Evaluating the Macro Landscape and Finding Great Companies with Jeff Muhlenkamp

[00:00:00] Welcome to Excess Returns, where we focus on what works over the long term in the markets.

[00:00:04] Join us as we talk about the strategies and tactics that can help you become a better

[00:00:07] long-term investor. In this episode of the Excess Returns, Jack interviews Jeff Mullenkamp,

[00:00:22] a portfolio manager at Mullenkamp & Company. They discuss Jeff's views on inflation, the

[00:00:26] likelihood of a recession, and the possibility of another financial crisis. Jeff shares his

[00:00:30] investment process, which focuses on finding good companies with strong growth, profitability,

[00:00:34] and financial strength. He also discusses the importance of understanding management

[00:00:38] incentives and how he incorporates macroeconomic factors into his investment decisions.

[00:00:42] As always, thank you for listening. Please enjoy this episode with Jeff Mullenkamp of

[00:00:46] Mullenkamp & Company. Jeff, thank you for coming back on.

[00:00:50] Thanks for having me back, Jack. Looking forward to the discussion today.

[00:00:53] We're going to cover a lot of ground today. We're going to talk about the markets. We're

[00:00:55] going to talk about your investment strategy. We're going to talk about where you're seeing

[00:00:57] opportunities. But before I do that, I wanted to start with inflation because that's probably

[00:01:02] something that's at the top of everybody's mind right now. It's something you've covered in

[00:01:05] your quarterly letters. I was reading them in preparation for this. In your January 2023

[00:01:10] letter, you laid out three core questions and then you revisited them in January 2024.

[00:01:15] I want to start by asking you those three core questions and how you're thinking about

[00:01:19] them right now. The first question was, will inflation remain high? If so, how high will

[00:01:24] it be? How are you thinking about that now in contrast to how you were thinking about that

[00:01:28] in January 2023? A year ago, we thought inflation would probably stay in the 3% to 4%

[00:01:35] range. Last year, we saw it get down to the low threes. I think it bottomed in June at about

[00:01:43] 3.1%. It ticked up a little bit since then. We look at CPI. We don't get too fancy. We

[00:01:49] don't split PCE, CPI. We don't manipulate it six ways to Sunday. We don't find that terribly

[00:01:54] useful. Right now, we're at a 3% inflation. The Fed has paused in its tightening. We think

[00:02:06] that kind of indicates that they're willing to tolerate 3% to 4% inflation. That's a useful

[00:02:13] piece of information for us. Then we're looking at the other things going on. What is

[00:02:18] government spending look like? We think that is a bearing on inflation. Then what is growth

[00:02:23] around the world look like? What is the expansion of the money supply look like?

[00:02:27] Those sorts of things. Ball all that up, I think you're still going to be in a 3% to 4%

[00:02:33] inflation environment for the next year. The risks are probably to the upside, not the downside.

[00:02:40] To your point about splitting inflation three ways to Sunday, that's something investors have

[00:02:44] to be so careful about because no matter what your opinion is on inflation, you can take those

[00:02:48] numbers and you can make them back up your opinion. You can do the trimmed mean of this

[00:02:52] or exclude this and that. No matter what it is, whether you think it's going to be crazy high

[00:02:56] or you think it's going to be crazy low, it's something to be very careful about because

[00:02:59] you can chop those numbers up in a million different ways. We use just plain CPI. There's

[00:03:04] a lot of different ways you can slice and dice inflation numbers. Some people like PCE

[00:03:08] or core PCE. Some people don't trust the numbers at all thinking that they're no longer

[00:03:13] reflect reality. We haven't found that to be a good use of our time, to dig into that,

[00:03:20] to try and parse what is exactly going on because it's not really useful in our

[00:03:25] decision making process. We are comfortable being approximately right instead of precisely

[00:03:30] right. That's good enough for us. That's kind of how we think about it.

[00:03:34] I'm curious, when you talk to your investors, do they still ask a lot about inflation? Have

[00:03:37] you seen that come down over time as inflation has come down or is that still a topic you

[00:03:41] get asked about a lot? No, they really haven't. That's a great question and on reflection

[00:03:47] that it is not top of mind for our investors. That's probably a sign you've got the right

[00:03:53] kind of investors. It's probably a sign you've got good long-term investors who are

[00:03:57] probably not thinking about this day-to-day stuff. We do. We've got great investors.

[00:04:03] They're wonderful to work with. So on the second question, this is an

[00:04:07] interesting question because this is something a lot of people have been calling for for a very,

[00:04:11] very long time. The recession is coming, the recession is coming, the recession is coming

[00:04:16] and the recession has not come. So your question you had in your letter was will

[00:04:19] the United States enter a recession? If so, how bad will it be? How are you thinking about

[00:04:24] that right now? I have to admit I've been in that camp. We've been calling for a recession

[00:04:29] for a very long time. We were calling for a recession really the end of 21 as the yield

[00:04:36] curve started to invert. We saw the stock market start to come down. We expected problems in the

[00:04:42] housing industry. We saw that happen. We saw problems in the financial industry about

[00:04:48] this time last year and none of that has been enough to put the U.S. into a recession, which

[00:04:54] is fascinating. So about a year, 18 months ago as things started to diverge in a positive

[00:05:01] fashion economically from what I thought was going to happen, I started to say, well,

[00:05:04] what's going on here? Why is that? Why is what we expect and not unfolding?

[00:05:12] The tentative answer to that question is that government spending and business spending has

[00:05:18] overwhelmed some of the other things that were going on. So if you look at, for instance,

[00:05:24] debt to GDP or deficit to GDP as a measure of how much we're spending, it's now at a wartime

[00:05:30] level. It's at about 6% of GDP. That's the amount we're spending over and above

[00:05:35] what we're bringing in. So we are putting a lot of fiscal stimulus into the economy even as

[00:05:43] we withdraw all of that monetary stimulus. That surprised me. I think that's at the

[00:05:52] root of what you're seeing. So the next question is, well, could we still get a recession?

[00:05:58] I hesitate to say no, because you really can't ignore the inverted yield curve.

[00:06:02] It's got a really great track record of predicting recessions with a variable time

[00:06:07] lag and it's still inverted. You've also got the problems with commercial real estate out there

[00:06:13] that have not fully worked themselves through the banking system. In fact, I would argue

[00:06:18] we're probably in early innings. So there are some potential problems out there that might

[00:06:24] create a recession. But I'd have to say that the odds are lower than they were a year ago.

[00:06:32] So I can't completely rule it out. I wish I could. I can't. But most of the other,

[00:06:38] when you start looking at ISMs and you start looking at leading indicators and those sorts

[00:06:42] of things, they stop getting worse and they've kind of bottomed down. A couple of them are

[00:06:46] starting to get better. ISM manufacturing that just released was starting to take up a little

[00:06:50] bit and then services never went into contract you're a tariff with. So those sorts of things

[00:06:55] give you some confidence things are getting a little better in the economy. So I would have

[00:07:02] to say remains possible, not terribly likely. I've put some money to work as a result.

[00:07:11] Well, I have to say I was in the same camp as you. I didn't see how we could increase

[00:07:14] rates as fast as we did and not have some sort of recession. And like you mentioned,

[00:07:19] the yield curve inversion is 100% track record historically. Now, it's not a huge end. It's not

[00:07:23] a huge sample size. But it's been successful with a lag time of varying lengths in predicting this.

[00:07:29] So I was in your camp. I was like, I don't see how we get through this without a recession.

[00:07:32] And maybe we don't. Maybe it's just a lot further out in the future than many of us thought.

[00:07:36] And it may be. So typically, the recession starts after you cut rates. We haven't

[00:07:42] cut rates yet. So there's nothing going on that is ruled out by historical precedent.

[00:07:51] Nonetheless, you're starting to see some things take up and there have been

[00:07:56] to me there's some really surprising things happen this time around. If you'd asked me

[00:08:00] three years ago, what would happen to the housing market when rates went from, let's

[00:08:06] call it 30 year mortgages went from 3% to 7%. I just said housing prices will change.

