IFB160: Buying U.S. and Capital Light Compounding Stocks with Braden Dennis
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Dave (00:35 ):
All right, folks, we’ll welcome to Investing for Beginners podcast. This is episode 116. Tonight. We have an old friend. We have Braden Dennis from the Canadian investor and Stratosphere Investing.com back with us tonight for another show. So without any further ado, I’m going to turn it over to the boys. And we’re going to go ahead and get started. So Brayden wants to say hi, and Andrew says hi.
Braden (00:57 ):
Hello friends. Good to be back, guys. Yeah, you bunkered down over there. Keeping safe and things are starting to feel a little bit more like summer, but still got a long way to go.
Andrew (01:12 ):
I think I got; I got frisky the other day. I went to the gas station and didn’t buy gas. I just want it cause I wanted to get something else. Wow. You rebel you speaking of risk. So we’ve had some good questions about investors who are in the UK, for example, investors who are in Canada.
Andrew (01:40 ):
They’re maybe interested in buying into us stock market, but you know, there’s a lot of hurdles that tend to come along. So maybe from your perspective, being a Canadian investor, the way I see it is there’s a risk. If you’re not getting exposure to the US and there’s a long list of reasons, I don’t want to go through all of them. But the fact of the matter is, is so much of the world’s economy today runs on US dollars. And so if you take the coronavirus as an example, obviously that was something that hit the global economy on a scale that we’ve never seen before. And so central banks had to print money to try and inject, and then kind of bring this sputtering economy back to life. And so different central banks in different countries did that. But the scale with which the fed did that here in the United States was a much bigger factor than let’s say happened in the EU.
Andrew (02:44 ):
And a lot of that has to do with the fact that there are so many dollars circulating all around and that it’s in such high demand, that a lot of money can be injected into the system. And so I think there’s a risk, particularly if you look through history at a lot of different countries and stock markets, where if they are not able to keep up with the standard with currencies and economies, then their stock market could do great as it looks kind of on the silo, but then reality, the investors are not experiencing great returns. And so I think there is a big risk in not being in, in the US market. And so from your perspective, maybe you can tell us a little bit about some of the challenges that are there with getting invested in the US stock market and maybe why it could be a good idea or not for somebody who’s in that position.
Braden (03:48 ):
Yeah. Great question. So I’m seeing that in two parts of the first part is I wholeheartedly agree that it is silly not to own exposure to us companies. There are some of the best capital, light compounding companies on the planet, and they’re only listed in most cases on US exchanges. So when it comes to our hurdles and investing us stocks, when I think of actual like technical hurdles, if your broker doesn’t sell us stocks or have, have exposure to US exchanges, you need a new broker. So we’ll start with that in terms of hurdles, what most people are worried about is they think that they’re taking on excessive risk by exchanging the currency as well. You know, if they, if they want to be withdrawing on that money and all the sudden the currency exchange has unfavorably affected how what your returns are going to be, then they could see that as a risk.
Braden (04:59 ):
And I don’t disagree with that, but on a longterm basis, that should not be something that is stopping you from investing in the US market. You should be investing in the highest quality of companies that will compound for you, and we can get into what the, what those companies look like. But that is more important of a decision on what you can control is investing in high-quality companies that versus something that is completely out of your control, which is foreign exchange, foreign exchange is completely out of your control. The smartest people in the world can’t predict what’s going to happen with currencies. So there’s no point of you even wasting a minute on it. Peter Lynch has a famous quote where he says 15 minutes a year, looking at macroeconomics is 15 minutes wasted. And I agree with him because it’s impossible
Andrew (05:58 ):
To focus on things that are out of your control and not helpful. So, so that’s, that’s the first part. Yeah. I am sorry to jump in. I know a lot of companies, and if you look through their 10 Ks, you’ll see that if they have different risk exposure, they will have these derivatives that they do, and try to offset some of that risk. And so something that I did last week that I hadn’t thought to do before, kind of going back to the whole common sense thing is if you can go through your portfolio and literally like partition it out into percentages of how much revenue is in each country, you can achieve geographical diversification without even necessarily needing, needing to own shares in various countries. So, as an example, I don’t know how much of you have been following what’s going on in Hong Kong.
