10% stake in a company. The reason why you see them wanting to do this is that there are tax implications when they receive dividends from a non-operationally-owned subsidiary.

Let’s take, for example, one of their smaller-position-sized stakes relative to the amount of equity that exists, like Apple. They do not operationally own Apple. They do operationally own GEICO. They own 100% of the equity of that company.

When you look at how they receive the earnings of GEICO versus the earnings of Apple when Apple makes money, that money sits on the balance sheet of Apple, and then Apple pays a dividend. When Berkshire receives that dividend, they’re taxed not only on the dividend that goes out the door of Apple, through the valuation of Apple, but also when the money hits their balance sheet over at Berkshire Hathaway as they receive the income of the company that they own because it’s not operationally owned. When it comes to GEICO, none of that tax implication occurs.

They can treat it as a sweep account. They can pull the money straight to their balance sheet, or they can allow the money to continue to remain down at the GEICO level, which is typically what they do, and allow the managers of GEICO to allocate the capital the best way they see fit. That’s why you see Berkshire and Markel trying to buy wholly-owned companies, opposed to taking 10% ownership here and 10% ownership there.

13:12

Now, where it gets hard is the size of the companies that they are trying to acquire, like a $50 million company. Think about it from the perspective of the company that’s being acquired. They’re not willing to be completely purchased unless there’s a large premium attached to the market price, like a 20% increase from what it’s currently trading for on the market.

So, Berkshire and Markel find themselves in this predicament where they’re bidding the price because they are trying to wholly own these companies when they could get a much better price if they don’t do that. But if they don’t, then they get the tax implications of receiving dividend payments because they’re not operationally owned. That’s important and interesting to see. It also shows you the challenge that they’re up against as they’re trying to increase their free cash flow. Every one of their target companies knows that and tries to use that to their advantage in the pricing.

It’s hard. It explains why Buffett voices so much at shareholders’ meetings all the time that they’re a victim of their size and success because they’re so big. All those implications kind of play out. It’s a neat learning point for maybe some of the younger people that aren’t familiar with either one of these companies, and what they’re up against as they’re trying to do this.

14:33

Something else that I want to talk about is the balance sheet of capital-intensive companies, like Berkshire Hathaway’s railroad company. These companies are extremely capital-intensive as their assets are tangible assets. If a machine breaks, they have to buy another machine. That’s a physical asset that’s now going to sit on my balance sheet.

The companies, in my opinion, have performed extremely well under the environment that we’re in right now. Let me define what that environment is. The central bank’s printing a bunch of money and inserting it straight into the economy. It’s going into the bond market and coming into the equity market.

Under that environment, from what I’ve gathered, companies that have intangible assets on their balance sheet have performed extremely well because they’re able to adapt to that environment much faster. If your company assets are brand power, like Google, they’re able to just manipulate a little code then capture these different bidding rates for advertising. Those intangible assets have an extraordinary value, and in my opinion, have led to the outperformance of capital-intensive type businesses that have a lot of tangible assets on their balance sheet.

So, when I look at Markel and Berkshire, and their subordinate companies that are capital-intensive businesses, I think that might be one of the reasons why you’ve seen some underperformance. If we expect that environment to continue to play out, and we see that dynamic of companies that have large amounts of tangible assets continue to play out, maybe we’ll see these perform less well than we’re expecting based on the valuations. I don’t know, and I don’t know how long that’s going to continue to persist, and how long this dynamic is going to continue to play out. But, in my opinion, that’s what we’ve seen over the last 10 years.

So, with that, I love the company. I think they’ve got extremely strong earnings and a strong balance sheet. I think the valuation on it is a sweetheart price based on the free cash flows that I’m estimating. I like it.

Stig Brodersen  16:48

That was a lot easier for you than it usually is, Toby, huh?

Tobias Carlisle  16:51

Yeah, that’s great. I’ll pick ones that you guys like all the time.

Preston Pysh  16:56

Hari, why don’t you go next? Let’s talk about Berkshire after we just talked about Markel. It’ll be perfect.

Hari Ramachandra  17:01

The reason I’m on this Mastermind is Berkshire as I met Preston in Omaha in one of the annual meetings.

I’m seeing meaningfully what happened during the 2000s when a lot of people lost their faith in Buffett and started also criticizing him. There are a lot of institutional investors who sold Berkshire, and one of them even wrote a famous open letter about selling due to Buffett missing a lot of opportunities to invest in tech, not paying dividends nor buying back stocks at the right time. There’s a lot of criticism going on right now.

On top of that, there’s also news of Berkshire being tricked in its purchase of Precision Castparts Corp. They acquired the company for $900+ million, but those guys were cooking their books. That has come out, and there’s litigation going on right now.

18:00

So, one of the reasons I’m picking Berkshire is that there’s a lot of bad news baked into the price. That’s always a good opportunity. That’s number one. Number two is that, in this environment, as Preston said, as the capital becomes cheap, companies like Berkshire and Markel are struggling to find value as there are a lot of private equity funds who compete in the area where they want to buy a company outright. Also, the public markets are not cheap, and the Fed is stepping in and making it hard for Berkshire to play its game the way it did in back in 2008. Those are the headwinds.

I highly recommend a fantastic podcast by Toby with Chris Bloomstran. I learned a lot about Berkshire. Chris talked about how Berkshire Hathaway Energy and Berkshire railroads are great investments and great investment vehicles even going forward. According to him, the area where they’re struggling right now is the 25% part of it, which is where all their retail businesses are located.

19:09

A few more factors we need to ask about companies now are: Is it COVID-protected? And is it China-protected? Berkshire is largely insulated from any trades with China as a lot of their businesses are local. It’s curious how Munger has always been a strong supporter of China and Chinese companies, but Buffett never went into China largely. I’ve wondered why, but now he’s proven right by not doing it. Are they COVID-protected? Kind of. Most of their businesses, like their Berkshire energy insurance and railroads, are not impacted that much, but 25% of their retail is. But I think with the cash cushion and the ability to borrow, they can withstand. Finally, are they Fed-protected in the sense that they can keep the money? How are they going to go ahead doing their business the way they used to? One example I would give is in Silicon Valley’s Amazon. If Amazon is today’s Berkshire, the reason being is that they can create businesses. For their AWS, they didn’t acquire anything. They just created themselves because they could borrow money cheaply and can create something.

