Finding Hidden Investment Winners w/ Jon Cukierwar (TIP726)

(00:00) Owner's earnings is very important, and it's the first thing I look at when I view a company and look at their financials for the first time. Owner's earnings is always the first calculation that I try to make, just on a very crude basis. You know, you do need to do a bit more digging sometimes to get there.

(00:16) Uh, but yeah, you know, owner's earnings—the other way that I view it—is steady-state free cash flow. I think that's a very important metric, and exactly what you said. Sometimes there can be a wide discrepancy between what the reported free cash flow is, the reported earnings is, and owner's earnings.

(00:33) Often times, I think net income, free cash flow, and they can be good practice for one another. Before we dive into the video, if you've been enjoying the show, be sure to click the subscribe button below so you never miss an episode. It's a free and easy way to support us, and we'd really appreciate it. Thank you so much. Now let's rewind the clock a little bit here and start from the beginning, from before you were managing so peak, and talk maybe about one of the investors who I know you've learned a lot from. I'm referring here to legendary value (01:06) investor Bob Rabati. Now I know part of the value proposition of bringing you in in the first place was based on the fact that you were willing to work for free, and this reminds me of the Warren Buffett offering of the same deal to Benjamin Graham many, many decades ago. So can you review maybe some of the primary lessons that you took away from Bob Rabati and other key value investors who have helped shape your investing strategy that you use today?

Yeah, absolutely. Oh man, that was 2016. (01:35) I was 22 years old, and yes, I worked for free. Well, it can't be exactly for free because of wage laws and regulations, but you think of it as close to it as you can get. And in hindsight, that was by far the best investment I've made in myself, in my career. So, a decision I'd make again a hundred times over. It's interesting.

(01:56) I think back, and there really were some powerful lessons from working there, being exposed in that environment at Robotian Company with Bob Rosati. You know, I think the most important takeaway for me there was that they truly are independent thinkers. I would say almost radically independent thinkers.

(02:14) And it's something you appreciate more when you leave the environment and just see how the rest of Wall Street thinks. You know, there's obviously—you go in their office—there's no TVs playing CNBC. There is a Bloomberg, but almost nobody ever uses it. I think the back office really uses it more than anybody. And you know, look, there's no brokers.

(02:32) I never saw a single broker who came in there to pitch stocks. They don't subscribe to basically any sell-side research that I can think of. Um, you know, look, they just want to get the facts from the bottom up. They want to get the data up, see what companies are trading cheap and mispriced on a statistically cheap basis.

(02:51) I think it's the only office I've seen those old-school value lines, the actual printout versions, right, where you can flip through hundreds of companies. They were not interested in what other people thought. You know, managers, you go to the rest of Wall Street, they wanted all the sell-side initiation reports. They want to talk to their other manager friends to see what they think about stocks, but they want to come to conclusions on their own.

(03:10) And I think that is really powerful, and as one of the managers there once told me who I really admire, every year, 40,000 people fly to Omaha. They come to see Warren speak, and they hang on to every word and they buy the Cherry Coke and Doritos and so on.

(03:28) But if you look back at Warren's career, his most important lesson was to think for yourself, right? Because so much of what he did was really ahead of his time. And so, yeah, so I think independent thinking was a critical thing. You know, obviously there's other lessons. Valuation—they never—I don't even think anyone there is open Microsoft Excel, you know, the senior folks at least.

(03:47) Um, every valuation can be done on an 8 1/2 by 11-inch piece of paper. But the point being, the number should hit you over the head like a baseball bat, right? And if you need hundreds of lines of Excel to tell you if something is a good investment or not, you probably don't have much. You know, aside from those, Bob himself, I've noticed, is a very good behavioral thinker.

(04:09) He has what I would call a behavioral advantage. I know a lot of people like to think they do, but I think he truly does, as far as his ability to, without stubbornness or blindness, with conviction, just go against the tide when the market's increasingly disagreeing with him.

(04:24) And then eventually, and it may take years, but he's proven right and in a big way with a lot of his picks. A lot of great lessons I took from Robotian Company, and it's one of those things—right—you're in college, and after you read your Buffett, you read your Munger, you read your Phil Fischer, you read everything, and all these principles that I just described—you know, all the greats communicate—then you go to Robati, you think, "Oh yeah, well obviously this is how investors should think," and then afterwards you see the rest of the investing world—wait a (04:48) minute—this is not normal at all. That was certainly the exception. So, look, terrific firm, great people, even better investors, definitely learned a lot of great lessons. So I know that at Roboti, they obviously lean towards very statistically cheap companies, and I know that you—obviously, I've studied, researched a lot of the businesses that you own and even own a few in common—look for these more high-quality businesses that I don't think Roboti would even bother looking at, given some of the (05:16) valuation metrics. So, was there like some sort of moment or maybe some sort of case study or concept that caused your shift to go from where Roboti was focusing on to what you're focusing on now?

I think that's a great question because you're absolutely right. I think statistically cheap companies, and especially with kind of a bias—or maybe not bias, but just pension—where the opportunity is for cyclical companies—right, home building, energy—those have been successful themes for Robotian Company, and for me. I think part of it (05:46) was really having the freedom to look at what I wanted at such a formative, young age in my journey, and I was looking at all sorts of different companies, and for one reason or another—and you know, investing can be very personal as to what you're comfortable with, what excites you. And for me, over time, those sort of high-quality companies—you can call it growth at a reasonable price—

(06:12) but really just the kind that Buffett might teach, Buffett might talk about a lot of it in his letters. And the later letters, of course, the partnership letters were a different story. But that really, for one reason or another, just attracted me more. And again, look, there's so much money to be made in statistically cheap names and cyclical companies.

(06:31) Um, just at the end of the day, after spending a couple of years just kind of drinking from a fire hose at all ends of the spectrum, it was really more the quality, the growth, the long-term holdings that attracted me more. So, you're paying further up the multiple spectrum, of course, but free cash flows on average may be more durable, and you may be getting higher growth rates. Um, I did take a course.

(06:49) There was a very kind professor at Columbia's executive MBA program, and he was very kind to let me audit his course. Um, his name is Tom Triforos, and he's a very influential figure to me over the years, and his course was called A Study of the Elements of Great Businesses. And so, if I had to point to maybe one other item that influenced me, it was probably that course and what I learned from there and use as my foundation for how I view the investing world.

(07:18) And then, you know, ever since then—because if I had to look at today—I definitely have this quality growth element, but I also want my cake and eat it too, and I want to find companies on the very low end of the valuation spectrum. So it's not for naught what I learned at Roboti, and the margin of safety and downside protection that can come from buying very statistically cheap companies at low multiples. I think it very much lives with me today, and my kind of investing approach today is definitely a blend of that statistically (07:44) cheap approach and also the quality and growth elements of it. I want to ask you here a little bit about your benchmark because you seem to be a part of a trend that I've noticed in some outperformers—at least ones that I've actually interviewed—and that's investors who invest in businesses that aren't even inside of the S&P 500 while actually using the S&P 500 as their benchmark.

(08:05) Now, I might be biased here because I'm usually interviewing fund managers who've outperformed. And obviously, if you outperform, it's a lot easier to compete with the S&P 500. However, I still notice that there are fund managers maybe with less attractive returns who might even have holdings in the S&P 500, and they're using other indices such as, let's call it, the MSCI World Index.

(08:24) So, can you tell me a little bit more about why you settled on specifically using that index, even though it's unlikely that you'll ever hold a business inside of the index and that you focus on businesses that aren't even in the US?

Yeah, that's a great question, Kyle, and I think to confirm, I don't believe I've ever held a company inside the S&P 500.

(08:41) So, the factual statement on your part, though, it really is a great question because there's a lot of managers who use many different indices. If you look from day one of our partnership, from our founding letter, I gave a lot of thought as to, "Hey, we're choosing the S&P 500 as our index, and here's why."