Andrew (07:04 ):
Any time on that spent also is probably a waste of time because it’s just infuriating to hear what’s going on. And maybe that’s political. Maybe I shouldn’t say that, but you know, the bottom line is there. Hong Kong is a place where there used to be a lot of free trade. And now that’s being restricted, not just by the US but by pretty much everybody in the EU, it’s pretty much everybody in the world against China on this. And they are pulling back and not going to be making as much trade in the Hong Kong area because of what Beijing has been doing over there in that area. So, you know, you have risks like that in China, where there are political risks, the systems there economically are set up differently, they have different values. And so like a big risk in investing in China is that they don’t have as stringent accounting principles as a lot of the countries in the West do.
Andrew (08:08 ):
And there’s been just a huge history of manipulation and deceit. And so you might think like an investor, well, I want to invest in China. How do I do that? If, you know, if, if all of these stocks on these exchanges are shady or as we’ve seen access lately for Chinese companies starts to go away as countries start to hunker down inside of their borders. So one way you can do that is by owning companies that export to those markets. And if you look throughout your portfolio and again, the partition between how much, how much exporting, and how much currency are you kind of bringing in based on how your portfolio is set up and what their key markets are. Then that’s one, that’s another way to achieve that outside of just having to buy a bunch of shares in a bunch of different countries and, and deal with the taxes there. Sorry, I didn’t mean to go on the huge spiel while you’re here. Still, I think it’s important for investors to think about, particularly as we discover more and more, you know, you saw in the, in the great recession, Oh eight Oh nine, just how a crisis in one country can affect a lot of countries. And that’s becoming more evident as every day goes by. And it’s something we need to think about.
Braden (09:30 ):
Agree. Especially on the piece about being able to invest in companies that have a global business. I love investing in companies that are top of large global tailwinds at their back. Those are some of the best compounds that you can find. So I’ll give an example here in Canada, Brookfield, asset management, ticker, bam dot a, and is also listed on the New York stock exchange of tech, just Tigger. BIM does business all over the world and real assets. So real estate infrastructure, project, energy utilities. They have offices in Canada, US South America, Europe in tons of business and Asia, and in and in India. So there’s a perfect example of a place you can go somewhere where you can invest in your currency, but get exposure to global business. So you’re getting instant geographic diversification from owning high-quality global companies. Another example says you live in Sweden home to Spotify.
Braden (10:45 ):
What I think is the Netflix of audio and an incredible business model is, you know, probably listed there in their home country, but does a large portion of their business in North America. So those are just prime examples of, you know, if you are worried about taking the hit on the currency risk or, or not even the currency risk, but seeing your dollars just did not go as far when the Canadian dollar is only 75 cents on the US dollar, it makes you feel like, you know, you’re getting an instant 25% haircut. So I get that, but long term again, what can you control? You can control the decisions you make in your investment portfolio if you’re managing it on your own. And by doing that, you’re able to pick only the highest of quality companies that have the global opportunity for the real ten baggers. They scale beyond just their home geographic location. And that includes US companies, you know, US companies like Amazon and Microsoft and Apple don’t hit 1 trillion market cap by just selling iPhones in the US they sell iPhones to every major market you can think of. So I, I, I agree there, that’s, there’s a lot of value in being able to, to be able to select those companies that perform global business and have wide, wide moats that’ll continue to compound for, you know, decades to come.
Andrew (12:31 ):
You mentioned moats, you mentioned scalability, but be fair to say that tech can be one of those that could have both in abundance, especially the scalability part.
Braden (12:46 ):
Both in excessive abundance, and you’re seeing them trade it extreme multiples. Right now, they’re getting high premiums. And I will say this, some of them may look tremendously overvalued. And if you go case by case, I would think that a lot of them are. But if you look at the business model, there’s so first light and so scalable that they had to create a crazy good gross margin on the top. So you’re getting at least 80% gross margins on these tech companies because you know, their input costs are so low. And then that trickles down to create high, free cashflow margins as well. And they’re able to reinvest that at such a high ROI that they deserve these high valuations. In my opinion, I mean, there is a limit to that. You know, I’m not going to buy something at 50 times sales, you know, like that’s just insanity, but they do deserve higher premiums.