The Berkshire model is not set up to create businesses except for the insurance business. Aside from the Berkshire insurance, they haven’t created any other business organically. So, they will probably struggle in this environment where there is a lot of capital and near-zero interest rate floating around. I don’t know where their growth will come from, but I do feel safe enough to park my money there rather than keeping it in cash. That’s what I would say. I don’t know about the IRR going forward. I would love to hear from you, Toby, Preston, and Stig. What do you guys think about the IRR and opportunities ahead?

Tobias Carlisle  21:09

That podcast with Chris Bloomstran was great because Chris is an expert in Berkshire. He’s been following them for 20-something years. He understands all of the intricacies of the deals that Berkshire has done over the years. The one that I find most fascinating is the General Re deal, which we talked about on the podcast a little bit. The significance of that was that Berkshire had this phenomenal run where Buffett bought Coke and various other things that had generated enormous returns. Berkshire was holding these stocks that now had very inflated valuations, and was itself trading at three times their book value. Berkshire’s concentration in equities also meant that the book value was also quite inflated because it held expensive stuff like Coca Cola.

By acquiring General Re for the stock, which he doesn’t like doing, but did this occasion because General Re’s books tended to be like treasuries. It was more like cash, so Buffett merged Berkshire, which was this inflated stock portfolio trading at three times their book value with an undervalued cash portfolio. Basically, what he did was completely derisk the portfolio, which turned out to be a pretty nasty bust that gave him the cash to then reinvest and take advantage of that run through the early 2000s. I think they don’t quite have that same problem now as the equities are somewhat beaten up. It’s been a rough run for value investors like me. Buffett’s a better value investor and a different type of value investor, but it’s also been a very rough run for Berkshire and for Buffett. It’s not that they’ve done anything wrong. They haven’t made any mistakes, except for maybe IBM, but they haven’t seen the returns based on the stocks they’ve typically generated in the past. There are a lot of theories about that. Preston and I can beat everybody to death with our Fed and underperformance of value theories, but we won’t do that.

23:00

I think the forward return on Berkshire is a little higher than most folks are giving them credit for. I think the forward return could be something like 13% compounded for about 5 to 10 years. I think it’s reasonably high at the moment because of some of their holdings. Apple is a big holding and is cheaper than those in FANMAG (Facebook, Apple, Netflix, Microsoft, Amazon, Google). I think that was a good purchase. They got that right at the right time and put a lot of money into it. It’s now their biggest holding. Still, compared to those other tech companies mentioned, it’s reasonably cheap.

I think Berkshire has some room to run. I think the wholly-owned subsidiaries, too, have good prospects for generating a lot of free cash flow over the next short period of time. If there’s any weakness in the market, Berkshire is in a very good position to take advantage of it the second time around. My estimate for Berkshire from here on is a little bit higher.

It’s hard to handicap Berkshire with Markel because Markel’s smaller and has more opportunities. It’s harder for Berkshire to deploy meaningful amounts of capital. Markel is a $12 billion company, while  Berkshire is a $420 billion company. There are just more opportunities for Markel. Having said that, I wouldn’t be surprised if Berkshire grows because they’ve got the greatest capital allocator investor to ever do it fully cashed up probably going out to battle for the very last time. I like Berkshire. Markel could also have a good run. For both, I think the returns could be at 11-15%, compounded, for a little while.

Stig Brodersen  24:42

This episode follows two episodes where we were only talking about Berkshire Hathaway, so I don’t want to repeat too much of what I said in those two episodes. But as I mentioned before, I added to my position here just a few days ago to at a $172. Whenever I look at the valuation, I’m looking at cash equity. How much am I going to pay for the operating companies? If it’s $300 billion, to me, it definitely looks worth a lot more than $100 billion. It’s very difficult to make an accurate calculation, but for something that’s spinning off about $20 billion+, annually, it’s probably worth a lot more than that. So, looking at the Berkshire stock, it’s probably at around the 30% discount right now. I would agree with the internal rate of return calculation that you made, Toby. It’s not the biggest discount, but it’s probably very similar to the discount that Markel is trading at right now.

Preston Pysh  25:38

Toby, I agree with your IRR. I came up with 11% when I did mine, and you were saying 11-15%. But I have to say I wasn’t accounting for the look-through earnings on the company. I was just accounting for the earnings that you were seeing on the Berkshire financial statements.

For people that don’t understand that term, we’ve talked about look-through our earnings a couple of times on the show, and Buffett has also talked about it in his shareholder letters from time to time. We were previously talking about non-operational subsidiaries paying a dividend to Berkshire. For a payout ratio of $1 of earnings per share on a company, if 30% was paid out as a dividend, the 66% of that still remains on that company’s balance sheet as earnings. If you understand how accounting works, that 66% of earnings remaining on your balance sheet adds value to the share price of that company over time.

Berkshire Hathaway has a substantial amount of non-operational subsidiaries on its balance sheets. That means they’ve got a lot of look-through earnings that aren’t showing up on any of their financial statements, but are there if you start digging into what those non-operational subsidiaries. If I account for that, I can easily see how Toby could get to 13% or even higher, on an IRR beyond the 11% that I came up with, which I got from just using the financials that are being reported by Berkshire,

Tobias Carlisle  27:13

Berkshire has $20 billion in earnings, another $20 billion look-through earnings, $137 billion in cash, and a $420 billion market cap. The actual residue that you’re paying for is cheap relative to the earnings it’s currently generating. Including the look-through, I think it’s very, very cheap. You can look at Berkshire on a price-to-book value basis. It’s a very simple metric. People use it for investment companies and insurance companies, so it makes sense to use it here.

You can think about book value as being the floor of valuation. For Berkshire, it’s clearly worth more than book value. Buffett himself has said that he will buy stocks back at 1.3x book value, and north of it. He has done that and brought it back to a high price, so you’re buying at a price below the price which Buffett would buy the stock. Right now, it’s trading about 1.14x book value. It didn’t get much cheaper than that. I think it got down close to book maybe something like that.

Hari Ramachandra  28:13

I wonder why Buffett is not aggressively buying Berkshire stock at this point. Do you guys have any thoughts on that?

Tobias Carlisle  28:19

It was pretty clear and amazing. I think that he’s looking at the unknown scale of the disaster from the shutdown, and Berkshire writes super-cat insurance. If a hurricane hits New York while they’re going through this, that doubles up on that disaster.