[00:08:12] And they haven't. Right? So you had a decline in home sales for all of about six months.

[00:08:18] But then what happened was everybody with an existing home decided they're not selling it

[00:08:22] because they don't want a 7% mortgage to replace their 3% mortgage. So you took an

[00:08:26] enormous amount of inventory off the market. And all you're left with is new home sales.

[00:08:33] And shockingly, demand for new homes and demand for the rest of the homes has maintained

[00:08:39] the pricing of homes throughout the country. And nobody would have predicted that. So you've

[00:08:44] got like a second order effect, overwhelming what should have been a dominant first quarter

[00:08:49] effect. It didn't happen that way. So there are some surprising things going on

[00:08:55] that are just quite difficult to predict. Yeah, I was on the same page with you,

[00:08:59] the housing. Like I missed the supply part of it. I missed the part that nobody's

[00:09:02] gonna put their houses on the market and supply is gonna be kept so low. When I thought

[00:09:06] about it, I was thinking about the demand part of rates going up and I didn't consider

[00:09:09] the supply part. But I guess a lot of people didn't because we've never seen anything like

[00:09:12] this before. Never seen anything like it before. Which really, you know, to me,

[00:09:17] we all try our very best to predict the future. And a lot of times that's based on

[00:09:22] what we saw happen in the past. But it just reminds me to be humble about your prediction.

[00:09:29] That's right. Right? Give it your best shot. You know, put yourself out there,

[00:09:35] but recognize that you might be wrong and invest that way a little bit too.

[00:09:39] I think this is gonna happen, but I might be wrong so I can't go all in on this.

[00:09:45] I have to hedge my bet a little bit in almost everything you do.

[00:09:49] Yeah, no, that's right. I mean, that's a recipe to blow up going all in on anything.

[00:09:52] The thinking you're 100% right in the markets. You know, I always think about how many smart

[00:09:55] people operate in the markets and I try to think about myself and my intelligence against

[00:09:59] the collective of all those people. And like what are the odds I'm gonna be right and every

[00:10:02] one of them is gonna be wrong? It's probably not that great. So I always think about that

[00:10:05] when I size anything I do. Right, right. Makes perfect sense.

[00:10:10] I'm just curious on the housing thing. Like, do you think, I've been thinking about this a

[00:10:13] lot. I've been thinking about like, when rates do go back down, this is kind of outside of my

[00:10:17] area of expertise, but I'm trying to think about how that, you know, obviously my first

[00:10:21] principle spring work would be, well, when rates go back down, that's going to make

[00:10:24] the housing market go up even more. But then I'm like, am I missing the same thing I missed

[00:10:27] the first time? There's some sort of effect where like supply is going to be unlocked

[00:10:30] because rates go back down. And maybe it doesn't have the effect we think. I mean,

[00:10:34] I don't know if you have any thoughts on that. It's just something I've been thinking about.

[00:10:37] Yeah, I've been thinking. So the way I frame it, the current situation is unsustainable

[00:10:44] over the longer term. Right? So I think a couple things are happening. A couple

[00:10:49] things are already happening. So the first thing that's happening is home builders are

[00:10:52] buying cheaper homes or I'm sorry, building cheaper homes. Right? So they went to building

[00:10:57] expensive homes, mostly because interest rates were so low and money was so cheap. That's

[00:11:03] what people wanted to buy. And now that those that you kind of that market has gotten

[00:11:09] priced out of the margin by the higher interest rate, they're going to adjust what

[00:11:14] they're building. So that's one thing that's going to happen. And as those

[00:11:18] price points start to come down and start to see more activity there, the other thing

[00:11:23] that I think is going to happen is even if rates don't come down, I think you're going

[00:11:28] to start to free up inventory on the use side simply because some moves are not optional.

[00:11:36] Right? So if I'm coming up on retirement age and I'm thinking about downsizing,

[00:11:41] I can defer that decision as long as I want. That is a completely optional decision.

[00:11:45] And if my house has paid off or I'm still at 3% and I don't want that 7% mortgage,

[00:11:50] I can defer that almost infinitely. No big deal. But if I'm a working guy or girl and I get

[00:11:57] posted, you know, I'm going to have to move from Pittsburgh to Houston and I've got two kids,

[00:12:01] I'm not moving into an apartment. I'm going to move into a house and I'm going to sell

[00:12:06] the house here in Pittsburgh to do that. Right? So there's just going to be now this

[00:12:12] level of forced moves that probably start to free up the market. You know, you might delay

[00:12:18] that home sale and purchase for six months, you're not delaying it for two years. Right?

[00:12:23] You're not doing that to your family. So over time, that will start to kind of

[00:12:27] break the logjam if you will. And then if rates came down,

[00:12:36] I think probably incremental improvement on the use side.

[00:12:41] You know, I think at the margin some people would say, okay, I'll do that downsize at 6%

[00:12:47] where I wouldn't do it at 7%, but unless rates drop dramatically, it won't necessarily be very

[00:12:53] sudden. So I guess my baseline is sort of a gradual falling of the used market if you will,

[00:13:00] now without necessarily a lot of impact on overall housing prices.

[00:13:06] So your third question is another one that a lot of people are thinking about right now,

[00:13:09] which is will a financial crisis erupt that prompts the Federal Reserve to

[00:13:12] drop interest rates and perhaps restart quantitative easing? If so, will this

[00:13:16] cause inflation to run up again? So the first part of that, like some of us thought maybe the

[00:13:20] Silicon Valley Bank type of thing could have been that financial crisis, but it wasn't. But

[00:13:24] then there's a lot of other stuff floating around. There's the commercial real estate market,

[00:13:27] you know, people are talking about the refinancing wall for companies,

[00:13:30] particularly in the high yield space. Like do you see anything?

[00:13:33] So how are you thinking about this question in terms of if another

[00:13:36] financial crisis might be brewing in the future? I think there are

[00:13:40] good reasons why it's possible, then good reasons why it's not certain.

[00:13:48] Right? So as interest rates move up, all these debt instruments fell in price.

[00:13:56] So anybody who uses that as collateral for another loan is in trouble

[00:14:01] if they have to realize the existing price and that's exactly what happened to SBB.

[00:14:06] They needed cash, they had high quality assets, they had treasuries. The problem was

[00:14:10] when they sold that treasury, they only got 80 cents on the dollar. And so it blew up their

[00:14:14] capital base because they had to sell them to meet, you know, cash calls from debauchers.

[00:14:22] So if the people who are holding those assets and are forced to sell them

[00:14:30] at a discounted price because interest rates have come up, then we're going to have a

[00:14:34] problem. On the other hand, if things work out so that that happens over a decade instead of

[00:14:41] in a year, we will not have a systemic problem. So it all really comes down to how fast do we

[00:14:48] work the new pricing into the existing financial structure? If it's very rapid,

[00:14:54] it will be a problem. And that will force, in my opinion, the central bank to react to it

[00:15:00] like it did with SBB. They will have to come in and do something to either bolster the price of

[00:15:07] that debt or to guarantee it or something else. They were pretty creative with how they did it

[00:15:14] a year ago. I expect they will be creative again if they have to, but you can't just let

[00:15:18] the banking system collapse because suddenly we've marked the market all the assets that

[00:15:24] really, if they were marked market would make it in Seoul. So you've got to have this

[00:15:28] extended pretend so that you can realize the losses over time. More frankly, just, you know,

[00:15:38] a 10-year treasury at 80 cents on the dollar today, if I go nine years, it's going to be

[00:15:42] trading far. No loss. As long as I don't have to sell it today, I'm good. So,

[00:15:49] coin toss. It could go either way. But you're not going to be able to say,

[00:15:55] oh no, we're good for a decade until you work through all the repricing of CRE,

[00:16:01] until you rolled over all these loans from four or five years ago that were made two and three

[00:16:06] percent into now four and five percent loans. Until you do that, you can't say, dodge that

[00:16:13] bullet because you're still dodging the bullet. We're in the middle of dodging the bullet.