(09:00) And at that time, we had no performance, and we had no idea if—look, obviously we strive to have great returns—if it would be above the S&P 500, below the S&P 500. But the reasons are twofold why I choose it. Number one is it really has been, for some time, and should be the hardest index to beat, right? From an institutional manager standpoint, and I think from retail investors as well, consistently around 90% of managers—of mutual fund managers, asset managers—fail to beat the S&P 500, right? And so if you have (09:32) 90% of managers can't beat something, and you can beat it, then you're probably demonstrating some skill, and that your vehicle and your way of investing should generate—volatility notwithstanding—greater returns over a long period of time. And number two is the way I view benchmarks.

(09:54) And the first is as opportunity cost, and the second is mirroring all of the factors of your investing approach. Now I think number one is a lot more relevant for us because we're not an institutional product, and I have no intention to be. My goal is to compound returns at the highest rate responsibly possible over a long period of time, and we're fortunate to have found many, many high-net-worth individuals in family offices who have aligned with that vision and who have partnered with us—right, over 50 people to date—and I would (10:22) argue of all those people, they're a lot more interested in compounding their wealth at a high rate of return over time than seeing, "Okay, how did your portfolio do against a mirror image factor complete version based on the global market?" Because if I were to do that, you would have to start globally; you would have to go micro-cap, small-cap; you'd have to exclude emerging markets; you'd have to exclude much of US exposure because we, on average, have little US exposure. And so I'm sure that maybe if (10:52) you really customize it, there is some benchmark out there, but then even if you find the perfect one, to me it's, "All right, well, you know, I don't know what exactly we're accomplishing because I'm not choosing those factors because I want those factor exposures." It's a bottom-up process to generate high returns.

(11:08) So, I think, just at the end of the day, it's a lot more valuable for these people to see, "Okay, if we want to invest in the stock market, right, or they can invest in their own business opportunities, but because we're in the stock market, if you want to invest your own money, what are the most likely opportunity costs there would be?" And for me, obviously, it's—think of the average mom-and-pop person—

(11:26) yeah, we'll invest in the S&P, or I think because of our small-cap exposure over time, I think the Russell 2000 is another very common index that people would look at right now. You can expand it from here and there, but I think just really honing in and narrowing it down—look, the S&P 500 is, I think, the most fair opportunity cost and the most fair benchmark.

(11:46) It has proven to be the toughest to beat over time. And so, I think going forward, my full intention is to continue using it forever as our partnership's benchmark. So, one part of your investing process that I've always admired is just how in-depth your research is. So, the first time that I got a chance to read your research was when I was having a DM conversation with Chris Mayer and was trying to mine some ideas from him, and he suggested reading your Dino Pulska report to learn more about that business. And I have to say, to this day, (12:13) it's probably the most insightful and informative research that I've ever read on a specific company. You know, some other company reports are just very superficial, surface-level, and just not informative. And oftentimes, they're just quant-based. They're just reiterating numbers.

(12:28) And it's just—it's interesting, I guess, if you're a quant, but if you're interested in actually understanding the fundamental reasons of why a specific business is really, really good, it just leaves me wanting more. And yours definitely did not leave me wanting more. It was one of the most complete ones I've ever read.

(12:43) So, I know that you have roots in analyzing specific businesses from your days at Tulane where you took a course called the Burken Road Reports class. Now, you researched the company Popeyes as an equity research analyst for that course.

That's right. So, can you please just maybe take us through your own research process when you do these site visits and discuss the advantages that it offers you?

Well, that's incredibly kind of you.

(13:06) The high praise for the report, and I didn't know that about Chris Mayer. Um, I haven't met him, but it's incredibly kind of him to refer to it. And yeah, the Dino Pulsko report—that research was a lot of fun; that trip was a lot of fun. I think generally, and I'm happy to use that trip specifically to give examples here. I think generally my approach is pretty straightforward in conductive field research, and if I had to outline it, I think there are just generally two buckets of data points I'm hoping to collect. You know, number one is (13:35) you always want to go in with a straightforward hypothesis or hypotheses, right? It doesn't have to be just one thing, but, hey, like here's what I'm hoping to accomplish with this. Here are the reasons I'm going because I need to confirm—is this part of the thesis true? Is this part of the thesis true? Is that part of the thesis true? Right? And it could be things that the company's told you, can be things that you've found through your own primary research, but things that are really only answerable or best (14:00) answered for yourself. And by the way, a lot of people like to talk about scuttlebutt and like to quote Buffett, but you'd be surprised at how very few people actually go and do the work for themselves and do the visits for themselves. So I think generally speaking, if you're ever hinging on the side of if you should do field research or not, do it, and you'll probably collect data points that most of your competitors aren't collecting.

(14:21) So, you know, I think that's number one, going in with the hypothesis. And number two is just being open-minded and observing the data points that you didn't know you were going to collect. And eventually, in just about every case, some of these data points end up becoming essential to your thesis, whether that's confirming your thesis or disconfirming your thesis.

(14:42) So those are the two buckets that I generally look for when I'm approaching field research. So one thing about scuttlebutt—I've done a lot of research on it, and I try to do as much as I can, although I obviously don't have full time to put into it. But one thing I've definitely noticed about it myself is I've had all these opportunities, especially with small-cap managers.

(15:01) You probably know the same thing, where I can actually get access to the CEO of the business. And so one thing that I found is that it can sometimes feel like I might be getting biased because a lot of times you're friendly with these people and you have positive feelings towards them. You know, obviously you're not—you probably don't dislike them because they're taking time out of their day to meet you.

(15:21) So just speaking towards biases, how are you actively trying to fight your own biases when you're meeting these people and just trying to focus on finding the facts of the hypotheses that you have rather than allowing them to be good salesmen and selling you on how good their company is?

Yeah, look, I think that's a terrific question.

(15:41) The truth is it's very hard to remove bias completely—maybe impossible to remove. If there's one thing I've learned from reading all these books on psychology, how people work, how people operate, and then kind of getting experience in various ways, I'm convinced we're all hardwired to be vulnerable to many different heuristics. And the best you can do is really just try to minimize it, right? So, I think you're right.

(16:02) Look, I think it's an advantage usually when you—especially international small-cap companies—are one of the first North American or US investors to visit them, and they typically roll out the red carpet, as far as—sometimes it's hard to get 30 minutes on the phone with them. They will meet you at headquarters.

(16:18) They will talk to you for four hours, and that can be incredible because you have a list of like 80 questions you want to get to, in an order of priority, and you can get to just about all of them, and then you learn other things. And so it's really good. And again, it's like, how many other people have visited? Well, if they're telling you you're the first, then you're the first, right? And this is nobody else.

(16:34) No, but look, in general, I think it is something that—and this is a hazy area—it's not something really quantitative, it's more qualitative, but just kind of judgment of another person, judgment of their character, judgment of can you trust what they're telling you, analysis along these lines.

(16:50) So yeah, look, generally I think—and I can think back to many instances where, yeah, like I do feel this person's salesmanship is showing, and they're being a little—and you have to balance that with, "Okay, the credibility of their statements and other things they're telling you." I don't have like a blueprint answer here, but I think what you're saying is very true; it's real. It is a risk.

(17:10) I think it is something you can minimize a lot, and I think it's something you just—you kind of evaluate that on balance with everything else that you're learning from that CEO. Now, I want to discuss a few of your major edges, and I want to start with the fact that you invest primarily in small caps.

(17:28) So, the

The average market cap of your portfolio over the last few years has been in the $250 million range. Now, this is kind of interesting because I think you can still find stocks that institutions, um, don't heavily own at this market cap, which I know you've pointed out can be a pretty big advantage because you get this, uh, discovery process.

Mhm. (17:45) So, can you kind of outline some of the other key benefits on top of the one that I just mentioned there of owning small caps and why you've chosen to focus on that market cap segment?

Yeah, I think there's a lot of benefits there, and I do think it really is a chance to describe our edge, our competitive edge, uh, here. You know, when you look at small caps in general, it's really well documented that small caps compared to, you know, larger caps, you know, big caps, large caps, mega caps, of course, they just have a lot less analyst coverage and (18:11) institutional coverage. Now that's well documented. Everybody knows this.