I think they’re carrying cash. That’s how they sold down a basket of airline shares. They’ve sold down Bank of New York to get on 10%. Basically, all they’ve done through this period is sell, which is very out of character for Buffett. He’s bought every dip.

Stig Brodersen  28:53

He’s probably looking to buy a lot more, and I’m not just talking about why he bought stocks. I think the most stock he ever bought in one quarter was $1.7 billion in Q1. He primarily bought around $214 in B shares, and right now it’s trading at $174.

Another thing is that if Buffett said, “Hey, it’s so cheap,” everyone’s going to buy it, and that would be bad for him, right? Because that would mean that he would have to spend more money buying the stock.

I think that we also have to pay attention to what he’s doing, not always what he’s saying. He has been scaling up share buybacks, even though not to the same extent, as a lot of investors would want. He’s talked about how they’re tuned to cost has changed for Berkshire Hathaway because of everything that’s been going on.

I also think that a lot of the criticism, which you hinted at before, Hari, has also been a bit unfair. We talked about the Apple deal. That was the biggest position he built with $35 billion at the time, and he more than doubled that. Now, people are criticizing him for not buying a lot more than $35 billion. It was by far, by far the biggest position he ever built. So, it’s very difficult to make people happy if you are Warren Buffett, and I think that’s worth noticing, too.

On the big bets, he’s usually right. I have to say that he did not perform well with Heinz. He makes mistakes, but he tends to do them while there’s not as much money around. For what it’s worth, that’s something to mention too. But I know I’m just talking my own position here, so I hope someone can give Hari a little grief. I don’t know if I’m doing a good job coming for me.

Preston Pysh  30:32

You can beat it up as much as you want, but you can’t do anything about the free cash flow that this company is kicking off. It’s enormous. Also, looking at the price that it’s selling for, you get substantial IRRs. When you look at the rest of the market, the numbers aren’t anything close to that. If the market wants to keep analyzing the price will then just buy more equity.

Tobias Carlisle  30:53

I guess the criticisms on Berkshire that are too big are worth addressing. There’s no discount for being a conglomerate, and now, the only thing it can do is keep on getting bigger or break apart. Buffett has said that he won’t break it apart in his lifetime, and I don’t think that he wants the managers who run the board now and the next generation of management to do that.

There’s also the fact that Buffett is 90 years old, and hasn’t done as well over the last 15 years as he has in the past. In the most recent dip, he didn’t do anything and lost a step. He hasn’t participated. He didn’t participate in this most recent drawdown, and that opportunity has now passed by. That’s the criticism. Why don’t you address that, Hari? Then I’ll address it afterward, just to save myself from getting any hate mail from Buffett.

Hari Ramachandra  31:45

Yeah, actually, that’s a good point, Toby. What I remember is that even in 2008, he didn’t just jump in as soon as the market crashed. That’s number one. Number two, the lesson I learned from the annual meeting was you have to be mindful as an investor. When you’re buying a dip, you need to understand the band of uncertainty.

What he essentially said in the annual meeting was that the range of uncertainty at this point is too high for him to evaluate any investment. That’s pretty prudent, especially considering that even in his insurance operations, the range of uncertainties is also very high. He’s dealing with both, and, at the same time, he is also dealing with a lot of his businesses not doing well. He might have to shut some of them down and lay people off. So, even from a PR perspective, buying back shares while laying off people or so might pose a lot of implications for him too.

I am curious to know your thoughts on why he sold Goldman Sachs. Is it mainly because he wanted to stay away from political hot potatoes? I believe that even regarding the airlines, he might have wanted to just be out of the limelight. Apart from financial considerations, maybe he also didn’t want to be dragged into public arguments of Buffett being bailed out by the Federal government. So, I think that was a smart move, too, from a PR perspective, at least.

Tobias Carlisle  33:08

I saw that too. I think airlines are a little easy. He looked at the potential range of outcomes, and it included zeros for some of the airlines if the Coronavirus shut down lasts for a long period. If you include a lower bound in your valuation shifts, that affects the median point of the evaluation. Maybe that’s what he’s thinking about. He doesn’t like to hold things that can be zeros.

Regarding Goldman Sachs, yes, I wondered if he just had a sweetheart deal when he invested in Goldman Sachs the first time around. There’s no criticism of him for doing that from me. But that was backstopped when the company bank was stopped by the federal government, which drew a lot of criticism that Buffett had been bailed out. Maybe it was just an opportune time to realize that investment and he just decided he’d rather have the cash over holding Goldman Sachs stocks.

When I look at the performance of Berkshire over the last 15 years, I can explain it in terms of what has happened to the value, globally. I don’t think that Buffett’s done anything different from what he has always done, which is trying to buy undervalued high-quality names. It’s just that strategy hasn’t been a great one for the last decade. It’s also only on a relative basis. Berkshire has still done very well over the last decade. It’s just that the market has bid these expensive stocks to an unprecedented level.

Because the S&P 500 holds those in market-capitalization-weighted holdings, as that’s the nature of it, when the biggest stocks are bid up and around, it pushes up the whole index. If you’re a value investor, and by definition, you’re holding stuff that is smaller and undervalued, you don’t participate. I think that’s what’s happened. I think that what happens here is that we do get a second leg down, as nuts as that sounds at this point, because we’ve all bounced so high, but I think we’re probably going to see a second leg. I think that when that happens, Buffett will become fully invested, and I think value is going to have a much better run. I would much rather be a value guy over the next decade than someone who’s just allocating to the S&P 500.

Preston Pysh  35:12

All right, I’m going to go ahead and talk about my pick if that’s all right with you, Stig.

Stig Brodersen  35:16

Yeah, go ahead. After talking about very traditional companies, like Markel and Berkshire, I’m curious, Preston, about what you came up with. Did you come up with a old school value pick? I’m just teasing you because I know your pick, and I know I’m going to share my pick afterwards.

Preston Pysh  35:32

I’ve got a 1990s tech stock here for you: eBay (EBAY). This one here has not had an impressive top line over the last 10 years. I would describe the free cash flows as pretty stagnant. I like this because I think the valuation for the free cash flows that it’s kicking off is strong right now. In fact, I talked about this two weeks ago on our show. Since we talked about it two weeks ago, the stock is already up 15%, and I’m not saying that’s because we talked about it on the show. If anything, it’s definitely not that. The momentum on this looks good, as of recently. I like the valuation, I did a free cash flow analysis, projecting what I think the free cash flows could look like into the future. I did a very modest 4% growth rate on the free cash flows. When I did that, I came up with an IRR of 9% on eBay.