[00:16:19] So yeah, possible. So the last part of your question could kind of apply to

[00:16:23] a couple different scenarios. One is like a financial crisis where the Fed has to cut

[00:16:27] rates dramatically. The other could be what looks like it's playing out right now, which is

[00:16:30] the Fed is going to start a slow, what they hope will be a slow process to bring rates back to

[00:16:35] normal. But the question in both cases is, will this spur inflation? You know, and is

[00:16:39] inflation entrenched enough that we're going to cause problems by being too soon on these

[00:16:43] rate cuts? So how do you think about that? Now, I lean towards inflation is going to

[00:16:49] be here until we actively fight it. So, no, it's interesting your comment bring the Fed wants to

[00:16:57] bring rates back to normal. So the first question is what is normal? Right. And historically,

[00:17:03] normal is that the federal funds rate is on or about the rate of inflation.

[00:17:09] And the long treasury is something like two or three percent above it. Right. That's normal.

[00:17:14] So if you apply that to today's three percent inflation, we'll just use three percent.

[00:17:18] Okay, then the federal funds rate ought to be on the order of three percent

[00:17:23] and the 30 year ought to be something like six.

[00:17:28] So that kind of forms the foundation of what I expect. So if in fact inflation is relatively

[00:17:35] stable here at three to four percent, then I ought to see the Fed bring short term rates

[00:17:40] down. But I still should see the long rate go up. And the last time the long bond went above five

[00:17:49] percent, things started to get really exciting in the bond market. Right. About October of last

[00:17:54] year, we popped over five percent. You got a lot of volatility in the bond market. And suddenly

[00:18:00] Janet Yellen said, you know, we're not going to borrow on the new money long term. We're

[00:18:03] going to work with shorter term. And what she didn't say was why. But my guess is it's

[00:18:09] because we can't afford to borrow five percent. And so we're going to go borrow here shorter

[00:18:14] term with something less. You know, two years gets you four and a quarter or whatever. Right.

[00:18:19] So the bond market wasn't willing to support that long rate.

[00:18:23] So normalization of the yield curve in terms of lower short term rates and higher long

[00:18:28] term rates is going to be very interesting to watch. It's also going to be interesting to see

[00:18:34] what happens to the federal budget as they continue to roll over all this very cheap debt

[00:18:40] into much more expensive debts. When you talk about, you know, the risk of borrowers having

[00:18:45] to roll debt, to me, the key entity to watch is the most indebted entity on the planet,

[00:18:53] which would be our federal government. And how do they deal with that? Do they in fact accept

[00:18:59] five percent returns or five percent interest on their debt? Or do they start looking to the Fed

[00:19:05] to do something like yield curve control, which there's plenty of historical precedent to do both

[00:19:12] in the United States and internationally. So this is going to be really interesting. And to

[00:19:16] me, you know, one of the risks out there is to do that long term bond holder, which is

[00:19:23] frankly why I don't want to be a long term bond holder. I'm happy to be on the short end.

[00:19:27] I have no interest in going over Wallia and I see too many risks and not enough rewards

[00:19:32] for me to want to play out there. Yeah, I think it's interesting how you looked at normal in both

[00:19:36] ways, not just from the perspective of the Fed funds rate, but also in perspective of like

[00:19:39] longer term rates to 10 year because yeah, you're right. I mean, normal might be 200 basis

[00:19:44] points less on the short rate, but even with a normal yield curve, that the long rate won't

[00:19:48] come down at all with that or might even go up a little bit. So for people hoping their

[00:19:53] mortgages and stuff are going to come down, you know, this may not play out exactly.

[00:19:56] You know, these Fed rate cuts may not play out exactly as they'd hoped it would.

[00:20:00] And I think the market is starting to not necessarily bet that way,

[00:20:07] but to start to realize that that might be possible. But we'll see. Really, we will see

[00:20:14] there's a lot of other things going on in the treasury markets that I think have a

[00:20:21] bearing on this from the kind of macro perspective, right? So if you look at what

[00:20:26] other central banks have been buying, they have been not net buyers of treasuries now

[00:20:31] three, four or five years and what they're buying on that is gold. You got to say,

[00:20:35] why is that? You know, why are the central banks looking to gold now as a reserve

[00:20:40] asset instead of treasuries? And then you look at what happened when Russia invaded Ukraine

[00:20:47] and we froze all their treasury assets. So any foreign entity that thinks they might be on the

[00:20:55] wrong side of the U.S. is probably not going to hold their reserves in treasuries because

[00:21:00] they're now at risk, whereas, you know, a decade ago, well, of course my treasuries would

[00:21:05] be fine, right? So there's that. And then of course you've got Saudi Arabia selling oil

[00:21:13] in other currencies besides dollars. So the whole petrodollar circulation of, you know, somebody,

[00:21:19] you know, gets dollars, buys oil, Saudi Arabia has excess dollars. They put them,

[00:21:24] buy treasuries with them. That whole cycle is now less big than it was, right? So

[00:21:31] you got some things going on, you know, mechanisms that had been in place for 40 or 50

[00:21:38] years are now unraveling at the edges. Things are shifting at the edges and you say,

[00:21:44] what's that going to mean? What's that going to mean to the dollar? What's that going to mean

[00:21:48] to treasuries? What's that going to mean to yields? As it has an impact on yields, it starts

[00:21:55] impacting, you know, the domestic economy and the investing world. So I don't really,

[00:22:03] assert that I'm a macro investor. I think that in general, you need to pay a little bit of

[00:22:08] attention. Usually macro doesn't matter, but once in a while it does. And so you need to

[00:22:13] pay enough attention to at least be alert to changes that might matter. And I think

[00:22:21] there are some changes going on in the global scheme of things that might matter to the

[00:22:26] domestic scheme of things. You heard about that about two years ago, I probably need to update

[00:22:32] that because the things I saw two years ago have not reversed. They've got to continue

[00:22:38] to grow and expand. So the likelihood of them becoming impactful is greater than it was two

[00:22:45] years ago, not less in my opinion. You touched on what I wanted to ask next,

[00:22:50] because we see kind of different managers on the show. You know, we see some managers who

[00:22:54] say, listen, we're in a different macro environment with inflation here. I have to

[00:22:57] at least pay attention to the macro environment and the way I've constructed portfolio. And

[00:23:00] then we'll get the bottom up people who will say like, I can't predict any of this. I don't

[00:23:03] care. Like I'm just going to pick stocks that I'm gonna move on my life. Like it seems like

[00:23:07] you do pay attention to it to some degree when you think about like picking stocks for your

[00:23:11] portfolio. Well, the piece that we've paid attention to really since Ron stood up

[00:23:18] the organization has been inflation. So Ron got into the business in the late 60s

[00:23:24] and his formative years were all in the inflationary seventies. Right? And so what

[00:23:31] he observed then, and the model he put together and the techniques he put together,

[00:23:38] you know, really starts with are we in an inflationary environment or are we in a

[00:23:42] deflationary environment? You've got to understand that you don't necessarily have

[00:23:45] to predict it because it doesn't change very fast, but you do have to recognize where you are.

[00:23:51] And so when we got the inflation here in, you know, 21, 22, we went through that again

[00:23:59] and we concluded we are more likely in an inflationary environment going forward than we

[00:24:04] are in the preexisting deflationary environment. And that shifts everything. Right? So,

[00:24:10] you know, commodities world being a primary one have not really done all that well

[00:24:16] the last 10, 20 years. But if you look at the seventies, it's about the only thing that did

[00:24:21] well during the decade. Right? So, you know, we're 20% energy right now. We have been for

[00:24:28] three years and that was a great, great thing for us in 22. Didn't help us too much in 23.