So, parlaying onto that is if you look at the United States compared to other, you know, developed countries around the world, emerging markets too, of course, um, but you know, we stick to developed markets. I've just found that the United States is very competitive right relative to other markets. (18:28) For every, let's say, 10 sets of eyeballs looking at a company even in the small or, you know, micro-cap realm, um, there's maybe, you know, there's far fewer people, you know, whether there's three sets of eyeballs, five sets of eyeballs, two sets of eyeballs in another country looking at a similar stock. And so I think when you parlay that, you know, small-cap company has less coverage, and then you kind of move into like international countries, then you just really tend to get this niche areas is where there's just very, very little coverage and which kind of (19:00) is, you know, the bottom line, you know, with these, um, small-cap companies right, and you can even call micro-cap companies, of course. And so, you know, when I think about our edge from a small-cap standpoint, um, you know, when we're looking for things, you know, along the three pillars of quality, growth, and value, if you're looking at things, you know, small cap and developed global, you can really find companies that meet all three of these criteria. It's not easy; it's still, you know, as somebody who does like to sleuth around, it's still very (19:27) hard, and uh, you might only find one or two of these opportunities a year that like really truly check the boxes. But, you know, if you find those one or two opportunities a year, that's really all you need, you know, because you can do very well on those opportunities.

So another one of your major edges, like you just mentioned, that you invest outside of the US, and I know that maybe over the past few years this might have acted as a little bit of a hindrance as more and more capital has been going into US markets on the back of (19:53) Magnificent 7 and AI, and that's been, you know, propping up those markets while maybe causing multiple compression as, you know, maybe there's some, uh, funds that were in your stocks or in indexes that held your stocks that would shift to other areas of the market. But as you pointed out, there is the disconnect between US and international markets, and it, it'll likely close at some point. (20:12) Who knows when. Now, from your experience, I'd love to know a little bit more about how long it takes for global businesses to close this price and value gap compared to maybe a US comparison.

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Yeah, closing the price to value gap. So I don't typically think of it that way, and I think that isn't so I think there's two parts of the question here. Um, one is generally referencing the shift in capital that's occurring, and number two is, you know, how those I guess the market valuation behaves in the US relative to other countries. So to kind of tackle the second one first, the it's not something I really think about where in the terms of okay, is there going to be market discovery, and if it does, how soon will it happen? Because look, when I make investments, (22:52) right? And the reason why I really prefer lower multiples to start on top of durability, on top of significant growth opportunity is because I'm looking for downside protection here, right? And I'm looking for if something goes wrong obviously, right? You know, how far can this price really collapse relative to expectations, right? And now obviously you don't want something where profits go to zero where there's just, you know, or something horrible because then yeah, it doesn't matter what multiple you buy it at; there's unlimited (23:16) you know, downside here. Um, when I'm looking at these companies, I don't assume any multiple expansion for the thesis to work out and for us to earn satisfactory returns. Right? If you're buying a company that you think should compound its free cash flow per share at 15 to 20% for the next three to five years and you're buying it off a really low free cash flow multiple or earnings per share multiple assuming that they're roughly similar, let's say, of, you know, eight times or nine times, right, you're probably not going to lose money in that (23:45) scenario, and if you just forecast and set your expected returns based on that free cash flow per share growth, then yes, you should earn 15 to 20% per year, and that's to me that's a very satisfactory return. Now, when you layer on the probability of multiple expansion or multiple contraction, um, then yes, odds are in these scenarios, you also will experience multiple expansion off of a low base because the company's delivering in a powerful way. (24:12) Their market will be getting bigger. And if you're really like one of the first people to discover these stocks, then you know, odds are eventually more people should discover it along the way as well. So in my experience, when you have a setup like that, it's almost usually leads to multiple expansion and, you know, sooner than later given discoverability because look, it's, you know, stocks these days relative to 20, 30 years ago, value gets realized a lot quicker, right? So when you find something, the bad news is you don't have much time (24:39) to get up to speed on an exciting opportunity, but the good news is if you do hold something and you think good things will happen fundamentally, it should get recognized sooner by the market, right? So the US, you know, but it's funny; it really depends on the country. There are countries that behave very similarly to the US, right? Australia, Canada, Sweden. Yeah. (24:59) Like a lot of these companies, if really good news happens, yeah, they will, you know, they will see, uh, stock price appreciation, and then there's some other countries that can be a bit slower to do so. And then there's a whole host of quirks in every country to be aware of. And that's why I think it's good before entering a market, you know, um, it's great to do a lot of homework to really get your arms around, um, the idiosyncrasies of each market. (25:23) And also another thing I found very helpful is developing a local network of managers in every market too. And that really helps. I can't tell you how many times I've had questions that I don't know where I'd be or where I would have received answers without them. And yeah, that's been very helpful. So yeah, I think your first question was interesting too, referencing the capital flight. (25:44) We could probably talk for hours about this, but this is not a macroeconomic conversation, and you know, I'm not making any macroeconomic predictions, but I think it is interesting to note that I guess since the inception of, of my partnership and for well before that, since about 2009, we've experienced this period of what they would call US exceptionalism in the media, right? where in a nutshell, you know, US assets, equities in particular, have just really outperformed the rest of the world. (26:10) The US dollar has gotten stronger as well, which adds a reflexive loop to everything because if you're a non-US investor, investing in the US and the US dollar appreciates, then your investment appreciates as well. And if you're in Europe and it helps against your Europe benchmarks, now we're seeing for the first time in 15 years or so, things are going in reverse where foreign equities are outperforming in general. (26:33) And who knows how long that'll last. But you know, the US dollar, I think that's very interesting because that is depreciating against other currencies. And you know, it has seen moves like this before. But given the way history moves in cycles, there is some chance that this kind of headwind of the US dollar moving against you and US markets just substantially outperforming foreign markets. (26:56) That could all kind of go in reverse for all we know. And if it does, you know, for someone like us who predominantly invest outside the US, obviously, look, I think we've done okay. We've done well despite any of this, and it's not something I take into account. But worth noting that it could be a tailwind for managers who do look at global stocks, um, for the foreseeable future.

(27:16) Obviously, we've been talking a lot about investing internationally, and so there's one more thing I really want to get your opinion on here. So you know, obviously when you are investing internationally, in my opinion, there's the question of circle of competence, you know, how well do you actually understand these other markets when obviously, like you said, you have this local investor network that you can rely on, but you'll probably can, you, I'm sure you would also admit that you'll never get to the same level of understanding that they will of (27:40) their local market. So I know that you mentioned in another interview that you can do this invest, invest globally because you specifically have a framework to allow you to do so successfully. Now, I assume, you know, this means, uh, the framework for finding good businesses doesn't really change whether that you're looking in the US, Canada, Australia, the UK, or Poland, which I know are markets that you like. (28:01) But the part that I've always kind of found a little trickier to navigate is accounting for unknowns in foreign countries. You know, there's things like regulation, culture, sentiment, political motivations, and they're all a little tougher to understand in foreign countries where you're not boots on the ground every day. (28:17) So, I'd just love to know, you know, how have you managed to fit those types of variables into your investing framework?