I like this because I guess I have a very bearish opinion of the global economy. I have a very bearish opinion of how the top 90% of people in the population are going to be dealing with the environment in the coming three to four years. I think it’s going to be a very difficult time in the coming four years for 90-95% of people in the global economy.

If that’s a true statement, then I think a company like eBay is going to be a hot company, specifically because it’s about selling your stuff. If you want to sell secondhand items, you can log on to eBay. I think eBay’s the first thing people think about whenever they want to resell things inside their house, and I think that that brand power is going to be huge for them.

The company obviously has good fundamentals, otherwise, it wouldn’t still be in business in such a competitive tech space that we’re seeing. I think when people think about selling their stuff, they either go to Facebook or eBay, so I think eBay’s going to do good. I don’t think it’s going to do great, but I think it’s going to do good. I think it’s going to continue to hold its own. Based on the price, compared to what I think it’s going to continue to earn, I think it’s going to perform quite well relative to the S&P 500 or whatever basket you want to compare it to.

So that’s my pitch.

Tobias Carlisle  37:55

What year is it? Haha

I like it. I’m just teasing.

Preston Pysh  38:04

I think the big competitor here is Facebook, to be quite honest with you, as we’re finding Facebook is continuing to take a lot of market share in this space of selling your stuff. I think that’s the risk. If that trend continues to persist, maybe that could wreak havoc on eBay long term, but I still think it has pretty strong brand power. I’m kind of curious, Hari, of what you think.

Hari Ramachandra  38:29

Yeah, I think there’s a very interesting pick, Preston, as eBay has just fallen off the radar. I remember back in the 2000s, eBay was one of the darlings and one of the growth stocks. They were the Amazon of their time, at that point of time. If I wear my value investing cap, I think this is a compelling buy. At the same time, if I look at eBay as a tech professional, what strikes me is that they are just having an enormous talent bleed. They have been going through a lot of challenges, and from what I’ve seen in Silicon Valley or the tech sector, it’s either you’re growing or you’re sinking. You’re not even shrinking. Basically, look at what happened to IBM. Unless you’re growing, you will not have the best talents join you. And if you don’t have the best talents, then you can’t compete with the “Facebooks” and “Googles” of the world. That concerns me.

I think Elliott Management is an activist investor. They took a stake, came up with proposals, and made the CFO the CEO. Obviously, when you do that, you look like you may be preparing to sell to someone. It looks like that might be one of the outcomes, and probably that’s a good outcome for eBay. The management is now trimming eBay. I think they’ve sold off StubHub and many other subsidiaries. It looks like they’re preparing to sell it to someone. Maybe this is not the right time. But I think that would be my concern as to like, as you pointed out that they’re up against Facebook. If they’re bleeding talent, and their average is employee age is in the 40s, how will they compete with Facebook? That’s what would worry me.

Preston Pysh  40:32

Thinking about the market that they’re going after, I think about Facebook’s resale is more for local exchange. If I’m in the market for a secondhand bicycle, I immediately think to go on Facebook and search locally so that I can drive over to pick up this bike that I just bought. When I think about eBay, I don’t think that at all. I look for products that can be mailed from California to where I live, many states away, so I can receive that product. I’m not looking for that on Facebook. I’m looking for that on eBay. The way they’re selling is a little bit different from Facebook.

But on to your comment there about them bleeding talent. That isn’t something that I had heard, and I think that is concerning. And boy, I mean, you’re seeing it with the companies that Toby had named earlier. These companies are coming out of that crash that we just experienced, and the speed at which those specific companies rebounded off the bottom was mind-blowing, relative to every other company on the market. It was indescribable. We’ve never seen anything like that before.

Anyway, Stig?

Stig Brodersen  41:53

I was talking about DATAROMA before. Every quarter, we always check what super-investors have bought. I mentioned that I follow five to seven guys depending, on what I’m interested in. I follow Warren Buffett, Tom Gayner, and also Seth Klarman. What’s interesting is that the biggest stock in Seth Klarman’s portfolio right now is eBay at 14.3%, He added more than 60% to that position, which was very interesting, now that we are talking about it.

eBay, as most tech stocks, has outperformed the S&P 500 over the past five years, but has vastly underperformed tech stocks, in general, which probably doesn’t come as a surprise whenever you’re seeing what the FANMAG stocks have been doing. I think the valuation is attractive. I like how much cash is spinning off, especially for this type of company. This type of company typically does not trade those low multiples. By “this type of companies,” I’m talking about tech companies spinning off a ton of cash flows. Obviously, one of the reasons for that is that they haven’t shown this impressive top line growth which we would like to see.

If you look a bit more at the fundamentals of the company, the buyback yield has just been very, very high for eBay. One of the reasons why they perform well is that they are spinning off a lot of cash, and they’re putting a ton of cash into buying back their own shares. We’re talking double digits here. I think that’s also something that needs to be included in the discussion. Anything you want to add, Preston?

Preston Pysh  43:25

That’s all the more that I have for eBay. I think it’s important for me to continue to disclose that I still have a very strong opinion that Bitcoin is going to perform well for the rest of the year. I’m just going to leave it at that, so I have eBay and Bitcoin as my pick of stocks that are going to perform well.

Hari Ramachandra  43:43

Preston, does eBay accept Bitcoin? I believe some of the companies have started accepting Bitcoin,  correct?

Preston Pysh  43:49

You know, I don’t know that, Hari. I don’t know if they do or not.

Stig Brodersen  43:59

All right, guys. I typically do very traditional value picks. I’ve been pitching AT&T here recently, and Allstate. I’ve also just talked about my positions in Markel and Berkshire Hathaway. They’re very stable companies with good track records. There’s not a lot of exciting growth, perhaps, but they have really, strong downside protection. This time, I decided to challenge myself to a very, very different stock pick. This stock pick is not making any money, and does not have a great track record. I decided to pitch Spotify.

Spotify is a Swedish company. It was founded in 2006. For legal reasons, it’s located in Luxembourg, but it’s a Swedish company. They have their headquarters in Stockholm. I think that most listeners out there are familiar with Spotify, and are perhaps even listening to the podcast on Spotify, but it’s a music video and podcast platform.