[00:24:34] We'll see how it is going forward. But that's a result of our conclusion that we're in an

[00:24:39] inflationary environment. Right? And that's to help protect us if we're right. If we're

[00:24:47] wrong, it probably won't hurt us too much. But if we're right, it's going to do us a lot of

[00:24:51] good. But yeah, so, and I think so you got the inflation deflation thing, but then you've

[00:24:59] also got this kind of global monetary machine that is shifting gears, changing up. However

[00:25:11] you want to frame it. But the dollar as the universal currency, I think is not going to be

[00:25:17] true in a decade like it was a decade ago. Not saying the dollar won't be a trade currency.

[00:25:22] It will be. There will be others. It won't just be the dollar. And in the U.S. Treasury

[00:25:28] bond as a reserve asset will not be the only reserve asset. And so, let me caveat that.

[00:25:37] We think it's likely, not certain, likely that these things are happening. And if that occurs,

[00:25:43] then you say, well who benefits? And so far we've arrived at cold will probably benefit.

[00:25:49] And so we've made some investments to the order of about six or seven percent portfolio

[00:25:54] that are long cold essentially. And we'll continue to think about that as things unfold. Okay,

[00:26:03] is that future that we kind of have in our mind more likely today or less likely relative to

[00:26:09] where it was six months ago relative to where it was a year ago? So far, things seem to be

[00:26:14] marching in that direction. More currencies are being used in international trade. Fewer central

[00:26:19] banks are interested in buying treasuries. So we think the pressure on long yields is

[00:26:23] going to be up in addition to what's going on with inflation, right? And that's informing

[00:26:32] the bets we're placing, the investments we're making. I don't want to be on the wrong side

[00:26:38] of that shift. I don't necessarily need to anticipate it too much, but I don't want to

[00:26:41] be on the wrong side of it either. So now I would say we are a little bit of a mix.

[00:26:47] We do like to focus on companies. Now, we have historically really focused a lot on the economic

[00:26:54] cycle in the U.S. because that was a very definitive sort of a thing. It was really

[00:26:58] controlled by the Fed. It was fairly easy to predict. That's less true now than it was

[00:27:05] 20 years ago, at least according to my dad who's been investing in both environments,

[00:27:08] and that's what he tells me. So I don't think you have to be all one or the other

[00:27:14] if you don't want to be. You can be. I think you can probably make money either way. If you're

[00:27:18] good at it, you've got the right information and the right tools to understand the information,

[00:27:23] the data you're getting. And we sort of straddle a little bit both. If we can identify a macro

[00:27:29] trend, we're happy to ride that sucker. And that's what we're doing a little bit right now.

[00:27:35] So we think we've got inflation, we have energy. That's the purpose of that. We think

[00:27:39] we're going to see a greater role for gold in international finance in the future than we have

[00:27:46] in the recent past. And we're happy to play that a little bit too. And we'll see how those work

[00:27:51] out. To your point on your dad, I mean, I think that's probably been a great resource

[00:27:55] for you. And it's something that I wish I had. Like, you know, Justin and I manage money

[00:27:58] for our clients and we're in our 40s. And so we can go look at the 70s and look at the data

[00:28:03] and look at all that. But it's a completely different thing than having lived it. Like,

[00:28:06] I know when I talk to investors that are younger than me that didn't live through 2008,

[00:28:10] they'll say they'll look at 2008 and see like this down move in the chart and everything came

[00:28:13] back and everything was great. And, you know, I lived through that. And that thing was brutal.

[00:28:17] Like living through that is completely different than looking at it and looking at the data

[00:28:21] after the fact. And I assume the same is probably true of the 70s. It's probably great

[00:28:24] for you to have somebody who actually managed money who was actually sitting there and

[00:28:27] understanding what happened at that time. It is right. So Ron's formative experience

[00:28:31] was the inflation of the 70s. My formative experience, I joined the firm in 2008,

[00:28:36] October 2008. So the first six months I was here was during the worst of the 08-09 crash.

[00:28:47] And that was formative for me, right? Everything I learned was viewed through the lens

[00:28:52] of that timeframe, for better or worse. And so I think you're right. I think it does.

[00:29:00] What you first experience when you start investing shapes your view going forward.

[00:29:06] So Ron is attuned to inflation and when inflation wasn't a problem,

[00:29:10] that really didn't help us much. Right? Not a competitive advantage. Now that inflation is back,

[00:29:16] what sure helped us in 2022 a ton. Right? We were up when the market was down. That

[00:29:21] was a pretty good relative performance year for us. We're pretty happy with that.

[00:29:25] I think it's going to help us going forward. Right? Because if you think about what's happening,

[00:29:32] cost of capital was very low and capital was readily available. And the types of companies

[00:29:39] and the types of strategies for a company that work in that environment do not work

[00:29:47] when capital is expensive or hard to come by. Right? So Silicon Valley that is all about

[00:29:53] gaining market share and worrying about profitability later. Right? Capital is so

[00:29:59] cheap. We'll deploy all this capital. We want to dominate this market, whatever it is,

[00:30:03] whatever software package we've got, we want to dominate it. We'll pay people to come

[00:30:08] to our website and we'll monetize the way. That does not work in an environment where

[00:30:16] capital is hard to come by and much more expensive. What works in that second environment

[00:30:21] is we're going to bootstrap ourselves. We're going to start small, we're going to become

[00:30:25] profitable and we're going to bootstrap growth of our existing profits because external capital

[00:30:31] is not available, not at a price we can afford. And so we're going to have to change how we do

[00:30:35] things. Right? So everybody that thinks normal is capital falls out of the sky and you can

[00:30:42] spend willy-nilly as long as you can paint a real picture 10 years in the future about

[00:30:48] how you're going to turn that into ridiculous amounts of money. Anybody who grew up like that

[00:30:53] is going to struggle when they've got to pinch pennies and become profitable early

[00:30:58] because getting that external capital is just so much more difficult than these.

[00:31:02] And I think that's what we're shifting from and to. And so the kinds of things that weren't

[00:31:08] here are going to struggle here and the kinds of things, you know, we always like

[00:31:13] profitable companies. That didn't matter for a decade. What investors wanted to see was

[00:31:17] revenue growth, not profitability. We were out of fashion. That was painful. The world is kind

[00:31:26] of in my opinion moving back our way. The kinds of analysis, the kinds of things we always like

[00:31:32] are going to be more effective because they don't rely on external capital and that sort of

[00:31:37] thing. Yeah, it's interesting. Like my formative experience, like when I came out

[00:31:42] of college, my first job was with an internet startup in like the late 90s. And what you

[00:31:46] were talking about is basically what we went through, which is like the venture capital

[00:31:49] store investing in us. We're like, we don't care about profits. We don't care about revenue.

[00:31:53] We care about eyeballs. And so like we ran the business that way. And like that was, it took me

[00:31:58] a while to get out of that mentality. Like when you saw that huge shift in 2000, you know,

[00:32:02] if you've come up and that's the way you've grown up in the business, it's a change to

[00:32:06] say, here's a new environment. I've got to adjust this new environment. And there's probably

[00:32:09] a lot of people going through that right now who are used to zero, you know, 0% interest rates.

[00:32:14] And now they're going to have to adjust in terms of the way they operate.

[00:32:16] Yeah, you know, I just got done reading the book on Elon Musk and his description of what

[00:32:23] happened at Twitter when Elon Musk took it over is exactly that. You know, you went from

[00:32:29] money is no object. We just subsidize all this stuff and all these extra bodies and

[00:32:34] all this other stuff to, oh no, we're very concerned about a cross and we're laying off

[00:32:37] two thirds of our people. What a sea change for that company. And I suspected various times

[00:32:43] that's going to hit different companies in specifically Silicon Valley startups.

[00:32:49] I know a lot of industries were enamored of the throw capital at it, get growth going

[00:32:56] and monetize later, but that's been the Silicon Valley model now twice. First, even

[00:33:03] the first tech bubble and then the second time here that I think is just ending.