Braden (14:01 ):
Higher quality businesses deserve higher valuations on a traditional metric basis. So I’ll give you an example here right now. You know, we’re in a pandemic stocks dropped a lot. There was this huge rally on the S and P, and it’s skewed to, for you to believe that the entire stock market has come back to all-time highs. A few companies have put the entire index on their back and carried the S and P up to, and the end of the NASDAQ to what are all-time highs. And it’s, it’s, it’s not true. You know, you can take statistics and take data and shapeshift them any way you want. And so you see that you know, NASDAQ, new highs, and it’s only because it’s market-cap-weighted in these ETFs too. And they’re taking on so much of those gains when they, since its market-cap-weighted that they make so much of the index.
Braden (15:05 ):
To give you an example, Microsoft Netflix, these are companies that are worth more than they were pre-pandemic, and they should be worth more Q1, Amazon Q1, Microsoft reported an 80% increase in their Microsoft teams platform. That is like one of the best Q ones I’ve ever read. And it was during the pandemic when, you know, the sky was falling. So it’s skewed when a lot of these big, big tech companies are making such, such big gains. And in most cases, you know, as a general blanket rule the Wolf more now than they were before on the stock market, and they should be worth more than the than they were before on the stock market because they’re doing more business than ever. And they’re proving the durability and the wide, wide moat that a lot of these companies do have.
Andrew (16:10 ):
I think the very key part about what I’m picking up from what you’re saying. You talk about these high gross margins. And so traditionally when you talk about businesses, the problem with very, very high margins is it attracts competition. And so as competitors enter the space of margins squeeze, and, you know, the margins mean river, they go back to normal and then you don’t have those great gross margins anymore. And so the valuations will fall. But when you start to talk about companies that have huge moats, that that will be that barrier to keep gross margins high. And I think, I, I don’t know, I’m, I’m shocked by the way that some of these companies have continued to keep their margins high or keep that competitive Mo intact. And you wonder if it’s something that gap has seemed, seems to widen now where you see a difference between businesses who can stay competitive versus those who are just kind of hanging around and being mediocre. And so, you know, I think there’s a lot to be said for looking for capital-light businesses, particularly if they have a strong moat. And I think that might be the most, one of the most important parts when you’re looking at a company like, like what we’re talking about here.
Braden (17:36 ):
Yeah, for sure. I mean, my favorite duopoly on the planet is I, you know, I talked about it for an entire episode. Last time I was on here as visa and MasterCard, MasterCard has 40% cash margins. So if people are not familiar with that is 40% of all the revenue they make on the top line is pumped into free cash flow. And they can take that free cash flow and reinvest it with a high return on invested capital as well. So you get this unbelievable compounding effect when you have high free cash margins and high return on equity and a higher return on invested capital, you get this amazing, amazing longterm compounding effect. And that’s why you’ve seen them perform so well. And the runway for growth for them still is so high. Even at 350 billion in market cap, super, super high runway cash is dead.
Braden (18:44 ):
Cash is done. I don’t know about how, what, what it’s like down in the States, but I know in Canada, the number of businesses that just do not take cash anymore is high because of COVID. And that was all that was; there was a trend that was already happening. So this kind of goes back to the big tech thing. All these trends were happening, and coronavirus sped them up by like five years in three months. You know, so MasterCard and visa are other examples of those companies that are not looked at as traditional technology plays. Still, they should, so maybe there’s others arbitrage there in the valuation. And not that they trade particularly cheap, but I think you can get under price free cashflow growth by owning those names.
Andrew (19:35 ):
Can you give an example of high ROIC and high free cash flow just to give some conceptualization to why exactly that means it doesn’t have to be visa or MasterCard, but give an example of how free cashflow can turn into the compound.
Braden (19:55 ):
Sure. So what happens is the cash flow statement starts with net income at the top. Then we’re going to unravel all of the funny things that happen on any account in generally accepted accounting principles into the ultimate metric, which is free cash. So what you’re going to do is you’re going to add back depreciation and amortization. You’re going to add that back because we should have never taken that out in generally like modern thought of stock investing. We shouldn’t have taken that out because that’s not a real cash transaction, right? If you own a car, for instance, and you’re you that sits in your driveway, and it’s depreciating all the time. Sure. You know, the value, the car is lower next year. Totally. You’re, you’re using it. It’s getting older. So you’re taking on that depreciation, but it’s not a cash transaction in your finances next year.