I have a few reasons why Spotify came on my radar. I’ve been a heavy user of Spotify for a long time, and I just know how sticky the product is. Being in the podcasting space, too, I can easily see why Spotify will be the platform in the future. I think the growth potential for that is highly underappreciated. Whenever people talk about Spotify, they typically refer to it in the music business, and that’s also where they are generating the revenue, but I think that there’s a lot of runway for podcasting. I think that Spotify is probably the best in the business in the podcasting space.

I’ve been following Spotify for years, and I always found it a bit too expensive. But again, it is also very difficult to value a company that’s never made any money. You always tend to feel that it is a little too expensive. Down in March, it was trading for $120, and I thought, “Now is probably the time.” And since then, it’s soared. Just a week ago, when I sent you guys the pick, it was trading at $160. Today, Sunday, the 24th of May, it’s trading at $190. There’s a lot of interesting stuff happening with Spotify.

46:13

Let’s talk a bit about the industry and business model. Spotify has a freemium model where you can use most of the features for free, as long as you’re online, but you’ll also be served regular ads if you want the free version. Historically, that’s how a lot of premium users started using Spotify. Including myself, 60% started that way before they bought a premium subscription.

There are two major segments to Spotify. We have, first of all, the music segment. Unlike physical and down sales, which pay artists a fixed price per song or album sold, Spotify pays relatively based on the number of artists’ streams, and they typically distribute around 70-75% of that revenue back to the artists.

Secondly, they have a podcast segment. They have been building the podcast business in many different ways. Partly, they’ve been buying podcast studios, like Gimlet, which is probably the most famous. They also bought RINGR, Parcast, and also Anchor, recently, which is how most podcasts are getting started today. Contrary to music, the margins here in podcasting are much bigger. Since they own the podcast content, they only have to pay for the content once. You can compare that to Netflix Originals, but it’s much better than what Netflix is doing as Netflix productions are very expensive. For example, The Crown reached $156 million for two seasons. good podcast productions would typically only reach the hundreds of thousands of dollars, instead, and you can still spread it out over all your listeners. The revenue you can generate for something like chrome would be different for something like a podcast, at least yet, but it is very interesting that they’re looking into because the market is so much better.

48:50

Other than that, they also have their own platform where you can upload your feed. They also have a bigger market share of people who go and listen to podcasts. In less than two years, that went from zero to 20%. It looks like, at least if you ask me, that they will dethrone Apple over the next decade as the biggest platform.

Also, just a few days ago, they made a deal with Joe Rogan. There are no official stats on this, but it’s probably the biggest podcast out there. If it’s not the biggest, then it’s probably the top three or top 5 with 190 million downloads last year per month of his show.

Finally, there were a lot of interactions with music to podcasting to having the vision of being the biggest audio platform. Just here last quarter, as you’re reading through the earnings transcript, the interaction of users who also listened to podcasts went up from 16% to 19%. So, it’s a very interesting trend there.

Tobias Carlisle  49:05

I think that there’s no question that Spotify is a very good business based on its historical financials. They’re growing very rapidly. I’ve looked at their free cash flow over the last three or four years. In 2016, they did $74 million in free cash flow; 2017, $143 million in cash flow, so that’s almost 100% growth; 2019, the following year, saw a very, very significant growth of about 50% growth; then $438 million last year, almost 100% from the year before. That’s an extraordinary rate of growth in free cash flow, so there’s no question this is a very good business and one that you would like to earn at the right price.

On the basis of that $438 million in free cash flow, with your market cap and the enterprise value being about the same number $35 billion, it seems stretched because you’re paying roughly 127 times free cash flow. That’s a very big number. I think Spotify probably may win, but there’s a lot of competition out there from Pandora, YouTube, Amazon, Apple, and other big world-capitalized competitors. I just wonder if, at some stage, this is a business that gets much more competitive and gets much more aggressive in their competition, and then the valuation becomes much more of a concern at that point.

Stig Brodersen  50:38

I think it’s a very valid concern. It is obviously very, very difficult to value a company, let alone a company that has been doubling every year in terms of free cash flow. Like, how do you plausibly do that?

And you’re right, there’s a lot of competition. If you look at the music business, first, the bigger players, the big four being Google, Amazon, and Apple, together with Spotify, all have a lot of capital. It’s very, very difficult to compete with them, but from what we can see so far is that Spotify has been doing a better job, not just because they’re the biggest now, but the user engagement is twice that of Apple Music and three times that of MSN Music. Also, if you look at the churn rate, that’s where you can see a huge difference. The churn rate of Spotify that’s 5%. For Apple Music, which is the second biggest, that’s 10%. Those were just some of the metrics I looked at going into this.

Following the podcasting space closely, which I think is going to be the big growth engine in many ways going forward, it’s just very easy to see why Apple Music has just been falling behind. Their platform has just been standing still for the past 10 years, it seems. Whereas what Spotify is doing right now is just much better. Spotify is making money off their own ads. Now, why hasn’t Apple thought of doing that when they had 90+% of the market share? They still have more than half of the total market share, but it’s like they’re losing almost by the day. Every time I see these statements about the podcast industry, they’ve been losing market share.

Preston Pysh  52:06

Two quick points. So, we had talked about earlier how some of these companies that have intangible balance sheets had massive jumps after the most recent crash that we experienced, this quick flash crash that we had. For Spotify, it bounced 73% after that bottom-hit. 73% bounce. That’s insane. So, what we’re talking about here is: Do we think Spotify is going to achieve the network effect that would cause them to have a dominant role in this space? So far, it appears like that is going to be the case. So, what we’re talking about is whether we think that Spotify can achieve the network effect that was going to catapult it into a position that allows it to be the dominant player for this particular space of media. I’m curious, Hari, of your opinions on whether that’s possible.

Hari Ramachandra  52:59

It’s a very interesting pick, Stig. One of the things Spotify has accomplished is the brand recognition and the network effect, and they’re strengthening it continuously by signing up folks like Joe Rogan. Also, one thing that we need to keep in mind is that they are using an AI algorithm. It’s almost like Netflix and Uber combined because the more content they have, the more listeners are creating playlists. The more artists or more podcasters coming online helps them improve their product better, so it’s a very good flywheel that they have running so far. It would not be easy for anybody to dislodge it. If it were, I’m sure Google and Apple would try to do it by now, so it’s not easy.