[00:33:06] And it's, you know, that's not really new. That's not really new. I'm reminded,

[00:33:13] you know, when they built the transcontinental railroad, the Union Pacific, I forget the one

[00:33:20] on the East Coast, but the U.S. did it differently. The U.S. did had very much

[00:33:24] that Silicon Valley model. We'll just throw a bunch of capital at it. We'll build it all

[00:33:30] one go and then we'll monetize it later. And the track was crappy and both of the

[00:33:37] halves of it went bankrupt and then, you know, it took 20 years for either side of that to be

[00:33:42] profitable after they built the railroad. Well, the Canadian Pacific did it differently.

[00:33:47] They built it one town at a time. So they built it from this town to that town and got

[00:33:52] that section working and profitable. And then that funded the next 20, 30, 40, 50 miles

[00:33:57] of track. And so they kind of bootstrapped their growth across the continent. So they were

[00:34:02] profitable the whole time. Now it took a long to get the track all the way across the continent,

[00:34:08] absolutely true, but they were profitable really from very early on instead of having to go

[00:34:13] through two bankruptcies and et cetera. So that difference in how you build is not unique

[00:34:20] to the last 20 years. It's been around a long time. And, you know, to me, the difference is

[00:34:26] what's the cost cap. What works when it's cheap does not work when it's expensive.

[00:34:32] And that's what we're going through now is a shift and I don't want to be on the wrong side.

[00:34:39] So shifting back to your investing process, you have some great criteria on your website in

[00:34:42] terms of the major things you look for in companies. And the first one was interesting

[00:34:46] to me in that like in the quant space where I operate, and I know you don't operate

[00:34:48] the quant space, but we have this idea of quality. What is a quality company? And like every,

[00:34:53] no matter which quant you ask, they'll be like, no, is this variable or is this balance sheet

[00:34:56] number or is this consistency of earnings or there's so many different ways you can look

[00:35:00] at it. And I assume in your world there probably is too. So I wanted to ask you,

[00:35:04] what do you think when you say you want to own good companies,

[00:35:06] what do you think a good company is? Like at a high level, how would you define that?

[00:35:10] So I would say they are profitable in their existing minds of business.

[00:35:15] They can deploy the profits at an equal or better rate of return,

[00:35:23] and they don't have so much debt that they can't manage.

[00:35:27] Bonus points for not needing to raise external capital to grow.

[00:35:31] But if their opportunity set is so large that they can't finance it internally,

[00:35:36] I don't penalize them if that's the reason they're raising external capital,

[00:35:40] whether equity or debt, but that's really what I'm looking for.

[00:35:44] Are they profitable on their existing business? Can they reinvest it well?

[00:35:48] And have they levered up too much or can they manage to get that? To me, is a quality company.

[00:35:56] It's interesting. That's not too far from how you do it on the quant side.

[00:36:01] You'd look at it in a different way, but the ideas are actually very similar.

[00:36:04] Oh good.

[00:36:07] You focus a lot on return on equity. Why do you do that?

[00:36:11] Well, so Rob built a model to value companies when he kind of entered the business in the 70s.

[00:36:18] And it used two inputs. It used return on equity, which at the time was reasonably stable

[00:36:24] for a given company over time. And he used the rate of inflation.

[00:36:28] So he used the rate of inflation instead of interest rates because he thought that interest

[00:36:34] rates were mispriced at the time. And the people that used interest rates,

[00:36:40] which were below the rate of inflation came up with a different, often higher value for a company

[00:36:45] than he did when he used the rate of inflation as the discount rate.

[00:36:50] So people were recommending, oh, this company is fairly priced based on, let's say an

[00:36:56] interest rate of 6%. And he's saying, no, it's too expensive based on inflation rate of nine.

[00:37:01] So they were making investments that he was shying away from because they overvalued it,

[00:37:07] because they were using it for base. So ROE was relatively easy to get a hold of the number.

[00:37:14] It was relatively stable over time. He used that as a useful proxy for profitability.

[00:37:21] And then he said, what has Wall Street historically paid for that amount of

[00:37:26] profitability? Have they paid multiple books? It was really the analysis that he did. And that

[00:37:33] formed his model. And we've continued to be helpful.

[00:37:39] HOFFMAN Yeah, that idea of using inflation as a discount rate is really interesting to me.

[00:37:44] It probably allows you to have some diversion opinions. It's great when you can have an

[00:37:47] investing when you can have a diversion opinion from the market and you can be right.

[00:37:51] And everybody's using interest rates in their models. So that probably allows you to see

[00:37:55] some companies very, very differently than other people see them.

[00:37:58] BELLAMY Invest rates in the 70s were for inverted, right? There were negative real

[00:38:02] interest rates. And by using inflation instead of interest rates, it allowed him to account

[00:38:10] for that. He said, essentially, negative rates are nonsense. And so what's wrong,

[00:38:18] it's wrong, is not the interest rate. That's not where I should plant my feet and evaluate

[00:38:24] everything relative to this. He said, I'm going to plant my feet on inflation and evaluate the

[00:38:30] value of everything relative to that. So much like physics, right? Where everything,

[00:38:35] you know, motion is all relative, you have to defy one place to be stationary and all the

[00:38:39] other motion is relative to that. Right? So if you're, if you say, well, how fast is

[00:38:44] the car going? The question is relative to what? If you play your feet on the ground,

[00:38:48] the car is going 50 miles an hour. If you plant your feet on the car, the car is stationer.

[00:38:53] And the world is moving at 50 miles. So you've got to kind of define by default,

[00:38:59] what is zero? What is ground zero? Where do I plant my feet? And then evaluate everything

[00:39:05] relative to that. Well, if you plant your feet in the wrong place, and he thought that bonds

[00:39:11] were mispriced based on inflation because they were negative real rates. He said,

[00:39:16] I can't plant my feet on bonds because they're off. So I have to plant my feet somewhere

[00:39:22] else. He planted one place in the work. It gave him lower valuations. He kept him out of

[00:39:29] overpriced stocks and put him in the stocks that do better during that inflationary time frame.

[00:39:35] Now, when bonds are properly priced price relative to inflation, which they were from

[00:39:41] the eighties until, you know, 2010 or 12, and arguably they're not far off now,

[00:39:48] then there's less of a difference, right? There's not a whole lot of difference between

[00:39:53] planting your feet on inflation or planting your feet on interest rates, treasury rates.

[00:40:00] But sometimes there aren't. When treasuries get mispriced, basing your valuation on treasury

[00:40:07] rates leads you astray. That's really his conclusion. And he simply said, okay,

[00:40:12] I'll use inflation and I'll use it throughout and we'll remain consistent that way.

[00:40:18] The next thing on your list was growth. And that's interesting to me because coming out of the zero

[00:40:22] rate environment, this idea of sustainable growth is probably very important. Like companies

[00:40:26] that are actually going to be able to sustain their growth into the future. How do you think

[00:40:30] about that? How do you think about evaluating the growth of a company and if you think

[00:40:33] it's sustainable into the future? So I think you have to, and I think it's hard.

[00:40:37] It is very difficult at the time to decide if somebody's growth spurt or growth collapse

[00:40:49] is going to hold for the long term or not. Right? So

[00:40:56] for some companies that are product oriented, right? So for Apple or for Tesla

[00:41:04] or for somebody like that whose product is unique to a degree, you've got to say,

[00:41:12] okay, what's the broader market? How fast and how far do I think this product is going to be

[00:41:18] adopted? Once it's adopted, then what's the normal turnover rate? So if you go from no

[00:41:25] smartphones in the world and Apple brings out the first smartphone, then the first question

[00:41:31] you've got is, okay, well how many people are going to buy one? And that's a guess.

[00:41:36] Right? And it could be, well I think everybody over 18 will end up having one. Well that's

[00:41:41] a different number from everybody over 12. Right? And that's a different number from

[00:41:46] 50% or whatever. And all of those will be a guess initially and then you have to start,

[00:41:52] you know, was my guess close or not very depending on how the data starts to come in.

[00:41:57] But then you'll have this huge spike in demand as people that didn't have one going by one.