Braden (21:05 ):
You didn’t have money that came out of your bank account because the car depreciated by $500, which was never a cash transaction. So that’s, that’s a real-life example of why we should have never taken it out. So we’re going to put that back in. Okay. So we’re going to add that back on, and then we’re going to remove cap-ex capital expenditures with John, depending on where you’re looking on your financial statements. Some people might call it property, plant, and equipment. Someone’s just capital expenditure, same thing. And what that line does is we’re going to take that all out. So here’s an example. If I have a manufacturing plant and I am going to build another manufacturing plant, why would I not be taking that out of the amount of cash that’s leftover at the end of the year, at the end of the quarter, if I have to build that, that is an investment that I, I need to make to grow the business.
Braden (22:07 ):
So why is that important? I hate to make this episode against those payment companies again, but visa and MasterCard don’t have to invest in those types of assets to grow. They can grow organically without investing in capital expenditure. So this just makes for a better business model when their capital-light. And that’s why you see super high free cash margins in technology because the CapEx they’re very asset-light, so they don’t have to take on those kinds of costs to grow. So that’s why people, you know, people in financer think free cash flow is like the Nirvana of, of, of accounting, because that’s the amount of cash that’s left over to invest in the business. So now we have another thing happening. I have a free cash leftover, and I’m going to reinvest it in the business or pay a dividend or buy back stock. Those are three things I can do so I can invest it back in the business and companies that have high returns on investing back in the business. That’s the line return on invested capital, which by the way, is not useful in one year, you know, what, what was their return on invested capital in 2019? I don’t care as much as what’s the five years, ten-year average, because it can fluctuate so much based on little things on the, on the income statement. So what’s a five year, ten year average on that
Braden (23:46 ):
Return on invested capital. And that’s what the number of returns they’ll be able to generate with the free cash. So if you can combine those two things, and this is, this is not anything I came up with. This is very widely accepted as, as very good longterm stock investing is high free cash. And then high return on those, on that cash, which is the return on invested capital.
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Andrew (24:22 ):
I’d argue that. I know we don’t want to talk about macroeconomics. Still, I’d argue that with the very, very low-interest rates, capital, light, and free cash flow becomes even more important than it did in the past because if interest rates are super low, cash is cheap. And you know, that those assets that are sitting on your balance sheet are not worth much when you can borrow cash for a half a percent of a percent. So, I mean, I liked the explanation you gave about free cash flow. I think that’s probably one of the most concise, simple, easy understand explanations I’ve heard about free cash flow. And that’s really what a lot of it boils down to. I mean, you can get as complex about as you want. I wrote my e-letter issue for July went out yesterday, and I talked about how for the company I was analyzing, I had to use, I use three different formulas for free cashflow because each one could be slightly different.
Andrew (25:26 ):
And, you know, sometimes depending on the business model or the industry, it can be a little bit different, but, you know, it’s important just to get a good grasp. And just this idea that we have the earnings, the profits, we’re going to add back some of the stuff that was non-cash like depreciation, and we’re going to take away the big capital expenditures that like a big plant or big piece of land that it takes to run the business. And that’s going to leave us with our free cash flow. Now, the one thing I guess I would add and see if you have any comments on this too, is I think particularly when you’re looking at companies with really high free cash flow, if I guess this a big, if, if the company is not reinvesting in their own business, or if, even if they are, you need to look at how they’re allocating the capital and make an ROTC determination based off of that.
Andrew (26:26 ):
And so a company could have great free cashflow margins or great free cash flow growth, but if they’re just pissing it away over in a corner then that a, of that value over the longterm, is not going to trickle back down to the shareholder. So I’ll give an example again, last month I was comparing two companies. They both seem to have decent free cash flows. They had good ones, okay. Particularly compared to where they were trading at the valuation, the multiple, it was very low. And so I was very attracted to both. One was using pretty much all of their free cash flow to make acquisitions. And so they had crazy amounts of revenue, growth, crazy amounts of earnings growth, and they’re making these acquisitions. So everything seemed like a perfect situation for an investor. When I started digging into how they are making these acquisitions, they were buying up these dealerships across the country.