I think what I mentioned before about having those local management relationships as you referenced, I think that that has helped a lot. And I really do think when you dive into a country, it's important to really, you know, first of all, view it as a totally, you know, unique country. (28:36) Yes, it can be a developed country and and similar in many ways, but at the same time, you know, culturally, the way even the capital markets think and behave. Everything can be very different and very idiosyncratic. And I, there are probably many examples I can give. And I think really just spending time to like get your arms around, understand what's happening, um, how it works, even if it takes months of just deep understanding. (28:59) And I think screening the stocks in that country helps too, just in a lot of, you know, subtle ways, just screening through hundreds and hundreds of stocks. You kind of you notice things, um, you know, what are the table stakes for valuation over there. You know, what are some of, you know, common, common ways the annual reports read and, you know, the the accounting, you know, little things that they do slightly different than than most other countries. (29:22) I think once you get comfortable with a country, you know, for me, culturally, you, you are probably never, you know, unless maybe you've lived there or you have ancestry there, you might never quite fully embrace how people behave with products or services. So, for that reason, right, I do avoid things on the consumer discretionary side. (29:40) I do try to avoid things where there could be a big cultural blind spot where, hey, this seems so obvious to me, but who knows what could happen, for that reason. By the way, I think exactly for this reason is why I avoid emerging markets just because the the tail risk, you know, which maybe is not so tail risk necessarily of just things that can happen, um, you know, yes, with culture, but also with, uh, with geopolitics, with, um, you know, with inflation and and central bank behavior, even things you would never imagine in the United States (30:09) like confiscation of assets, right? I've had one situation in the past, um, where, you know, you start questioning, okay, the stock looks extremely cheap on a multiple basis, but and everything's going fine and then the profits are stable, but then like, you know, you kind of realize, wait, the money that they have in one of their countries might be trapped, and then you start to ask, is the money really there? And then you think, well, wait a minute, this is not really investable all of a sudden, is it? So those are questions you never want to (30:34) worry about, and in developed markets that essentially kind of gets rid of, you know, all those big headaches. Now look, and that's not to knock; there's plenty of smart people in emerging markets, right? I'm sure, just not, not a game I think Warren Buffett even had a line in the latest annual meeting of just, you know, not a game I think I do very well in, right? I think is maybe how I would phrase it. (30:54) I do tend to lean towards more kind of consumer staple-like durable businesses over there, things that are more simple, less complex, more simple, you know, things that have also businesses that have existed for 20, 30 years where, you know, okay, you don't really have to guess so much as to, you know, there's a new manager or a new business segment or a new business line. (31:13) It's something that the same people have been doing for, let's say, 10 years, 20 years, 30 years. It makes all the sense in the world. It's a consumer staple product or something that's, you know, like a necessary in in that industry for one reason or another. You know, for me, I think that layering those on has helped me minimize, you know, those risks in these countries.

(31:32) One thing I was ecstatic about when researching was you was, um, that you're also a fan of Buffett's owner's earnings, which is a metric that, uh, you know, I really, really like, but I don't really see very often spoken about in shareholder letters. And so, you know, just to, uh, give an understanding of what that metric is for those unfamiliar, it's a metric that Buffett used to think about a company's cash flow. (31:53) And basically the main difference is that, uh, he differentiates between growth capex and maintenance capex. So I know that you use this metric to help you determine a company's value. And you can often find some pretty wide discrepancies when comparing owner's earnings and say just free cash flow. Obviously, free cash flow is great, but it can hide a company's true cash generation as it nets out growth investments. (32:15) Now, while there's companies that have high free cash flow and that can be excellent, a company with low free cash flow but ample reinvestment opportunity, I think is probably one of the optimal ingredients to make a compounding business. So, can you comment on the importance of this metric and how you utilize it to maybe help you understand a business's underlying cash generation as well as valuation?

Yeah, owner's earnings is very important, and when I view a company and I look at their financials for the first time, owner's earnings is always just like the (32:43) first calculation that I try to make just on a very crude basis, and you know, you do need to do a bit more digging sometimes to get there. Uh, but yeah, you know, owner's earnings, the other way that I view it is steady-state free cash flow. I think that's a very important metric, and exactly what you said, sometimes there can be a wide discrepancy, right, between, you know, what the reported free cash flow is, the reported earnings is, and owner's earnings. Often times, I think net income, free cash flow, and own, they can be a (33:11) good practice for one another. Though, yeah, look, you know, there's, you know, first of all, obviously, capex is something that a lot of people, you know, will look at and rightly so, um, you know, looking at what, you know, the discrepancy is between depreciation and and capital expenditures and the capex, how much that is gross capex, how much of that is maintenance capex. (33:28) You know, purchases of intangibles you include obviously. Um, you look at leases and, you know, with the new lease accounting, it's not always clear what depreciation is, and so there's different schools of thought, but from my school of thought, I think you do need to parse that out because, you know, depreciation from from operating lease expense, I think that's a real expense, like you're paying rent, you know, you're paying whatever every month, every year, and so, you know, but a lot of people might add that back, but then the real kind of discrepancies could lie in the (33:55) income statement too, and you know, you have companies maybe they are more heavy in R&D. And you have to make your own assessments and judgments there of okay, what, how much of this is, you know, growth of future, how much of this is, you know, just kind of on a maintenance basis. Customer acquisition cost in the form of, you know, sales and marketing can be big as well there, um, if you really do the right math, um, and look in the cohorts and really drill down. I mean, but it's funny because I get questions sometimes, right, for, you know, I own a couple of (34:21) distribution-based businesses. Auto partner, we can use specifically is one that we probably both know, and one common question I get is, hey, John, this is great, but if you look at their free cash flow or their cash flow statement, they have no free cash flow because it's all going into buying inventory. So, therefore, I can't buy this stock. (34:39) Like they have no cash flow, and like Buffett would say this is 100 times free cash flow to get, like, okay, well, to which I would say, well, look, let's say this company tomorrow decided we're never going to grow again. What would their steady state, right, free cash where they have to maintain their competitive position, right? So they have to spend something to, you know, to keep the facilities in check, you know, keep the cars on the road, things like that, and how much to just not grow, not shrink the business, but just maintain their current (35:04) profit levels, what you would see is they don't need to buy tons of added inventory every year, right? So the change in network capital would be essentially zero from an inventory perspective, right, unless maybe the inventory gets slightly pricier every year, but then that gets offset by other. So yeah, so then in that case, like your owner's earnings or your steady-state free cash flow, you'll be a lot closer to net income, um, right, probably very similar to net income compared to what the cash flow statement says.

I'm not saying there's a (35:30) right or wrong answer; everybody has a different way of thinking about it. For me, this makes all the sense in the world; this is the way I think about it, um, and I think it's generally a good tool to use in your arsenal. So you mentioned, uh, previously today that you like back-of-the-envelope type math and valuations. So therefore, you tried to, you know, maybe try to avoid overly complicated things where, in order to come to an evaluation, you have to use a spreadsheet, that's, you multiple times sheets.

So, for instance, let's say u (35:59) you're looking at a company, and let's say it's trading at four times next year's owner's earnings or free cash flow or earnings per share or whatever. So, using your framework there, you know, you don't really need to twist the numbers much because if that number is five times or six times, you still probably have a very good investment, especially if it's growing its intrinsic value at, you know, 15 to 20% per year. (36:18) So, tell me a little bit more about some of the key ingredients of like a no-brainer investment like this one that I mentioned would be look like to you.

Yeah, you know, and there's a lot of different ways. There's a lot of different types of no-brainer investments. You know, there can be special situations of all sorts, right? You can, um, you know, and something that we've definitely participated in in the past like American Coastal, the, you know, from kind of the the common I guess no-brainer that I look for is something (36:44) that meets all three criteria of high-quality business—right now we can talk about, you know, what quality means—but high-quality business and high-quality management team, right, substantial growth opportunity ahead for for many years or, in industry jargon, you know, a larger addressable market for that to penetrate, and the third would be valuation. (37:04) And that's where, you know, just, you know, whether you're looking at free cash flow yield, whether you're looking at on a multiple basis, um, just as you said, it's just so obvious, you know, you don't need to build a giant spreadsheet. And I agree with that. So that's typically what I would call a no-brainer investment from my end. And kind of, you know, the final element there is, you know, my preference is in in looking at these international markets and looking at the small micro-cap end is, you know, meeting those criteria and not needing a variant view per se, but (37:34) just approaching a situation where there is no prevailing view. So you don't need a variant view; you just need a view that is not really existent in the market.

And so, you know, to me, it just worries some risk that look, there are so many smart people out there. There are tons of smart people out there. (37:52) And I'm going to do my work, and I'm going to come to the conclusion of I think whether I'm right, you know, or very convinced that I'm right. But, you know, there's always that risk that hey, maybe the other smart people out there, they have a view, and it seems to be the prevailing view, and maybe maybe they're right, and there's some risk that I'm wrong here. (38:05) Hopefully, my downside isn't that big, and I'm do what I can to protect it by buying cheap. If you have a situation where there is no prevailing view and you're totally convinced you're right, to me it's just it's a lot easier to get comfortable that you should do okay in this investment and like there's no looming, you know, consensus downside risk from these from this share price level.