But an interesting thing is that they say that they would have a 30-35% gross margin. Will they be able to accomplish it or can they have a runway where they can keep expanding the total addressable market and reinvesting their money, like how Amazon did for a long time to grow? Or will there be a day of reckoning where investors will demand profitability at some point? I think those are what my questions would be.

And the second thing is, as Preston said, if it has run up by 73% already, it’s like already jumping in the bandwagon when everybody is on board already. So, that’s something that will worry me at this point in time. It’s just about the price, not about the company.

Stig Brodersen  54:32

There are a lot of things to unpack here. Talking about how much can they grow, I think that’s a good point because whenever you see a company that’s growing as fast as Spotify, looking at the year on year here, going through the last earning transcript, the total monthly active users grew 31% to 286 million. It’s growing fast, but how big is the market?

What they would say, probably because they believe it, but also because they have to say that, the addressable market is probably between 2 billion and 3 billion people. The question is who’s going to win in that market?

Spotify has talked about how they see themselves if they can maintain a third of that market, which they’re doing right now. Right now, they’re doing 36%. Is that winning or not? And how much of that is networking effect? That’s the other thing too. You mentioned some of the things before, Hari, but it doesn’t have the machine learning effect. The service does get better the more you use it. Having used it myself, I can definitely testify to that. But they don’t have the same networking effects like Facebook or LinkedIn. They do have the friend-to-friend messaging, sharing, and the integration with Facebook, the playlist creation and collaboration, and all that. But to me, that’s not what makes it stick. That’s where I would see more networking effects coming in. It is sticky in the sense that the people who do quit the service, 70% of them are coming back within 45 days of leaving, which to me is just absolutely mind-blowing numbers.

The other thing I also want to talk about is its future growth is then even though there are 286 million monthly users and perhaps the market is 10 times as big as that, clearly not all of that would go to Spotify, and that’s one thing. If they kept the market share, it might be in that range. But you also need to think about which users do they not have yet, and how much money can they make from those users.

Now, living in Denmark, I’m paying 50% more than you would do for the same service in the US. In the US, you’re paying twice as much as you’re doing in Mexico. This is my way of saying that they’re having 286 monthly active users and 130 of them on premium subscription. They’re also, from a money perspective, their most valuable customers. There’s still some runway in North America. The market is much more saturated Northern Europe, but a lot of the users they are now going out to get, they’re not paying $15 a month. They’re paying a lot less for that service, and I think that’s important to note when you look at some of those lofty projections that I mentioned before.

57:10

Being in the space, I went to a podcast movement back in February in LA. And speaking to the people, it’s very clear which way the technology is going in the podcasting space. I would say that the big platform, or at least the best, is Spotify. They’re just making very interesting moves right now. What’s happening is that these platforms are beginning to make more and more sophisticated recommendations.

Think about something like Apple’s platform, who does not have their own production, and when they do, it won’t be to the same scale as Spotify. They will recommend podcasts that’s owned by other people that they’re not monetizing, so they’re not making any money there. Compare that to Spotify. They’re producing more and more shows of extremely high-quality podcast shows with great budgets that spread out to all their listeners, and if you want to listen to those shows, you have to go to Spotify.

As for which shows they’d recommend, say you’ve been listening  to a podcast show about stock

investing. Do you think that they’d want to recommend Toby’s show or our show? They’re probably going to recommend their own show. And if that’s the platform everyone is using, and they’re making money from premium subscription, and if you’re not there, then they’re making money from the ads, that, by the way, has amazing machine learning capabilities.

The way they serve ads is that in the space right now, if you’re interested in selling a mattress, you might try to find a podcast where it might be a *inaudible* group. That’s not what Spotify is testing right now and what they’ve been improving on the past two years. What they’re doing is that they’re saying, “Okay, you want to sell a mattress? We have $10 million. Target the right people.” They have all the information and they’re tracking every time people skip through the app, so they won’t be served the same again. So, they can charge much higher rates than other podcasts, who have a somewhat look alike audience to buy a mattress. All of that is internally driven through the machine-learning on Spotify, which no other platform is doing to the same extent.

Preston Pysh  59:06

What you’re describing right there is what Google and Apple salivate to because it’s all about data. They can harvest that data into their bigger architecture of a network effect of knowing exactly who everybody is and what they want, and predict what in the world they’re going to want in the future.

So, I’m with you, I think that this is pretty exciting stuff when you look at the network effect that they’re achieving, how they’re capitalizing on that, and ultimately, it’s all about the data and how they can harness that data for other things other than what it seems it is just on the surface. I don’t see the competitor stepping into this. It’s almost like Netflix, but five years ago where Netflix was at. That’s kind of how I view this today. I think there’s a lot more to this, and I think if you’re looking at it with traditional stuff like value, investing metrics, and just looking at the numbers based on how much money they’re making or their top line and all that kind of stuff, I think you’re missing the boat on how these companies’ market cap continues to balloon into these epic levels. And it’s because of all those intangible things that we’re talking about, with respect to data, that’s super important to understand.

Stig Brodersen  60:15

We can do like traditional free cash flow, and then it will depend on your assumptions of how much it can grow. You can put in 20% or 30% or whatever and you’ll come up with very different results. But now that you just made the comparison to Netflix, Netflix has 182 million subscribers. They have similar growth rates, especially if you look five years back. Right now, it has three times as much revenue as Spotify. Now, Spotify has 130 million subscribers, and it’s at a similar price point right now. Plus, they have their free users. The enterprise value of Spotify is just above $30 billion. For Netflix, it’s $208 billion. So, I’m not saying that that itself makes it sound. It can also just mean that Netflix is trading at an outrageous level. But I think you’re right Preston. When you’re talking about valuation in market share with some of these, that’s not how the market, at least for the time being, are evaluating those stocks.

So, that’s my pitch, Spotify. I don’t know if you have anything else to add or bash me over, especially in terms of valuation. What do you guys see right now?

Preston Pysh  61:21

I think this pick is such a great example of what we’re experiencing in the market as a whole. Right? We’re learning –and you know Jeff Booth talked about this a lot when he was on our show about the power of a network effect, and the power of capturing data and then being able to intelligently use that in order to do all these other things that add value but aren’t relatively noticeable on the surface. You have to understand the deep strategic business strategy of what it is that they’re doing with this data that they’re capturing through these network effects to understand the real value of a tech company. I think casual value investors miss a lot of that. I think for Bill Miller and other people that are really, deep thinkers, they totally get it.