Andrew (27:31 ):
And then it was almost like a flip or flop like that, that home building episode where they would buy it up, fix it up all nice. And then now they would have a lot more on a lot more efficient income stream. And so when I started running the numbers on some of the latest acquisitions they made, I was looking at an ROI, see of like 1% and in their earnings presentation, they were talking about how they would take these gross margins and, and turn them into a three X. So we’re talking about ROYC going from one to three if they’re successful in doing this makeover for these businesses that are acquiring these old dealerships. So I’m looking at that, and I’m like, okay, you’re, you’re giving me a lot of free cash flow, but I’m only getting a 3% ROYC over the very, very long term.
Andrew (28:23 ):
That’s going to destroy a lot of the shareholder value and negate the positivity from this free cash flow. On the other hand that I had another business I was looking at; fortunately, it looked like they were a lot more efficient with their capital. They were buying back a lot of shares, and over the very, very long period that was turned into positive ROI, see for the shareholder because they were, they were getting bigger ownership slices of, of this company. They were getting higher free cash flow per share, higher earnings per share book value per share was all growing because they were buying back shares at an attractive price. And that’s all flowing back to the shareholder. So I guess all that to say, I think precast was very, very important with the added, you know, everything we’ve, we’ve been talking about everything you talk about investing needs to have an accompanying, but also this right. So when you talk about capital-light or high gross margins, but also with a high competitive moat, and when you talk about free cash flow, but also with good capital allocation, do you agree, disagree? What do you have to say? What’s your definitive stance on the matter? Like, I
Braden (29:42 ):
Agree with what you’re getting at in terms of when you can combine a few metrics; then you’ll find some really big winners in the stock market. And that makes total sense if companies who have the opportunity to reinvest in, at a higher expected return than company B, then they’ll probably be giving you better returns than investment B. That’s, but it goes back to combining a couple of things. If company a, that those metrics look all great, but trades at 50 times sales, then there’s no multiple expansion for me there at all. And then that kind of falls apart. So I agree with what, with what you’re saying. It’s yeah, growth is nice, but, but at what price, at what price are you, are you going to pay for that growth? And I am totally in the camp of, I think it’s far better to buy wonderful businesses at fair prices than, you know, good businesses at good prices, the old Warren buffet quote.
Braden (30:59 ):
And I agree, I agree there, but the important word there is fair prices or slightly high prices I’ll even go there. But when you see things, you’re seeing so much software as a service right now. Oh, well, people call SAS trading at 20 times sales, and no one even is questioning it. Like that’s, that’s expected. I remember, you know, for a while there, these companies were expensive at eight times, and now, they’re cheap at that. And when I say that, I mean sales and then all of a sudden, Oh, well, you know, they’re expected to be 10. And that multiple keeps creeping up more and more and more. And I get that these businesses are very, very, very good. They are capital-light. They don’t have to invest that much to grow. These are all the things that you’re looking for, but at what price. Right. So, I agree with you.
Dave (32:06 ):
Can I, can I have her to hazard a thought on some of this?
Braden (32:09 ):
Dave (32:13 ):
Well, I guess I, I I’m questioning as you guys are talking back and forth about some of the metrics and, and whatnot. I’m wondering if maybe we should start considering different metrics for these kinds of businesses, simply for the fact that a lot of the things that we’re talking about tonight are things that were not happening
Braden (32:34 ):
30, 50 years ago when a lot of the finance and accounting were
Dave (32:40 ):
Kind of, I guess, set in stone, if you will. And I wonder, because as you guys were talking, these companies are so different than the companies that dominated the SMP 20 years ago even, and will be different 20 years from now. So I wonder if we have to, I guess, shift our thinking on how we think about what is air quotes expensive compared to what it used to be because I think some of the rules have changed with thinking about something like the price to book return on equity return on invested capital. Those, you can’t compare a return on invested capital of Microsoft to Wells Fargo. There they’re completely different businesses, and it’s just not in the same week of how they operate and how they function based on their business. So I wonder if we just need to start changing how we think about the metrics.