[00:42:05] But at some point, everybody that wanted one has one. So now the question is what's

[00:42:09] the sustainable replacement link? Right? How often do I want to trade in that old iPhone

[00:42:16] for the new iPhone? And a little bit that's going to depend on the person. Some are

[00:42:21] going to want to be very up-to-date with the latest development that they're going

[00:42:25] to want to trade in every time Apple brings out a new slightly-imposed product.

[00:42:30] And others are going to be like, ah I use this one until it wears out or I drop it in the

[00:42:34] toilet or whatever. Right? But it's going to be less than that adoption link. And so for

[00:42:41] all of those things, it's really tough and we tend to be on the low side of things in

[00:42:49] most cases. And sometimes that works out, sometimes that doesn't. Right? So when you

[00:42:55] start talking about, you know, when I started 15 years ago and analysts were talking about

[00:43:01] electric automobiles, right, the mantra at the time was shared, autonomous, and electric.

[00:43:07] That was the future of the vehicle fleet and it was going to happen in a decade.

[00:43:12] They were all going to be shared, they were all going to be autonomous,

[00:43:14] and they were all going to be electric. You don't hear that anymore.

[00:43:20] Right? You don't hear much about sharing. In fact, every company that I can find that had a

[00:43:28] shared fleet kind of a product, whether it was scooters or automobiles has gone bust.

[00:43:34] So that didn't happen. So whatever you were guessing about the amount of shares,

[00:43:40] shared vehicles, all those guesses were wrong and ended up being zero. Autonomous? Yeah,

[00:43:46] we keep getting that promise every year. It's an annual effect. I suspect we'll get there.

[00:43:50] And for all I know, by the time we do everybody will be, you know, have completely

[00:43:55] discounted. Ah, it's never going to happen and then surprise it will. But that one's

[00:43:59] taking longer than anybody's expected. Now with electric, I would argue that

[00:44:04] the eventual adoption is still unknown. Right? But I have always been

[00:44:11] projecting lower adoption rates than many of the analysts that project high adoption rates.

[00:44:17] You know, if you believe and if the high adoption rates come to fruition,

[00:44:23] then frankly, you know, the valuation of Tesla is not extreme. If lower rates come to

[00:44:28] fruition, then that is extreme. And it's all a guess. And some of it really has to do with the

[00:44:36] mindset of the person making the forecast. Are they kind of a techno optimist or are they

[00:44:42] a techno skeptic? Kind of a thing. That's hard business and getting that right is difficult,

[00:44:48] but you have to guess. And then you have to kind of update your guess based on how things

[00:44:53] are unfolding. But that's also a part of the valuation of the company, right?

[00:45:00] So when people say, are you a buyer or growth investor? I'm like, well, growth is a part of value.

[00:45:05] How can I not look at the prospects for growth and then try to put a figure on that

[00:45:11] in terms of what the total use of work? Now, usually the way I look at it is I'm looking for

[00:45:18] that growth to be a call auction. I'm looking for tautness where that potential growth is not

[00:45:27] priced into the stock. And so if it happens, it's an upside surprise and I will benefit thereby.

[00:45:35] Because if you say, well, that high adoption rate, that rapid growth is baked into the price,

[00:45:41] well, now you're kind of in the position where if they disappoint,

[00:45:44] you're going to pay the penalty. You're setting yourself up for disappointment,

[00:45:52] not a positive surprise. I'd rather set myself up for that positive surprise.

[00:45:56] That's kind of how I think about it. And that doesn't always work great in the short term.

[00:46:05] Okay. Yeah. What you're talking about is I think one of the core concepts is the most

[00:46:10] important investing, which is this idea of expectations versus reality. Just because a

[00:46:14] company is growing huge rates, if the market expects it to grow faster than that, then it's

[00:46:19] not a great investment. So it's like trying to figure out what the expectations are in the stock

[00:46:23] price. Michael Mobson's work is really good on this. And then trying to have a divergent

[00:46:27] opinion and being correct is the challenge of this whole thing. And I think the idea of

[00:46:32] optionality is useful. Setting yourself up for that kind of a thing, limited downside,

[00:46:41] much higher upside, having some optionality in there that the market does not recognize.

[00:46:46] I think that's a useful concept to have when you're looking at companies.

[00:46:50] How do you think about financial strength? That's something I've thought about a lot too.

[00:46:54] We had Steve Romick on the podcast and I've typically thought about financial strength in

[00:46:57] terms of having a strong balance sheet, but he was making the point to us that in the

[00:47:02] current market, he looks at financial strength from the perspective of the quality of the business

[00:47:06] a lot, in terms of the consistency of the business he's looking at. And he thought a lot

[00:47:10] of the tech firms were very financially strong firms, the big tech firms from that perspective.

[00:47:14] So how do you think about this idea of financial strength?

[00:47:18] I think both are useful. I think we start with what does the debt load look like?

[00:47:25] What is it mature? What are they paying on it? We also look at what do the cash

[00:47:30] flows look like? How sustainable do we think they are? And how much does that cover their

[00:47:35] sort of thing? But you also have to look at what is, if it's a lever company,

[00:47:47] what is the asset base? And that really starts when you're talking banks or insurance companies,

[00:47:51] what is the asset base? What is it valued at? And what are the possibilities for what the

[00:47:58] future value of that asset base are? And that's part of what makes banks so tough.

[00:48:04] You don't know what their loans are. But if you're buying a regional bank today,

[00:48:09] you've got to try and figure out what's their exposure to commercial real estate

[00:48:13] and how confident am I that their $10 per share of book value is really $10 per share

[00:48:21] of book value in today's commercial real estate environment. They can realize that for cash if

[00:48:26] they needed to. Or why need to discount that by some factor because the market has changed

[00:48:32] and they have no price to get. So a little bit, it depends on quality changes based on what the

[00:48:41] industry and what the structure of the company are. Banking is very different. Insurance is

[00:48:45] very different. We can start looking at those sorts of things. Now, the rest are a little

[00:48:51] bit easier. We always start with what is the actual debt? And we also add in their pension

[00:48:58] expense. Right? So for a fairly small subset of U.S. companies, there are significant pension

[00:49:05] liabilities and you have to include those as well. How do you think about management? This

[00:49:09] is something like as quant investors on our side, we don't really think about it all.

[00:49:12] But when I talk to discretionary managers, you kind of have two different camps. You have

[00:49:15] one camp that says, I love talking to management. I think I get really great

[00:49:19] information from that. You have the other camp that says, management's just going to tell me

[00:49:22] what I want to hear. So really, it doesn't help me at all to talk to management. Like,

[00:49:26] how do you think about, first of all, what do you think a good management team is? But also,

[00:49:30] how much do you think communicating with management is important to you?

[00:49:35] Communicating with management, we'll start in a second. Communicating with management

[00:49:38] to us is more important the smaller the company. Larger companies tend to have processes

[00:49:45] and systems. And so it's difficult for a bad manager to go too far off the rails when

[00:49:49] you've got a larger company. And it's also, you know, when you've got six or eight or ten

[00:49:55] analysts all covering it, you usually find out pretty quickly from one or two of them

[00:50:01] if something screwy is going on. You've got a lot of attention focused on that company.

[00:50:05] Whereas, you know, small cap or micro cap, they have no attention. Nobody's paying attention.

[00:50:11] Nobody's analyzing their business and you need to do more due diligence because nobody else

[00:50:16] is. I'm not saying you can accept and face value what a self-signed analyst bring to the

[00:50:21] table, but they do bring value to the table. And it's interesting you asked that question

[00:50:30] because there are a couple of times where I have allowed my opinion management to influence

[00:50:42] my decision to buy or not buy the stock. And in none of those cases has it actually helped

[00:50:49] me make the right decision. Right? So, you know, 15 years ago when we were looking at Apple,

[00:50:56] which we ended up buying, we're still on today, full disclosure. Now, I looked at Steve Jobs

[00:51:02] and I said that guy's whoo. You know, he's just a complete jerk as a manager. I wouldn't

[00:51:07] want to work for him. His company is going to implode. Turned out not to be the case.