(38:28) So, when I was reviewing your shareholder letters, I found your biggest investing mistake pretty amusing and not just because of any shade in Freud or anything like that, but specifically because I think that's probably the most significant problem that nearly every investor faces, and that's a problem of selling winners too early, unfortunately. (38:46) Now, I know you've trimmed, uh, several of your multibaggers maybe a little bit earlier than you'd like given how far they've climbed after the fact, but you also mentioned that some maybe quicker multibaggers can expose you to increased risk. Can you maybe describe how you balance the need to stay invested in winners while reducing risk as they appreciate in price?

Yeah, that's an interesting subject. (39:08) It's one maybe one of the most difficult things that I've grappled with, you know, over the last several years and almost four years since starting the fund, and you know, evolving, you know, my thought process towards is, you know, you find these great companies, right, and it's easy, you know, with from a position sizing standpoint and just from a conviction standpoint at the no-brainer stage, and then as they appreciate in price, durability and quality if you're right about that, you know, shouldn't change much; the valuation side it should change somewhat or it could change (39:37) dramatically. Right now, there's an extreme example where if you see, let's say, a 2020 2021 bubble, we saw how silly some of these valuations can get. And then, yes, it could be just maybe that'll be an easier decision. Hey, my thing went from 10 times to 100 times earnings. We should sell. There's a 1% yield a year. (39:58) You're I don't care what you probably should sell that stock unless it's growing at like 50% a year into perpetuity. Now, not to that extreme, but yes, you mentioned Mater Group, for instance, and you know, everybody likes to say, "Oh, well, you can't kick yourself over mistakes of omission and and so on and so forth." But I do think it was our biggest mistake just even quantitatively because if you take, you know, how much appreciated after and how much we trimmed and um it it probably is like a greater missed gain than the biggest single loss we've had in in the funds (40:27) inception, right? So, it probably was my biggest mistake.

Now, it's just hard because, you know, with these companies, if you take a long enough time horizon and they're earning really high returns on invested capital and they're growing at high rates, then the starting valuation shouldn't matter too much. (40:43) And I think the right answer long term is to on the side of holding these stocks, holding shares in these companies because yes, over a one to three-year horizon you may be wrong or foolish for holding on to them if they then you know the multiple contracts a lot and something happened short-term, but over the very long term if you think you're right, you know, you should still earn a very good return. (41:02) And what I've learned is and I think from this experience is that in the short term my thinking was well we were coming out of kind of the 2022 lows; this was my maybe one of my best performers, and the valuation was maybe, you know, one of the highest of my portfolio companies. I thought, well, there's all these other great opportunities at really low multiples that I want to take advantage of. (41:20) So I guess in the sense that like recycling that capital into other opportunities was okay, but I think almost, you know, most of them did not perform as well as Mater. So, you know, it long story short, the multiple expanded from say 18 20 times earnings to 37 times, 38 times earnings at one point, and I miss all that as far as the trimming that I did, you know, in a short period of time.

(41:44) So look, I think it's a tough question, but the more I speak to the older, the really successful investors who have lived for decades with this type of investing approach, they all say, "The biggest mistakes I've made in my investing career have been selling too early." There's always a good excuse for that. The stock had a good run. (42:03) It looks expensive. Other things look cheap, you know, some other reason, yada, but then you sell it, and then it's just so hard. Even for these great people, they found it's just so hard psychologically to buy at a higher price than you sold it, and you end up waiting for that price or and then it just never gets there again, and you lick your wounds for the next 30 years.

(42:26) So obviously a lot of what we've been speaking about today is quality, and I also, similar to you, love quality businesses. Also to your point here about buying when things go up in price, I had a question specifically about that. So, when I first started investing, I had this bias, which was once I bought a stock, I would only ever repurchase it again once it was below my initial buy-in price. (42:45) But, you know, as I've gained more and more experience and had actual stocks go up in price, I've really observed that a lot of my winners would grow so much that, you know, in order for me to even reenter it or buy more of it, I'd have to have like a cataclysmic event that would allow me to purchase below my initial buy-in, which, you know, obviously as investors, we all want to avoid cataclysmic events. (43:05) I'd love to know just a little bit more about position sizing after you first buy in. You know, are you purchasing most of your shares right away at initiation? Are you trenching in over time? And also, how do you think about averaging up or down once you've established a position?

When I look back at our best, you know, performing positions, I think in almost all of them, I have averaged up over time. (43:25) And in each case, it wasn't because I wasn't actually actively thinking I should average up. I think it's more, you know, trying to stay disciplined and thinking, okay, at any given time, you know, the way I monitor these these portfolio companies is, okay, you know what is quality still in check, right, and by the way, out of all my criteria, quality always has to be there, at least, you know, perceived quality; if it's not, then it's an exit candidate, right, um, so you know, for me quality is paramount, um, so you kind of confirm, okay, quality is there (43:52) you know the growth opportunity where is that at right now, right, when I underwrote this three years ago, here was the forward-looking growth opportunity; have they kind of plucked the hanging had the law of large numbers crept in as their addressable market runway may be smaller and their growth rates are lower as a result or maybe greater, you know, things change for the better sometimes, and then you look at, you know, valuation. So I think in all those opportunities, right, you find something that's extraordinarily cheap for one reason or (44:15) another, you know, it runs up, but then you you kind of get more conviction, you're more comfortable, you keep doing more work, and you kind of realize I don't own enough shares of this company; I'd like to, you know, I think it deserves a bigger portion of my portfolio even if it's run up 20%, 30%. (44:32) If you really think that this, you know, has triple-digit return potential in in some short period of time, yeah, you probably should buy. So, in I think in most cases like I have, but again, not cuz I'm thinking about I should average up or average down, but it's been more just from a disciplined mindset that I try to keep, right? Looking at everything, all my portfolio companies together and okay, like what deserves my capital, what deserves, what doesn't deserve my capital maybe right now, you know, reevaluating and assessing things. And I think, you know, (44:57) just as a side note, that's been a discipline that I've really tried to adhere to over time, right? Just, you know, always, you know, frequently reassessing things. Um, I tend to be more of like a a cynical or or maybe not cynical, but just, you know, a suspicious mind when it comes to companies, and as a result, I just kind of be very careful. (45:15) So, if and when like something does happen, even if it's a minor event, like my mind immediately just goes to like we need to be over careful here. We need to reevaluate or just just check in on everything that you can. Um, so this kind of mindset, you know, probably leads me to, yeah, like I prefer the the cheaper, safer multiples. (45:30) I prefer the durable businesses, but when it when it does cross that threshold, when it does meet that threshold, um, you know, I tend to sleep pretty well at night, you know, with these companies.

So, since your fund's inception in 2021, you have quickly grown your partners to over 50. And, uh, you've noted that a lot of the capital at inception was your own, and obviously it's changed a lot since then, I assume. (45:52) But since your strategy is based on small-cap businesses, I'd love to know more about um what your plans are for once you continue growing your fund. Obviously, you're you're outperforming the market, meaning that uh your assets under management are going to grow. And uh I just love to know, you know, what are your plans once maybe your assets under management grow so high that you maybe can't execute on the same strategy that you're using now?

I think it's an excellent question and something I've given a lot of thought to. I think it's (46:17) an excellent question because of kind of the behavior that you see in the industry and and that tends to play out and what I think the right answer should be at least for, you know, from the perspective of compounding at at a high rate and doing what you say you're going to do. So for our partnership and our strategy here, right, the best way to approach this calculation is you look at your investment style in the past; you look at the companies you've invested in; what have been the average daily volumes, you know, a time of investment; what are (46:44) your kind of portfolio sizings that you're comfortable with to achieve these returns and invest in these companies, and you when you when I when I've applied that not with the volumes today like when we got in when there was like low lower liquidity when like nobody knew about this; you apply that; you apply, you know, your comfortable position weights such that you're not compromising your returns, right, and you extrapolate that to okay what's the maximum capital base at which we could operate this partnership, right, based on (47:09) my analysis that I think that kind of level that range where we just really cap out at strategy is $1500 to $200 million in AUM. Right now, that obviously that seems a lot lower than, you know, what most people would say or or think or, but for me, it's really yes, like that is the limit, and I have no intention of sacrificing icing our returns in order to raise more capital, right? Because the way you would do that is, well, okay, maybe we can manage 400 million, 600 million, $1 billion one day, but the sacrifice and the (47:43) compromise that you have to make is, you know, all else equal. Let's say you find there's one or two no-brainer situations every year. You can no longer make it say like a 10 to 15% position. You can only make it a 5 to 10 or 3 to 5% position. And then all of a sudden, look, if you're finding one or two of these a year and they're driving a substantial part of your returns, then you will be handicapping your returns.