Braden (33:46 ):
Yeah. That’s an interesting thought. And I think about that all the time. And at the same time, I, I do not want to be in the, in the camp of, Oh, we can value these businesses like we used to. But at the same time, if you’ve been ignoring these types of companies over the last decade, you’ve just flat out underperformed the market in a major way. Like not by just a little bit by like, by a lot, because you see so much of the gains in the S and P come from a few names who happened mostly all be technology companies. Still, I agree they’re so different than traditional businesses that have lots of assets that invest in manufacturing that just have so many other complicated intricacies logistics and costs associated with that compared to a capital-light Spotify, you know, comparing them. And then, and then again, there’s, there are exceptions to the rules, right? The Netflix costs are super high, and that’s a that’s, that’s one that is maybe tremendously overvalued. I don’t know, because when I look at that, I go, well, this isn’t a free cash-generating machine when it costs a billion dollars to put together a, you know, a Netflix original or whatever the cost is. So yeah, it’s, it’s a, it’s a very good question. Dave and him, I’m interested as to what Andrew has on this.
Andrew (35:39 ):
I’m cautious about it. So it’s like a conflicting opinion, right? Because on the one hand, you have a very similar firstname.lastname@example.org bubble where a lot of the indexes turned to overwhelmingly tech, and people started talking about different metrics. Like all of a sudden, website visitors became like a finance metric, or I don’t know what the other ones were, but it was to that extreme where companies are being valued just for no reason at all. So, you know, you have to be cautious about getting into that kind of a mindset and, you know, this phenomenon of having a small group of businesses to dominate the index that, that has happened in bull markets before. And that doesn’t mean, I think the bull market’s about to end, but you know, we’ve seen it before. So it’s not this crazy idea. On the flip side, I was looking at; I wanted to see what were the top 12, top 15, even top 10 businesses in the S P 500.
Andrew (36:58 ):
I did this maybe a month or two ago. And I just wanted to see what seems to be the common theme here. Why are all these businesses really good besides the fact that a lot of them are names that we all know, or we all use daily. And I was noticing the ROI CS for all of these businesses, not only just double digits but close to 20%. And I’m talking about not one year, not two years; we’re talking about like ten years, the median ROYC is 20%. So that’s Amazon, Facebook, Apple, Microsoft would fit in their Google. And so they have huge ROI for very long periods. What does it lead to while like Brandon was talking about when you have all that free cash flow, you can do things like grow your revenues aggressively grow your earnings per share.
Andrew (37:53 ):
And so, yeah, I think it, I think it’s worth considering, and obviously, you want to do it intelligently, cause it’s just not a cure. All fix all kinds of ideas. We can’t just throw everything to the wind as they did in the dot coms. But we do have to understand that technology does change the game in the sense that the asset, I almost think the assets change now where it’s not even like a piece of machinery, but it’s, it’s, it’s increasingly more intangible. And I think people become so much more important. A workforce becomes so much more important, particularly when they’re highly skilled or highly technical. And so you just have a lot of these intangibles that are hard to quantify and financial statements. And so you do need to take it out on a case by case rational basis and what brains.
Andrew (38:44 ):
I was a perfect example, like Netflix, it’s a sexy name, and everybody knows it. And that sounds tech, and it sounds like it’d be like capital, and it sounds like it’d be great compounding. Still, when you get into the financials, it’s not because right there in the cash flow statement, it shows you that they’re spending unseen like crazy amounts of free cash flow just to sustain themselves, to keep creating new content. And they’ve, we’re talking about the other day that content gets old real quick and they need to replace it over and over and over again. And so, you know, you contrast that with some of the other great businesses that brain mentioned today. I think you can pick your spots, and maybe this is something I learned from you today. And I think maybe it doesn’t need to be so black and white. You can find yourself somewhere in the middle where you’re taking the best of both worlds and intelligently applying some metrics and finding those great businesses that can do good. Not just ten years prior, but the ten years to come.
Dave (39:48 ):
Yeah, I like that. And I think I’m sorry right now. I think I agree with what you guys were saying. And I guess maybe I didn’t clarify the correct way. I think maybe we should consider moving the goalposts, I guess, is a better way of putting it. I feel like a lot of the metrics that we discuss and consider are based on more old school styles of businesses. And I think, and I guess, I don’t think I’m wondering if as the technology improves that those goalposts probably need to change a little bit because of just the examples you guys have been talking about, Microsoft zoom, visa, MasterCard you know, just, we can just go on and on and on. And those are arguably fantastic businesses, but they’re different than Exxon was 20 years ago. That was a very capital heavy company. You could argue that Netflix, that’s one of the things that they struggle with, is they’re a capital heavy company, just because of what you just mentioned. And I wonder if we need to adjust to the goalposts a little bit for a company like a Visa or MasterCard or Amazon, or God forbid, Tesla he could just go on and on. And I just wonder if at some point maybe we need to adjust the goalposts on those kinds of businesses, simply for the fact that they’re doing things that are different than Ben Graham was talking about 50, 60 years ago. I, I think a lot of the concepts that he talked about are still obviously in play and are very, very valid, but
Dave (41:34 ):
I just wonder if maybe the metrics that we use to decide on what is good and what is the bad company and what’s expensive and what’s not expensive. I just wonder if some of that has changed.