[00:51:14] All those statements are true. None of them were critical. What was critical is even though he was

[00:51:23] horrible and a jerk, he managed to drive his people to produce things that they would not

[00:51:28] have otherwise produced. And I think you can say the same thing about Elon Musk. I think it

[00:51:31] has been said. Right? He's not a great guy to work for. And, you know, I was looking at

[00:51:35] Tesla six or eight years ago, whatever, and looking at the high turnover of some very senior

[00:51:40] people. And I go, my God, how do you run that business if you're turning people over that fast?

[00:51:46] And yet his personality is such and what he demands is such the people are actually producing

[00:51:51] far more. They're overachieving in that environment. It's burning them out fast

[00:51:56] and he's replacing them, but they still do. Right? So, you know, you can't...

[00:52:03] And yet, third example, Google. Google three, four years ago, there were a lot of headlines

[00:52:11] out there about all the infighting with the different political factions inside of Google.

[00:52:16] And I'm like, how can you have a culture where this group spends half its day yelling

[00:52:21] at this group on their shared little message board and create any value for me to share?

[00:52:28] Why would I want to buy into that dysfunctional culture? And yet, if you had ignored that and

[00:52:33] bought the stock, you'd have done great because it was such a powerful business model.

[00:52:39] It was almost irrelevant what the people did in the short term because they had such a

[00:52:47] dominant position in advertising and search. Right? So yeah, we look at... We look at

[00:52:54] management. We like to look at the incentives that management sets up for bonuses. That is

[00:52:59] one of our key questions. What behavior are you trying to, you know, to incent and how do you

[00:53:06] do it? So we're much more interested in incentives along lines of profitability,

[00:53:12] growth in profitability, growth in market share with profitability, unless, you know, excited

[00:53:19] about, no, you want to grow earnings per share. Right? Because that doesn't necessarily make for

[00:53:24] a better business. That just makes for better service. Sure, we're looking for what is

[00:53:28] incentivized by the compensation structure that got in place. We do like to talk to management.

[00:53:34] Sometimes they are honest and give you unique insights. And sometimes they're salesmen,

[00:53:42] which frankly is part of the CEO's job, particularly for the startup. He's got to

[00:53:46] sell his product. He's got to sell his company. And so, you know, I, as the listener, have to

[00:53:53] put on my skeptic hat and say, okay, how much of this is sales pitch and how much of this is

[00:53:57] ground truth? And how do I, you know, tease apart the different elements of what the man's telling

[00:54:05] a lot of times we'll ask, you know, what do you think, what do you think is going to

[00:54:09] happen in the next six months? What do you think is going to happen the next year? What

[00:54:12] are you trying to achieve? And then we'll come back to you later. They compare notes. Okay.

[00:54:17] How did he do? And what did you learn from the outcome of what you tried to do? Right? So if

[00:54:24] they're, if they're trying to grow the company and they're trying to cut costs, okay, how'd you

[00:54:28] do? You know, on your own, I've asked you what your score sheet is. What does success look

[00:54:34] like to you? And then I'm going to compare what you actually did to what you were trying to

[00:54:38] do. And that, that helps me over time. One, do I agree? Is what he's trying to do,

[00:54:44] what I think should be done, but useful from an outside investment perspective.

[00:54:49] And then two, how, how able is he to deliver on that?

[00:54:52] So when you apply your framework, like what are you finding attractive in the market right

[00:54:55] now? You mentioned energy, you mentioned gold, you mentioned you own Apple, but I don't think

[00:54:59] you like a lot of the other big techniques if I'm correct. Like what are you finding attractive

[00:55:03] right now? So, well, right now, most of the companies we look at are fairly valued or

[00:55:12] expensive. Right. And I would put most of Big Tech in that category. Big Tech has

[00:55:18] been very popular. It came off a little bit in late 21 and 22. And they kind of

[00:55:24] re-inflated at the end of 22 or all through 23 as new AI products became available. And

[00:55:31] got a lot of people excited. And we still own Apple. We think that's probably a great

[00:55:36] company for the long term, but their product land and right now all their products are

[00:55:41] kind of at the end of their growth stage. So in my opinion, Apple is not going to do

[00:55:46] a lot as a stock until they have a new product out there that gets people excited

[00:55:50] about it and starts to drive revenue growth again. Do I think that's possible? I absolutely

[00:55:55] think that's possible. Do I know what it is or when it's coming? I certainly do not.

[00:56:00] We own Microsoft. Microsoft, we bought 2016, I think it had a 4% yield at the time. I

[00:56:08] think it was trading at a 10p. And they changed their CEO and they were generating tons of

[00:56:14] cash, which to us is like optionality. Cash, if employed properly is great. If employed

[00:56:22] poorly, it doesn't do anything for you. And our changed CEOs jumped onto this idea of the

[00:56:29] cloud and that's been their growth engine now for a decade. And it continues to be

[00:56:34] driving their growth. And now they've added another one to AI. So they're spending a ton

[00:56:39] of money to roll out this AI capability. It remains in my mind a question mark what kind

[00:56:47] of return they're going to get on that investment. And that was the thought about CEOs. I always

[00:56:53] like to ask CEOs, what returns are you trying to get on your investments? Or what return did

[00:56:58] you get on this investment? So particularly when they buy another company, what were

[00:57:04] your returns on that two, three years later? And it's hysterical for some of the answers

[00:57:11] you'll get. Well, we really don't think of it that way. Well, why not? When I put money

[00:57:16] in the company, I at least can say three years later, here's my return. I've made money,

[00:57:21] I've lost money, here's the return on my invested capital. You tell me you don't do that?

[00:57:26] And if they don't, that makes me kind of not terribly interested in investing in their

[00:57:32] company because they're kind of demonstrating they don't know how to reinvest profit.

[00:57:38] And that's part of, first they have to generate profit and then they have to reinvest

[00:57:41] profits. So if you can be the first and not the second, then please give me your

[00:57:45] profits. I will reinvest them because you can't. And there are companies like that,

[00:57:50] right? They tend to be very high payout companies. And if I find a company that's got 10 or 12%

[00:57:58] free cashflow and they're paying me a 6% yield and they're buying back 6% of their stock

[00:58:03] because they got no better options, I'm good with that. I'll take that yield, I'll reinvest

[00:58:07] it someplace else. But at least the guy's honest saying I can't reinvest my profits well,

[00:58:11] please do it for me, I will give you the money. Cool, that's great. If I find that same guy

[00:58:17] and he's buying LearJets and redoing the headquarters building, I'm not excited. He's

[00:58:23] saying I'm generating a lot of profits, I'm good at that and I'm going to make my life

[00:58:27] better. Well, you go dude because you're not working for me, you're working for you.

[00:58:32] Yeah, the return on the LearJets is probably not that great, I would assume.

[00:58:35] I think, you know. So, and Bob has thought a lot about this, right? A lot of CEOs are good at

[00:58:41] running the company and generating profit and they're not so good at reinvesting that dollar

[00:58:47] of profit into the next thing. So I'm looking at both aspects and we're a little bit,

[00:58:52] you know, I backtracked on you a little bit, I apologize. And I think that's important to think

[00:58:56] about, right? Because part of what you buy in the company is the current profit stream,

[00:59:02] but you're also interested in what do they do with that dollar of profit? Can they compound it

[00:59:10] or not? Because you want the guy that can compound it, right? That's what you got to

[00:59:15] get going for you, that's what you look. So back to tech. So we own Apple, we own Microsoft,

[00:59:22] we own a chip company called Microchip, MCHP and we own Broadcom. Broadcom did SuperForce

[00:59:30] last year because of AI. That's not really what we bought it. We bought it because of their,

[00:59:36] really their investing philosophy. So what they do, as I boil it down, is they buy cash cows,

[00:59:45] make them better cash cows and use the profits from those cash cows to go buy the next cash cow.