I would challenge the value investing community to dig into this, and ask yourself “Why?” five times to get to the heart at what Stig is seeing in this pic, and I completely agree with him. I think that there’s a lot to this pick, way more than what is there on the surface. In your investing approach, I think it’s going to require some of this, moving forward. I think that what’s worked 15-20 years ago, of just looking at the numbers from a financial standpoint, it might require a whole lot more than that to outperform the S&P 500 or the top 100 companies moving forward.

Stig Brodersen  62:53

To add to that, not to beating my own drum two months about this pick, having a platform that people go to where they have a lot of data, the way that you can make money out of that’s just absolutely amazing.

Let me give you one example. Spotify was sending me so-called friendly messages about, hey, these artists that you’ve been listening to, they’re having a concert close to you. Now, I would be highly surprised if Spotify is just doing that to be nice. I would imagine someone had been paying Spotify to send out those emails. That’s just one of a million different initiatives that they can do now that they know everything about you and how you listen to audio.

I think that’s very important to understand that if you do compare it to bigger platforms like Amazon or Google or Apple. They may be a small company, but none of those companies are concerned about podcasting and music right now, at least not to the same extent. That’s something they do on the side. Say Apple, the biggest competitor with Apple Music has been falling way behind, but they’re worried about disruption on the iPhone. Like, what’s going to happen when we don’t use iPhones anymore? That’s their main issue. They don’t care about streaming music. They don’t care about podcasting. If you look at what Spotify is doing, it’s all about needing to be the number one audio streaming platform in the world. I think I’ll just round off my pick with that.

Guys, thank you so much for taking the time to come on the show. Toby, Hari, could you please give a handoff for the audience where you can learn more about you guys?

Hari Ramachandra 64:25

Thanks, Stig. You can always reach me at my blog, bitsbusiness.com, or my Twitter handle, @harirama.

Tobias Carlisle  64:34

I have some free screeners up on acquirersmultiple.com and run a firm, acquirersfunds.com. You can find my fund, The Acquirers Fund, with ticker ZIG. It has all the holdings up on the site. You can probably best see performance data at Morningstar, but it’s been a good time for value, so it’s worth taking a look at it.

Hari Ramachandra 64:55

Yeah, same here. Love chatting with you guys.

Stig Brodersen  64:59

So as we’re letting Hari and Toby go, it’s time to play a question from the audience. This question comes from Robert.

Robert  65:06

Hi, Preston and Stig. I’m Robert. Thanks so much for the wealth of knowledge you’ve shared with the community. It’s truly incredible. My question is about habits. I’ve read, listened, and deeply-digested intrinsic value frameworks. However, I, and other fans of yours, would love to learn how you put that into practice. You’re both excellent and investors yourself and have interfaced with the best investors in the world. Do you have insight on what your day to day portfolio management looks like? Do you check your screener every day? Do you spend most of your time reading, like Munger and Buffett? Do you have to go to sites that you start your day off with? I know you study billionaires, but I’d love to learn a little bit more about you. Thanks so much.

Stig Brodersen  65:48

Wow, Robert, thank you so much for your question. I’m kind of excited that someone wants to study us, so thank you for the kind words. But to answer your question, I don’t have a daily habit of managing my portfolio, and that is by design. I think if I had a daily routine, I would subconsciously trade way too much. So far, this year I only bought one new stock.

I do what I can only to invest in my very best ideas, so I try to protect against myself if you like. How I apply this is that I’ve created my own database with my entire portfolio, including the stocks I have on my watch list.

Whenever I get new information about any of those stocks, I go in and put a note in. It could be after earnings call or after a mastermind discussion, like today. So, when I said that I only bought one stock this year, it doesn’t mean that I only use my cash flow to add to that one position that I just bought. For instance, I’ve been a longtime shareholder in both Berkshire Hathaway and Markel that we just covered here in the episode. The fundamental value does not change on the picks. But, as you might have seen for those two picks, the prices have changed quite a lot.

So, what I would do is that I would put in a limit order quite far away from the prices it might be trading at, and utilize some of that volatility to add to the position at good prices. Perhaps that could even be your 10% or 15% of what it’s trading now.

67:14

I would highly encourage you only to invest in your best ideas. And the best ideas are very often your old ideas. For instance, Berkshire Hathaway, at least if I’m writing my assumptions are trading around 30% discount, which is not typically the type of discount that I like to have. But it has a huge downside protection, which I find very attractive. Also, I don’t want to be too much in cash, so that added to that position. There’s an added benefit for you here because you’ve already done your analysis. Of course, you have to keep track on what’s happening, and you have to go in and update your analysis, but it’s not as time consuming as if you’re investing in the new stock pick.

So, rather than daily routine, I have a monthly, or even better, a quarter routine. I put down different ideas and then make a decision to how to allocate my cash. Very often, that decision, after a thorough analysis, is not to do anything at all.

Aside from extensive reading, I often come up with more specific actions after earnings season and after I got latest information from super investors like Warren Buffett, Seth Klarman, Mohnish Pabrai, Tom Gayner, and a few others. But, I honestly don’t have a set process.

68:28

Perhaps one of the best examples is Spotify. Spotify, that I just pitched here in this mastermind discussion, didn’t come from reading specific books that made me more interested in Spotify. It didn’t come from following a super investor. I couldn’t find anyone investing in Spotify at the moment.

Another thing I didn’t do was sit down for two weeks, and then say, “Hey, I want to spend 80 hours analyzing this specific stock.” I just don’t think that’s the right way to do it. It’s a much lengthier, but not as intense process.

Sorry for digressing there. Let’s go back to Spotify. It’s been on my radar for more than a year. The qualitative factors are publicly available, and I’ve been following that throughout that time period. But that’s only a part of the analysis. You also have to do a qualitative analysis too. I’ve been speaking to the team at conferences. I’ve been speaking to other people in the industry to hear what they’re doing. I’ve been learning more about *inaudible for the best podcasting shows, how you’re paying royalties for music, and just learning how the industry works.