Braden (41:46 ):
I couldn’t agree more with that. I’m hesitant. What I’ll say is I’m, I’m hesitant to say the game has changed. Cause I don’t, I think it’s still very, very similar, but the types of businesses that exist now that dominate the S and P are without a doubt, I’m no problem sounding off though, just better businesses than ever. They’re just, they’re just higher quality businesses, and business models that encourage the things that we’re talking about in terms of the metrics of high free cash and high ROIC are baked into that model. And that’s why you see such incredible returns, but I’m, I’m hesitant, but it’s I do, I, I think about this all the time, Dave, I do,
Andrew (42:46 ):
I guess I guess I’ll put my 2 cents into, I, I, I generally agree with, with that thinking as well, in a sense, so I think Ben Graham P so if you go back and read his, his book, the intelligent investor, he doesn’t mention the price to book that much. And it’s become gospel to a lot of value investors, myself included, particularly in the past. But if you read what he’s talking about with margin of safety, he’s talking about finding a discount, finding a company that’s trading at a discount to its earning power. And so that doesn’t necessarily need to do with price to book, and it doesn’t necessarily need to do with free cash flow. It just so happens that free cash flow tends to lead to high earning power. So I guess I would push back a little bit against what you’re saying, Dave, and say, I don’t think the rules of the game have changed in the sense that it’s still going to be about earnings.
Andrew (43:53 ):
It’s still going to be about free cash flow, and you know, the concept of free cash flow. That’s not new either. This guy named John Burr Williams wrote a book called the theory of investment value, and it was back in the 1930s. And that’s really where the first DCF model came from, which evolved to the free cash flow DCF. So they’re now practicing today and finance and taught in the schools and buffet referenced that book and his 92, 1992 share shareholder leather. So I don’t think we’re necessarily dealing with super brand new concepts where you need to change the goalposts completely. I will say, though, that there’s a possibility that a metric like a price to the book might, might not be as valid as before. That doesn’t mean it’s not useful, but it just means you need to be smart about how you use it.
Braden (44:54 ):
And, and who knows. Right? I was looking at a really interesting chart today that showed the biggest separation between different, like a quant strategy of growth versus value and value. As of today has become the most out of favor. It has in like over a hundred years of stock market data. And all of those times it hits these, these, these troughs of value being out of favor, it then goes on to outperform everything else. So we could be back here in Q4, and value has this amazing, amazing recovery, or maybe it takes a bit longer than that. True value investors know that for the, it takes years and years and years of sometimes looking like an idiot before you see that multiple expansion that you were buying the business, and that’s what you were looking for, returns. There’s multiple expansion. It can take the market a long, long time. Here’s the problem with deep value investing is that the market may never agree with you ever. It just may never agree with you even if by every stretch of your model that you’ve put together in terms of what the intrinsic value is, some businesses are undervalued for their entire lifetime. So that, that has to be built into your risk understanding and, and traditional measures of a margin of safety. You have to bake in that risk, in my opinion,
Andrew (46:47 ):
I like that we’re talking about this. It’s not like we’re going to solve it overnight. This is a so hotly debated and I, I, on the one hand, so I’m like torn because, on the one hand, I agree that as value gets more and more out of favor, that’s the time when it’s going to be probably become it’s most profitable. I saw something the other day. I was a char about how that brief period where the market kind of whipsawed back after the Corona crash value had one of its best short term performances against growth that it had had in a very, very long time. The thing I’ll ask you, Braden, then you mentioned a time difference in, and did it give a period? Like how far back did that go? As far as one outperforming the other?
Braden (47:43 ):
Oh, it went back like, like into, I think like the, a late 18 hundreds, this, this, this chart. Yeah, it was very cool to look at.