(48:03) Now, you know, people think, "Oh, well, I'm a smart person. I'll find three to four of them or five or six of them every year." It's probably not going to work that way, right? Don't overestimate yourself. It's probably not going to work that way. I think it's interesting because when you look at the industry, I've seen this play out a lot in my short career, right? But you look at you see other funds, and you see, you know, the these funds get the very big AUM very fast, and you know the way that the allocator world works is once you get (48:27) one allocator, you get two allocators, then it's, you know, you get the soap proof from it; you get the big names in the door, and and then becomes a bit of a beauty contest, and everybody kind of, you know, rushes in, and but the point being the managers it becomes a lot easier to scale if they want to attract that capital, right? So if you have a great track record, you're marketing well, you hit this breaking point in escape velocity, and you were 200 million, $300 million, and you know you're whatever the narrative might be, then you could if you (48:54) wanted to and with all the right tools and think you should be so lucky scale to a billion dollars, and now you know I've seen a lot of managers who they did well in the micro small maybe small midcap space think, you know, and I don't know what they think, but I can only imagine, oh, you know, it's somewhere in the back of their mind or yeah, I I can I can do well in midcaps, you know, because that'll be, you know, more midcaps is going to be my yeah, I can I can do midcaps or I'll find, you know, two or three times the small-cap opportunity and just (49:19) like a significant departure from where they've built the returns in the past, and like four out of five times it doesn't really pan out well, either, you know, there's kind of two scenarios I've witnessed; either it's kind of a a slow bleed of, you know, mediocre returns or worse over some period of time, and then eventually, you know, they hold on to the capital as long as they can or it's kind of a quick collapse if, you know, they get a bit overconfident in concentrated positions in some questionable companies and and they don't do well, but you know (49:45) I just think the incentives are bad because the manager And again, you know, not to manage anybody specifically, but just general Wall Street behavior, the managers, if they get to keep their management fees, their performance fees, like while they have that asset base and they can make their however much amount of money, right? Put some big number on it to them, they can say, I won, right? This is to many many people, and look, there's nothing wrong with this. (50:08) You know, this is an industry that attracts a lot of money. But if you say but if your fund collapses or just, you know, you have a mediocre track record and you've made all this money for a lot of people, I think that's winning for them, right? Now, for me, that's, you know, complete opposite, right? That's the what gets me out of bed in the morning, right? For me, I yes, the money will come obviously, but the track record, the putting up the best numbers at the end of the day, making your mark on the industry, getting out of bed to find, you know, the next great (50:34) company XYZ that really just gives you this thrill, this rush, that is what gets me out of bed in the morning. Right. And so, for that reason, I definitely I fully intend to abide by that cap. And I also want to, you know, go back to the plans for the fund and the partnership. You know, I really don't plan to raise capital above, call it $40 million, maybe a bit less, but roughly around that area. (50:56) And I know a lot of people might say that's crazy, but I want to, you know, for two reasons. Number one, if the capacity is, let's say, $150 to $200 million, I don't think it's good business or just a good idea to raise up to say $100 million. You have a couple of good years, let's say, and then all of a sudden you have to tell your partners who just joined, hey, you might have to return your capital to you. (51:14) Probably not going to go over well. Just not good business in general. Not good practice to treat people. And number two, like I really I want these people, look, if you join, you know, well, we're up to, you know, before $40 million and and you get in, I can look them in the eye and say, "Look, I don't know how long it's going to take, and I can't make any promises, but if we compounded the rates that I'm happy with, we can triple, quadruple, quintuple your money before we even have to have the conversation of, you know, who gets (51:39) their capital back or it's a pro rata distribution." So that from a business standpoint, that is the plan for the fund. I'm in no rush to get there. The way I view it is I'm compounding capital the way that I'm comfortable with that I think is going to make us money, and anyone who wants to join along for the ride for the long term, please join.

(51:55) Yeah, wonderful answer. Thank you for that. So, you've invested in several companies that I think are pretty low-tech and boring but have excellent unit economics. And you know, boring to me, well, I think a lot of investors see that as a negative; I don't, you know, boring is beautiful to me, especially in investing. (52:14) So, I think that it it seems to me at least that you're intentionally looking for these kind of non-glamorous

Businesses and industries may be a fertile hunting ground for future opportunities. So, I'd love to just know what are some of the patterns that you've observed in some of the companies or industries that you've invested in, um, that you think the market consistently is underappreciating?

Yeah, it's it's funny, the I guess the boring or non-glamorous companies here (52:38). I think it's never been by design; it's been, you know, there are more maybe tech companies or companies in tech-adjacent industries and, you know, a bit more flashy. And I think the reason is just that, from when you're screening and look at their companies from a bottom-up standpoint, they just tend to be at higher multiples, right? And, you know, from—I mean, I look at it from, you know, more free cash flow, owner's earnings, steady-state free cash flow (52:59)—and these companies trade on multiples of EBITDA, multiples of sales that I'm just simply never going to get comfortable with. If a company is not profitable, it's almost an absolute dealbreaker for me. I don't think I have any companies in the portfolio today that are unprofitable. And so, you know, profitability is essential (53:14).

And a lot of these companies, they are unprofitable. Or, you know, they're long-duration stocks, I would call it, where you have some people who, you know, have a 10-year forward view. Hey, this company is very cheap on a 10-year forward basis, and if we're right, this will be like a 100-bagger, or that's it—it's okay, just not for me (53:31). And so I think it just tends to be like the more boring, non-glamorous businesses that have these lower multiples to begin with. And then also, if they're in a more boring, like non-glamorous industry, it probably also filters for like less interest, less people looking at it, longer track records, and also like less likelihood of disruption (53:49). If, let's say it's an essential service, right? It's not too fast-moving. And so you look—they haven't been disrupted for the last 30 years. It's not that they can't be in the future. It's just that maybe they're just in an industry where it's just—it's really hard for tech, even like AI, to really change this radically in like a short period of time. And often times, like for instance, the chain—you can see the beautiful thing is, I think, is and from a risk perspective, you can see the changes coming and you know what they're going to be, and you just know this is going (54:15) to be okay, a really long time from now. We can take Auto Partner as an example—it's a company we both know and that I've studied. Electric vehicle adoption is a risk to the business, and it's one that—okay, you're selling auto parts right now, right? And you know that internal combustion engine cars, over time, they will spend more dollars for replacement parts than, you know, electric vehicles (54:39).

So I think then the math becomes pretty straightforward. Okay, well, there's two things that really matter. Number one, how many years until we see, you know, 100% adoption of electric vehicles or close to it, and then number two, what is going to be the reduction in spend over that time period, you know, for that. So you think, okay, if this is the biggest risk for the industry, then that's great because you can calculate, okay, let's say it takes, you know, 25 to 30 years, right, for full—and look, Poland, they import their cars that are like 13 years old from (55:06) Western Europe, so there's like a 13-year delay behind what the first world's doing, so it's a—I'm—I'm—these things, they're actually moving in reverse this year because electricity is important, people want their gas cars. It's an adoption I think is just going to happen slower than people think, but let's say 25 to 30 years, right, and you can do the math yourself, and let's say, you know, and I've done the work as well (55:24). Let's say we think there's going to be a 30% reduction in overall spend, right? There's fewer parts, but those parts you have to replace are a lot more expensive, and they're just going to get more expensive over time. But let's say there's a 30% reduction in like lifetime spend for car and auto parts. So 30% over 30 years, it's—you get to around a 1% reduction in spend (55:41). So it's like, okay, if I thought Auto Partner was going to keep its profits at 13% for the next, let's say like 12% for the next 30 years. Okay, well, let's subtract 1% from that, and now we're at 11%. Is that going to break your thesis? It shouldn't, but—and it doesn't, right? So that's, you know, I think that is actually a big positive of these, you know, non-glamorous, boring industries (56:03).