Then, I have been researching the studios that Spotify bought. I didn’t research them as an investor, but more as a business person. For instance, I was jumping on the call with Anchor not too long ago, which is owned by Spotify, and it’s the main platform for new podcasters. At that time, they were interested in working with The Investor’s Podcast Network for different reasons. Now, it turned out that the deal wasn’t that interesting, but since I did talk to them anyway, I had a chance to learn more about the business. It was very clear to me that not only did they have the best production studios, for instance, Gimlet, one of the top studios out there. But what Anchor did was that they provided a very sticky service to new podcasters. I think as many as 70% of new podcasters are using Anchor or are depending on Anchor, and thereby, also depending on Spotify as they grow. That’s just something that, to that extent, I would have a hard time reading about that from annual reports. I need to research that as a business person, and what better way than you know, already doing best with them one way or the other.

Another way that I was learning about Spotify was indirectly through another business. For instance, when we talked to Bill Nye about Netflix here on the podcast, I recognized that, in many ways, Spotify is Netflix just five years ago, and I could use a lot of that in my analysis and in my valuation.

71:00

So, going back to your original question; no, I don’t have daily habits of what I need to do at this point in time that day and these other five different sites that I visit, but rather, I would say that I do what I can to absorb information, and then let my subconscious mind work out the details for me, more than just sitting down, typing up an entire case from A to Z.

Lastly, I always aim at acting on a larger scale just a few times a year.

Preston Pysh  71:30

So, Robert, I love the question. I think this is a very important question. If there’s one thing you’ve got to focus on, it’s your habits. You’ve got to understand what they are and what you’re trying to work them towards because so much of what you do is pushed into your subconscious whether you want to admit to that or not, as you’re going through your day. So, developing those habits and developing those protocols that you’re using in your own life in order to manage where you’re trying to go is so important.

Here are some of my thoughts on that question. First, having a very structured way of investing is important. Having flexibility built into that is also important. I would tell people, “You can go hardcore. You can say, ‘This is my checklist. I’m going to do this every single day,’ like you’re writing lines of code. For some people’s personalities, that works great. For other people, that would drive them absolutely nuts. So, I think it’s important for a person to think about how they work, how their personality works, and then having some kind of flexibility in between not being too rigid, but also putting some systematic steps into your day.

72:41

So, here are some of the things that I do. First and foremost, I learned very early on that Warren Buffett, and these other people that I admired for how they were able to invest so well, they had a common thread. The common thread was that they read like crazy. So, for me every single day, I try to at least do 30 minutes to an hour of reading, listening to an audiobook, or something that is making me smarter.

Personally, and I think this just has to do more with my personal interests and the objectives that I have financially, I focus on a particular set of nonfiction books. I primarily read nonfiction. The obvious one is all the business books. I read a lot of macros. I read a lot of techs. I thoroughly enjoy learning about biology and physics, so I sprinkle in quite a few of those books as well. I also enjoy reading health books. It kind of goes along with a lot of the biology interests that I have. Recently, I would say in the last four years I’ve had an intense interest in how cryptocurrencies work, in particular Bitcoin. It’s a very complex topic to understand, way more difficult than I think a lot of people might give it credit for. So, I read a lot of books on those.

I think that that habit alone is just vital to a person’s success. If you don’t do 30 minutes a day on some type of Audible or some type of book, I’d tell you, if you can add that type of habit into your day, it’s going to have a profound impact on you, especially if you look at it five or 10 years from now. If you’ve kept that habit up, I can’t even tell people how much it’s going to add value to your life.

74:39

The other thing that I’ve done recently is I’ve replaced the news. 10 years ago, I would log on to the various news channels. I’m persistent in checking out all of them because I’ve always felt like a lot of the news media had their own type of spin. So, if I go to CNN, I go to ABC, I go to Fox –I go to all of them, and I would filter them. Recently, though, I don’t do that anymore. I’ve pretty much replaced all news outlets. I probably started doing this a year and a half to two years ago, where the only thing that I use to capture news is my Twitter feed.

I started doing this is because there are a few people on Twitter that I trust when it comes to the messaging and the things that they share. And so, what I’ve effectively been able to do is I’ve been able to use those people that I follow on Twitter as a filtering mechanism for the truth, or at least my understanding of what I think is the most truthful way to represent an issue or an idea. And so, if a person that I followed on Twitter starts to appear to have a very polarized way of reporting something, I just stop following them. I’m actively seeking people that I think are very balanced in the way that they view the world. I follow those people and I try to add more people to my feed. But I also try to prune it pretty aggressively if it appears like somebody is not balanced in their thinking. So, that’s something that I’ve got tremendous value out of from Twitter by following the right people, and only following a few people. If you got 2000-3000 people you’re following I would, I would argue that you’re allowing too much noise to get into your feed. But that’s totally up to people. That’s how I do it.

76:35

With respect to actual stock investing, for years, Stig and I would have to go on to sites like Morningstar or whatever to try to filter results and read up on various investors, what are they buying, and then go in and look at that pick in more detail. And so, Stig and I, we, we built the tool that we always wanted to have ourselves. That’s our TIP Finance Tool. I’ll go in, and I’ll look at that. I probably look at the filter tool every other day, every third day, to see what new companies are popping up on the top of the list because it’s filtering them by valuation. It also shows me the momentum status right there as I’m looking at the filtering.

For me, I’m able to go in there and you don’t see too many changes every three days to every week. Some new companies are popping in there at the top of the queue. When I see those companies, I then dig deeper into the tool that I can look at their free cash flows, what they look like, and then I can conduct my own discount cash flow model right there on our tool. It’s much easier for me nowadays than it was years ago when I’d have to go into an Excel spreadsheet to conduct those. I can do it real fast by just looking at the tool, so it helps me sort through it. I do that every three days.

I’m sure I could give you more habits that you might have an interest on, but for the basics, I would tell you those are the things that I find very important for me to do and kind of the operational tempo of how I’m looking at my week as I’m going through that.

So, Robert, for asking such a great question, we’re going to hook you up with a one-year subscription to the tool I was just telling you about, and I hope you enjoy it as much as I do. I think you’re going to get a tremendous amount of value out of it. We appreciate you asking the question. If anybody else out there has a question to get played on the show, go to asktheinvestors.com and just record your question there. If you get it played on the show, you’ll get a free subscription to our TIP Finance Tool.

Stig Brodersen  78:35

All right guys, Preston, I hope you enjoyed this episode of The Investor’s Podcast. We will see each other again next week.

Outro  78:42

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