Andrew (47:55 ):
So, so we’re, we’re talking about a possible multisensory snapback is what you’re saying.
Braden (48:04 ):
Like yeah. Based on what that graph was implying, you could; you could make some sort of prediction that, that could have some high probability to it. However, just like how I think I’m looking at charts and graphs to make investment decisions is goofy. I think it’s pretty goofy to look at that longterm trend and assume that something’s going to happen on that front as well. As soon as you get people who go on CNBC and start talking about head and shoulders, found formations as a reason to invest in a stock is when you instantly turn off the TV and never listened to that person ever again.
Andrew (48:47 ):
Well, maybe the circle back to what we were saying at the beginning of the episode, you mentioned, this goes back to the late 18 hundreds. I wonder if it is just referring to us equities, or if it’s talking about global equities, you may or may not know the answer to that.
Braden (49:06 ):
I’d have to look; it was on Tobias Carlisle’s Twitter this morning.
Andrew (49:09 ):
Okay. So I mean, I guess my point is that there’s a lot of like you said, a lot of charts that you can make. And I think a lot of the comparisons between this strategy versus strategy, this metric versus that metric, a lot of it can be made out of context. And so I think anything that goes, let’s say back to the 1920s, even if you’re looking just at the 1920s to 19 for these, and that’s how far back you go. And if you’re only looking at our stocks, then your study, your examination of the data is already useless because we’re talking about a time of prosperity in a country that’s had world reserve currency status and just immense financial power. And so you can’t use that as a feature looking metric. And so, you know, we can apply that maybe to this chart, maybe to other charts, to other arguments. And I think, you know, the deeper down this rabbit hole, we go, the more cautious we need to be about making inferences or decisions, big kind of strategic decisions based on these sorts of things that could be flawed and maybe pay more attention to this stuff.
Braden (50:32 ):
That just makes sense, you know, simple stuff fully, because this is not just investing. This is in life. When you see a statistic or a metric that is on the news, it can be shaped in any way to tell a different narrative. Here’s an example of investing. I think it was last week or the week before all the airlines soared over 20% in one trading day. And I think American airlines were up like 25% by noon. That day off the news that air travel was up like 80% from the previous month. It’s like, well, 80% from what base for one zero, zero, those are 17 Americans took flights last week. Great news. That’s fantastic, right? Like incredible news time to buy a Delta airline, right? So, those narratives can be shaped in any way. And this isn’t just an investing. This is with everything. Statistics can be shown in a way to tell whatever narrative is convenient for the story that they’re trying to tell. So there’s a, there’s a prime example of the market reacting irrationally to news based on a number that is meaningless to me, but that may be enough for us stock to go through the roof.
Andrew (52:10 ):
I think that’s a perfect way to end our discussion tonight. So Brayden, for people who want to learn more about these capital-light businesses that you talk about, they want to hear more of your voice and hear you speak about these capitalized businesses. Where can they do that?
Braden (52:25 ):
I am on a weekly podcast called the Canadian investor, which you can get it where you find your podcasts. Well, finally. Yeah, it is. It is. It’s, there’s a different RSS feed. I don’t; I don’t know. It’s very confusing. But yeah, that’s, you can, you can catch me on that podcast weekly with my cohost. And then additionally, you can see all the things I read about on my email@example.com. If you want a list of what I think are some of the best companies and some of the capital-light compounders that I talk about, you can go to getstockmarket.com that redirects you to stress your investing. So that getstockmarket.com, and there are lists there for you.
Dave (53:12 ):
Perfect. That’s awesome. Thank you, Braden. I appreciate that. And by the way, folks is a little, a little side note, definitely check out his podcast. It’s worth listening to; I enjoy it. I listened to it every week. It’s it’s great. Ian, he and his call are fun
Dave (53:26 ):
It’s a great show. So I highly encourage you to check it out. Appreciate that. So, yeah. You’re welcome. So without any further ado, I’m going to go ahead and take us out. All right, folks, we’ll, that’s going to wrap up our conversation for this evening. I wanted to thank Braden for taking the time out of his busy night to come and talk to us. We enjoyed having on the show. We’ll have him back again real soon. So without any further, do you guys go out there and invest with a margin of safety emphasis on the safety, have a great week and we’ll talk to you all next week.
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