So we haven't had much of an opportunity today to discuss what you look for specifically in management teams that you're considering investing into, but I know you've made some excellent points that the CEO of a business, you know, has to make decisions on a daily basis that help guide the company into a better or worse state (56:19), and as well as that is shaping the culture of the business. But I'd love to know a little bit more about what other management aspects that you're actively looking for to determine if the management team is above average.

Yeah, management, you know, evaluation—that's an important part of the process for me, and and it's something that I I enjoy (56:37). I think, you know, there are—I suppose you can call it—more quantitative aspects about a management team that you can screen for, right, from a screening standpoint that help me get comfortable. For instance, for me, sort of, you know, table stakes for me for companies are often not only has the company uh have had an impressive track record of stable and growing profits over, you know, a long period of time, say at least 10 years, 30 years, 40 years, and have the people responsible for that growth, you know, are they still with the company? And sometimes it (57:07) might be somebody older, like as a chairman. But then at any case, okay, well, the people they picked to replace them, and then the culture in the company, probably is not radically different than when they were there. So for me, like number one, you know, look, if I had a company where there's like very little track record, there's a new CEO, who then—it's just so tough for me to even get excited and comfortable with that (57:25). Not that it's not a right or wrong answer, just my comfort level. So number one, they're—number two, yeah, you know, founders are obviously great, and people love founders for obvious reasons. They tend to be more ambitious. The company's personal to them; they want to see a success (57:39). They tend to live, eat, sleep the company. You could also have, you know, either like a new CEO who was maybe promoted internally or that the founders steps aside to be chairman, but they handpicked somebody, and, you know, you can kind of—okay, does this make a lot of sense? Mater Group, for instance, that worked out beautifully (57:53). They had a CEO who—he was an outsider, I think in 2021, give or take, Justin, and he's proved to be more than capable, and the company has multiplied its profits in a short period of time under him. And one of the reasons, I think—you know, there were many reasons—but you know, one I remember was just they're looking to expand to North America; he had, you know, from his career, a very deep rolodex of relationships in those areas, and that's a unique thing to the company, and you think for yourself, does that kind of make sense? So generally speaking, look (58:19), when I look for a management team, you know, I like to see longevity, right, in that standpoint, you know, are the people I'm investing with—do they have a track record of success here, right, or is this a new team? So longevity—I do want to see ambition, right? Founders—this tends to be mostly the case, but you know, with with other folks, when you sit down and you spend an hour with somebody, at least in my experience, I think it's pretty—it's like a barbell of outcomes; either they are very ambitious and you can tell, like (58:46) they're ambitious for the company, not for themselves, for the company, and they want the company to become the best in the world at what they do. And they do eat, sleep, and breathe this company. Every decision—like they're—every second of the day, their mind is consumed with like, what can I do to improve this company? Then you have the other end of people who, you know, it's just more of a job to them, right? They're here to collect a paycheck, or there's some—there's some bonuses tied to some easy EBITDA bogey that they're going to achieve (59:12), right? And you just don't get that passion. You can just—it kind of oozes out of them, right? That either they have it or they don't. So I think meeting people in person and going through questions, you know, asking them questions, seeing how they think, how they feel, I think that's important. I think number three, integrity (59:25). Obviously, you need integrity, right? And people—it's one of these things—like it's funny when I took the CFA exam, you know, there's like an ethics portion. A lot of people don't study. Oh, I'm ethical, and then they fail it, and that's a dealbreaker because like if you fail that, you can ace the rest of the exam, but you actually fail the whole thing because the curriculum requires you to pass that one (59:41). Um, but I think the same thing here is you think, oh, it's integrity, but it's so important because, you know, to look for because like these are kind of subtle breaches where they might do one or two or three like small things—like they tell you something here, but then in the results later on, you know, there's something totally different, and then they kind of change their story (59:57) that you kind of have to remember, okay, well, they're being inconsistent with me, or, you know, it could take a lot of different shapes, but then there's never really one cockroach in the kitchen. So, if you kind of find them being a bit unethical or cutting corners too much, right? These like these people, they they move fast and break things, but they cut the corners too much (1:00:12). They do something where they kind of cross the—it's usually not limited to one thing. It just leads to the question, okay, is the company doing things like that, or are they going to do things to shareholders that aren't great? So, integrity—obviously you need to look out for. And then lastly, I think it's alignment of interest, right? I think in this case, owning a lot of stock tends to be, you know, and that's another quantitative string by the way—there—like it's, you know, the more companies I look at—it's one thing that I used to say, okay, well (1:00:36) you know, you could overlook it to some extent maybe—like they're going to make enough salary and enough bonus, but I I really think there's nothing quite that can replace like large ownership right now. If it's a—you know, it could be like, let's say $10 million for them is only 3% of the company—that's still a meaningful amount usually to these unless they come from, you know, royalty, but then they're probably a second or third-gen founder. I don't get excited about because they weren't the originals, and they tend to, you know, I (1:01:01) think studies show they tend to be, you know, worse outcomes. But, but look, it's usually meaningful to them. And you want to make sure as the company's profits are growing, the minority shareholders are going to see the spoils as well, right? Because if you have somebody—they don't own much stock—either there could be some—either through like bad incentives or whatnot—they—or or taking just big operational risk with the company—they might try to do things and, you know, Charlie Munger says, you know, tell me the incentive (1:01:25)—I'll figure the outcome—I think he's right—they could do things where, you know, they stand to make a lot of money if things go right, and if things go wrong, you're the one who's holding the bag—you know, heads I win, tails you lose. So I think alignment is very important. So I think those four things, you know, kind of sum up a lot of the management analysis.

So there was another interesting concept that you wrote about in your letters, which was not letting good enough get in the way of perfect, which is the inverse (1:01:49) of don't let perfect be the enemy of good. So you've noticed that many investors in markets make errors when they do things such as satisficing on investments that might not necessarily tick all the boxes. You've noted that your three boxes are quality, growth, and valuation. So can you maybe take us through an example of when you or someone you've observed has settled for just good enough as an investment and maybe how that decision played out?

Yeah (1:02:16). Um, well, I can cite somebody, and that would be me. That's still—it's still very much something that that I do, and I try, you know, every day to fight against and to improve in the sense that, you know, look, it's—it's—I think it's more of like—it's—if you think about not letting good enough get in the way of perfect, and I think that's right. I think it's a good mindset to have, and I think it's—it's a goal (1:02:34). It's something you should strive for because in an ideal world, you think of the best investment that you've made over the last 5 years and the setup of that investment going into it. And now imagine owning 10 of those or 15 of those in your portfolio. That would be like the perfect portfolio in a way, right? Something you're comfortable with, great setup, and they all do very well (1:02:51). Now you're going to make mistakes, and you know, not everything's going to pan out. So, you know, you can—even if like 11 out of those 15 do well, you're going to have a good outcome. But yeah, it's—it's more like a challenge to remind yourself every day because I think what a lot of people do—and look, and myself included—is, you know, whether it's because you can't find, you know, these quote-unquote perfect investments or just you kind of drift away, you know, from that discipline (1:03:11). Yeah, you might sacrifice or compromise a bit more on, you know, whether it's quality or growth or value or whatever the pillars that are important to you are—you just might drift away from them a little bit where the investment just—you know, you—you take a step back and you think, wow, yeah, like I definitely should pay more attention to that aspect, and then you end up paying the price for it. Maybe you don't—anything can go up, and you can be right for the wrong reasons or or mixed reasons, but when you think about those opportunities, yeah (1:03:37)—there's—I think even in my portfolio today there's like elements of, okay, this is good enough, but it's not perfect. Even—even if we look at Mater Group today, right? Um, now you size for it accordingly, right? It's no longer the big size it once was. That's something that could theoretically be replaced if I found a portfolio of 15 perfect companies, right? That were like Mater, right, with like a much lower multiple and a higher growth rate (1:03:59). Like yes, like I would buy that one over the one today because look, today it's no longer at nine times earnings. It's at, you know, call it 18 or 20 times earnings, right? Forward earnings, depending on how you look at it. You know, the growth rate probably isn't 30 to 50%. Maybe it's closer to 20%, give or take, for the foreseeable future (1:04:15). And you know, quality, I think, is still the same. If anything, it's probably better because, you know, their position in Australia has gotten stronger, and they've proven their North America opportunity. It was way more—way more early stages now. They've proven that, you know, they have a strong position there, and they should continue to grow, and this concept works in Canada and the United States (1:04:32). So, if anything, quality has probably gone up, and you maybe you're more comfortable holding the stock for that reason. But yeah, it's—that's probably—might be more on the good enough side of things where, you know, at a 20-time, 19-time, 18-time multiple, you know, and that growth, you know, profile—all else equal, quality equal—yeah, you would do better, you know, in finding the Mater Group of four years ago. And so I see it as like a personal challenge for the portfolio, and it's something that I strive to, you know, all the time. So I know that you've been (1:04:59) spending some time these days looking at Japan, and you know, Japan, unfortunately, has been historically kind of a market that's just been full of value traps, but there's, you know, new corporate governance reform going on now, and it seems like they're attempting to optimize more for creating shareholder value, which is great, of course. Now I know many other value investors are looking in Japan as well, and they have been looking for a long time and often not very successfully, but uh I'd love to just know a little bit more about what (1:05:27) you're doing specifically in Japan. Maybe know a little bit more about what adjustments you're making to your investing framework specifically when looking in Japan.