[00:59:51] They're not interested in taking any, they buy zero growth companies on purpose

[00:59:56] and they're not interested in turning them into growth cows. They're just interested in

[01:00:00] running them well and then using the profits from them to go buy the next. So, you know,

[01:00:05] I've heard people call them cash compounders. I think that's a great phrase works for me

[01:00:09] and I think that's a logical and potentially profitable way of running those businesses.

[01:00:17] And I would argue that that's pretty much what Mr. Buffett does, right? He buys profitable

[01:00:22] companies not to grow but to simply take the cash from them to go buy the next really profitable

[01:00:27] company and you grow the whole that way. So, that's why we own Broadcom and the fact that

[01:00:32] some of their businesses became growth businesses thanks to AI is optionality, cherry on the top

[01:00:38] of the cake. Unexpected surprise. It works for me. I'm happy to take it. We do like oil.

[01:00:46] We think it's a much better industry than it was a decade ago because everybody went through

[01:00:52] 2020 when oil prices dropped to minus 20. So, you weeded out everybody that was too levered

[01:00:58] were past the shale boom, right? When everybody was interested in more and more shale assets

[01:01:03] and growing their productivity now they're interested in profitability.

[01:01:09] So, you have completely shifted the mindset of all the surviving players. Oh, by the way,

[01:01:13] we picked most of those companies up at really good prices shortly after the 2020 bottom.

[01:01:18] So, we own Occidental, we own EQT, which is a natural gas producer here in Pennsylvania.

[01:01:25] We own Schlumberger and we own Transochi. It looks to us like if oil stays between 70

[01:01:33] to 90 dollars, which is a fairly broad range, that all those companies will be quite profitable

[01:01:38] and they will make good investment decisions as opposed to poor investment decisions,

[01:01:43] which is what they were doing 10 years ago. So, we're happy with that. We also think

[01:01:50] that this round, I mean, oil is stereotypically building bust. Shale boom, shale bust. Now

[01:01:58] we're ready for the next boom and it'll take however long to get there. But it looks to me

[01:02:04] like the activity is more going to be offshore than onshore, right? So, because you went from

[01:02:12] Donald Trump's administration to Mr. Biden's administration, you've had a change in the

[01:02:16] regulatory environment. So, onshore exploration and production is really not rewarded and it's

[01:02:22] difficult to jump through all the regulatory hoops. So, my guess is that most of the growth

[01:02:27] in the industry is going to be offshore, which is why, for instance, we own Schlumberger

[01:02:32] and not Halliburton. That's why we own Transochi. When I first started in the business

[01:02:38] in 2008 or 910, the offshore, the deep offshore was the undiscovered territory and that's where

[01:02:45] all the growth in oil production was supposed to be coming from. Except then shale was figured

[01:02:51] out and it was much cheaper to go explore the shale assets than the deep offshore assets.

[01:02:56] So, the boom actually happened onshore and offshore dried up and died. Transochi,

[01:03:03] who was the biggest offshore, almost went bankrupt. So, they've been hanging on by their teeth now for

[01:03:10] the better part of a decade. This time around I think that's going to reverse. I think most of

[01:03:14] the activity is going to be offshore and you're already seeing a lot of that in terms of daily

[01:03:19] rig rates. So, the rig rates keep ticking up. So, as Transochi's rigs roll over from the last

[01:03:26] contract to the next contract, the company is going to get much more profitable than we think

[01:03:33] we can benefit by owning them. So, that's kind of the story, some of the details around what we're

[01:03:39] seeing in energy. We're not all that interested in most of the clean energy. It's too expensive.

[01:03:45] You know, it's very fashionable to invest in clean energy. Fashion usually means the price

[01:03:49] gets driven up and so that's less interesting to us. And then gold I talked about a little bit

[01:03:56] now. We do have exposure, too long exposure to gold. And so far, and I would say that's

[01:04:06] probably the most interesting opportunity like right now, right today of anything that I see

[01:04:14] because you've had the spot price of gold continue to go up but the gold miners and

[01:04:20] the gold royalties at least, the price of their stocks have not moved very much. So,

[01:04:24] even though gold is at all time high, the miners and the royalties companies are typically about

[01:04:30] in the bottom third of their little trading lanes for the past three or four years.

[01:04:34] So, all the excitement in gold is really not coming out of the, but I would argue is probably

[01:04:40] the domestic US investor. I think it's probably coming from overseas and sooner or later,

[01:04:46] my suspicion is the domestic guys will catch a whiff of what's going on and they will pile

[01:04:51] in because you know, Fulbrook kicks in and all the other happy stuff and it drives them a little.

[01:04:57] But yeah, the most immediate opportunity I see, I see a big disconnect between the price of gold

[01:05:03] and the price action of the miners and the royalties companies. And my guess is that the

[01:05:09] miners move up in tandem as gold continues to rise. I don't think gold's coming back down

[01:05:15] anytime soon. This has been great and I've taken up more of your time than I had

[01:05:18] scheduled. So, I want to shift to our standard closing question and you answered our other

[01:05:22] standard closing question the first time you were on. So, we've been shifting to a new one

[01:05:26] and the question is when you look to the future, what are you most optimistic about

[01:05:30] and what are you most worried about? And this can be in the context of investing or

[01:05:32] in the context of life or anything, any way you want to take it. But what are you most

[01:05:36] optimistic about and what are you most worried about as you look to the future?

[01:05:39] So, when I look at the future, I'm really excited about what technology is doing in healthcare

[01:05:47] and kind of the resurgence of interest in nuclear power. So, I think technology has some great

[01:05:54] solutions for us to really improve the quality of life. Nothing improves your quality of life

[01:06:01] faster than cheap energy. And we've gotten on the kick of we want it to be carbon free

[01:06:08] and without arguing the pros and cons of that approach, we do have a carbon-free cheap

[01:06:14] solution and all we need is kind of the political will and the regulatory environment that allows us

[01:06:19] to roll that out quickly. And we're doing some amazing things in biology and as we apply all

[01:06:26] the computing power that we have built over the last 20, 30 years to the problems of biology

[01:06:32] and of health, I think we're going to see some amazing solutions. They're going to come

[01:06:36] slowly because it's a heavily regulated environment because it has to be if you get it wrong,

[01:06:40] people die, but they're going to be amazing. And so over a period of time,

[01:06:45] we're going to see some really sunny things happen. My fear is that for political reasons,

[01:06:53] we make stupid decisions and we collectively humans kind of have a pretty long history

[01:07:01] doing that sort of thing. And usually in the end, physics wins out, common sense wins out

[01:07:11] and then we make decent decisions, but the path isn't always very straight to get there.

[01:07:16] Right? So it is my hope that we don't do stupid things out of fear or greed or hate

[01:07:25] and that we don't choke off the innovation and the growth and the improvements

[01:07:32] that are very near at hand for us. Right? So, you know, homeowner dot days, I worry about that.

[01:07:40] And then all my optimistic days, well, yeah, we'll figure it out. You know, the kids will be

[01:07:44] fine. Yeah, we usually do figure it out. So hopefully we will. Usually, but not always.

[01:07:51] Well, this has been great. We really appreciate you coming back on. If people want to find out

[01:07:54] more about you or your firm, where's the best place to go? Mollicamp.com. You know, we've got

[01:07:59] a website and you've got phone numbers and email addresses on there. You can learn everything

[01:08:03] we're doing, learn how to reach out to us. And that would be happy to talk to you,

[01:08:08] whether it's about investing or you just want to grab a beer and shoot the ship. Happy

[01:08:11] to do it. Well, thank you, Jeff. Jeff, this is great. I really appreciate you coming back on.

[01:08:15] Thanks, Jeff. It's been a pleasure.

[01:08:20] into this episode of excess returns. You can follow Jack on Twitter at practical quant

[01:08:25] and follow me on Twitter at JJ Carboneau. If you found this discussion interesting and valuable,

[01:08:31] please subscribe in either iTunes or on YouTube or leave a review or a comment.

[01:08:36] We appreciate it.

[01:08:50] Thank you.