Yeah. And I'm a bit later to the party than than many with Japan. It's very interesting, and it's something that I've been taking a serious look at uh recently (1:05:45). And you know, with Japan, it's—it's a developed market, of course—a terrific country in many respects and definitely, aside from communication, which I'll get to in a moment, definitely investable, like for all those good reasons. Now, you know, it's—I guess going back to March 2022. Somebody who I I know well, and he'll know who he is, but he he urged me to look at Japan, said, "Hey, John, there's a bunch of corporate governance reforms that look like they're happening (1:06:07)." And they were still kind of in COVID lockdown until October 2022. So, in hindsight, yeah, that would have been an amazing place to to invest. But the reason I didn't, and the reason I still didn't—foolishly—until just a couple of months ago, um, was because just the the communication barrier to me has always been something tough to get around (1:06:25). If you're going to build concentrated positions, right? Look, you can—I'm perfectly comfortable translating documents in other languages, right? There's Google Translate, there's other AI-based tools out there where you can retain the format of the PDF or whatever the document is and translate it, and it's great (1:06:41). It's excellent, right? And it's—you're just reading English basically. It's the speaking to management that is more of the dealbreaker for me where, let's say you have a scenario—I think it's the important scenario. You know, you own a stock there, and you know, you're two years into ownership, and things are going well—pieces go well—then suddenly, one day, on a micro level or an industry level, something happens and the stock is down 40% (1:07:00). Right? And most stocks that do well over a long period of time, studies show they will be down 30% or 50%. At some point, if not many points, it's down 40%, and it seems scary in the moment, and you—you realize—you try to call the company to ask what's going on, get some comfort, and like you can't really—you can get a translator, which everybody does—he can speak to them, but there's a lot lost in body language, there's a lot lost in intonation, and you're just kind of getting words, and and generally speaking, too, I—I've been told by many that (1:07:29) Japanese CEOs, they just—their communication is just not the same as in the West, and not in a bad way—it's—look, every country is—is its own—is the way that we're used to—like you're not going to get kind of the same, you know, free-flowing information, and and it's just a different type of response to communication, right? And so, um, all that being said, you know, you're in a situation where you might sell the stock down 40% for the wrong reasons or for the right reasons, but either way, so if I'm thinking about, okay, well, if I'm (1:07:55) going to build a concentrated position or something, and I'm almost like, then I'm underwriting the chance that at some point it's going to be down 40%, and I'm going to sell, you're just handicapping your forward returns like tremendously. So now to get around that, I have found a solution, and it's the first time I'm really considering this, but is taking a basket approach to Japan, right? Not something I've done in other countries, but it's, you know, a bit more of a quantitative approach—they call like a quantimental approach, applying (1:08:19) fundamentals, but you know, from a much more quantitative sense of—look, there are pockets of Japan in the small—

Cap and micro-cap areas that have done very well. From speaking to a lot of people, I posted something on X, and it's incredible. You just get like everybody reaches out to you; it's still, you know, a wonderful community. And I had like six or seven conversations like over the span of a couple of weeks, and a couple of the people especially were very helpful, and I really appreciate them and shout out to them. And um, you know, it was (1:08:45) you kind of start looking, okay, in Japan, small-cap territory, you know what has worked, what hasn't, and there's pockets there where if you look at certain factors like they have kaggers, you would be shocked by like there's this kind of one factor that, you know, looking at in the small cap like the 15-25 year keer is like 17%. (1:09:02) I think that's better than the S&P 500, and it's certainly better than the benchmark, which has done like 0% over over the time in Japan. And so you think, okay, so you kind of you can start there and and you know the beauty is like there's something for everybody there. But I think while that's true, I think for me it's you can tighten the screws even more. Like look at first you filter, okay, things that you know meets quality standards, meets, you know, growth metrics, and it's trading at below like 10 times earnings or free cash flow, and then you get like over 100 companies (1:09:28) 100, and you're like, wait a minute, like any other country you screen for the developer world, you might not find anything. So, okay, but then so you have permission to kind of tighten the screws on, you know, on book value, on on net, you know, and NCAV, like there's so many nets out there on cash on the balance sheet, and maybe one day it'll wake up. (1:09:45)

And what you said about the capital reform is interesting because look, I think everything above 2 billion basically is is kind of been picked over. That game might be over, or it's it's in the later innings, you know, because all the big asset managers who who want to go for liquidity um go there. (1:09:59) And because look, just for those who might not have been reading about it recently, the government essentially said to all companies listed on the Prime Exchange, right? That's their kind of S&P 500 equivalent. If you're below one times price to book, you have a deadline by it was March 31st, 2025, to submit a plan of how you're going to get above one times price to book. (1:10:15) There's a lot of companies who were below one times price to book. And the easiest way to solve that is to return capital if you have a lot of net cash through one time big buyback or or dividend. And a lot of them do that, and then the stock pops like 50% or 100% or 200% in a short period of time. (1:10:30) Now a lot of those might be picked over. But in the standard exchange where you know the small cap micro caps um there hasn't been as much pressure yet. 49% as of a couple of months ago might have ticked up, but 49% of companies have submitted a plan, and that doesn't mean you do the plan. You have, I believe, 5 years to do the plan. So essentially in small-cap Japan, even from the capital to return angle alone, you still have most of the companies who have either not submitted a plan or not taken any action on that plan, and so that's like a a catalyst that, you know, (1:10:58) can help and then you know and if if that doesn't happen then there's so many companies out there that have done well with certain factors. So yeah, so you know to kind of summarize, very interested there, may take a basket approach and uh you know see how that goes.

Well, John, I just want to say thank you so much for coming on to the show today and sharing your insights with me and the audience. (1:11:18) I'd love to give you a handoff and share with the audience where they can learn more about you. Yeah, Kyle, this has been great. Thank you so much and your team for having me on. If anybody wishes to learn more, you can visit my website www.sorpeakcap.com. Accredited investors can see our letters, and our research should be available to everybody. (1:11:37) And if anybody would like to reach out personally, you can find my email and send me a message. I'd love to hear from you. Perfect. If you have two fast-growing companies, let's say they're growing at the same rate, but one of them has a higher return on capital, it won't have to invest as much in order to achieve that revenue growth and that profit growth. (1:11:58) And as a result, it'll generate more cash flows and and it should be worth a lot more. And that is why, for example, some slow-growing companies like consumer package goods companies that have fairly high valuations if you look at sort of enterprise value to Ebidas or pees or whatever, not because they're growing fast, but because they have high returns on capital. And I think there's a big misconception that a company's valuation multiple PE or enterprise value to IBIDA is a function of growth, right? It's clearly a function of both (1:12:29) growth and return on capital.