WEBVTT - Rainwater’s Shaposhnik on Predictable Businesses 0:00:15.360 --> 0:00:18.560 Welcome to Inside Active, a podcast about active managers, goes 0:00:18.560 --> 0:00:22.840 beyond sound bites and headlines and looks deeper into the processes, challenges, 0:00:22.880 --> 0:00:26.160 and philosophies and security selection. I'm David Cohne, i lead 0:00:26.239 --> 0:00:29.920 mutual fund and active Research at Bloomberg Intelligence. Investing often 0:00:29.960 --> 0:00:34.120 involves making forecasts about an uncertain future. Portfolio managers spend 0:00:34.240 --> 0:00:37.720 enormous amounts of time trying to predict earnings, economic conditions, 0:00:37.800 --> 0:00:41.559 competitive dynamics, and market sentiment. Yet for many businesses, those 0:00:41.600 --> 0:00:45.200 outcomes can change quickly, making even the best forecasts difficult 0:00:45.240 --> 0:00:48.440 to sustain. One way to reduce that uncertainty is to 0:00:48.479 --> 0:00:52.120 focus on companies whose businesses are inherently more predictable. Firms 0:00:52.240 --> 0:00:56.960 of occurring revenue, strong customer retention, discipline, capital allocation, and 0:00:57.040 --> 0:01:00.920 durable competitive advantages can provide investors with greater confidence and 0:01:00.960 --> 0:01:03.920 long term cash flows even as markets become more volatile. 0:01:04.400 --> 0:01:07.000 That doesn't eliminate risk, but it can change where investors 0:01:07.040 --> 0:01:09.679 choose to take it. Today, I wanted to explore what 0:01:09.720 --> 0:01:13.440 makes a business truly predictable, why recurring revenue is such 0:01:13.440 --> 0:01:16.280 an important part of the equation, and how those ideas 0:01:16.319 --> 0:01:20.440 translate into portfolio construction, security selection, and long term investing. 0:01:20.840 --> 0:01:24.640 So joining me to discuss that is Joseph Seposnic, portfolio 0:01:24.720 --> 0:01:28.880 manager of the Rainwater Equity ETF ticker RW. Joseph, thank 0:01:28.880 --> 0:01:29.600 you for joining me. 0:01:30.440 --> 0:01:31.280 Thank you for having me. 0:01:31.360 --> 0:01:35.240 David, So you often say that most businesses can't be predicted. 0:01:35.480 --> 0:01:38.000 What led you to that conclusion and how's it shaped 0:01:38.000 --> 0:01:39.440 your entire investment philosophy. 0:01:40.400 --> 0:01:42.720 Well, I want to take you back to my start 0:01:42.720 --> 0:01:45.640 in the industry. I started at Fidelity and I joined 0:01:45.680 --> 0:01:48.400 out of undergrad. I went to Berkeley for undergrad and 0:01:48.480 --> 0:01:51.480 I came to Boston and my boss said, you're from California, 0:01:51.560 --> 0:01:54.000 so you must know something about semiconductors. So they gave 0:01:54.040 --> 0:01:57.200 me research coverage of the semiconductor industry back in two 0:01:57.240 --> 0:02:02.000 thousand and five, small cap semiconductor businesses. Those businesses are 0:02:02.000 --> 0:02:05.160 not the businesses of today, which are great businesses with 0:02:05.240 --> 0:02:10.079 lots of customers, tremendous demand, and a very bright outlook 0:02:10.160 --> 0:02:12.760 for the future. Back then, they were very small companies 0:02:12.760 --> 0:02:16.519 with just a couple of customers, and they were kind 0:02:16.520 --> 0:02:18.959 of going in and out of business. And I had 0:02:18.960 --> 0:02:21.800 I had research coverage of these small, small companies and 0:02:22.200 --> 0:02:26.400 they were very unpredictable. I can remember I hosted a 0:02:26.440 --> 0:02:29.919 company of a I hosted a meeting with the CFO 0:02:30.160 --> 0:02:35.280 of a small chip company supplying chips to the flat 0:02:35.280 --> 0:02:38.680 tanel display market, and he was talking about how great 0:02:38.680 --> 0:02:41.440 his business was and how everything was going well, and 0:02:41.480 --> 0:02:44.600 they had they had approximately three customers at the time, 0:02:46.000 --> 0:02:48.160 So we had the meeting. A couple of days later, 0:02:48.240 --> 0:02:51.880 they reported quarterly results and the stock went down sixty 0:02:51.919 --> 0:02:55.560 percent in one day. And all I can say is 0:02:55.680 --> 0:02:58.239 I was very happy that I didn't recommend that business, 0:02:58.680 --> 0:03:05.480 but I was also shocked into paying attention and trying 0:03:05.480 --> 0:03:12.320 to understand what could make businesses not have that outcome occur, 0:03:13.560 --> 0:03:17.680 What could help me as an analyst understand the types 0:03:17.720 --> 0:03:21.359 of businesses that are susceptible to being crushed and broken 0:03:21.960 --> 0:03:25.200 in the way that company was crushed and broken just 0:03:25.360 --> 0:03:29.360 a couple of days after my meeting and update with 0:03:29.400 --> 0:03:33.560 the CFO. So I had research coverage of semiconductors at 0:03:33.560 --> 0:03:37.680 the time, and then I was given research coverage of 0:03:37.720 --> 0:03:40.720 software businesses a year or two later. I found those 0:03:40.760 --> 0:03:45.000 businesses to be somewhat better businesses and more predictable, but 0:03:45.160 --> 0:03:50.440 that memory always stuck with me. I joined TCW a 0:03:50.560 --> 0:03:53.440 couple of years after that, and I was given research 0:03:53.520 --> 0:03:57.600 coverage of another cyclical sector, the industrial or chemical sector, 0:03:58.160 --> 0:04:02.640 and I had to grapple with this same issues cyclicality 0:04:04.200 --> 0:04:07.880 cash flows that were all over the place, difficult to predict, 0:04:08.360 --> 0:04:15.400 sector and in market. In the course of studying businesses 0:04:15.440 --> 0:04:20.320 in the industrial space, I came across a Maverick CEO 0:04:20.400 --> 0:04:26.320 who transformed his traditional industrial company it was called Roper 0:04:26.360 --> 0:04:32.280 Industries now called Roper Technologies, from a traditional pumps and valves, 0:04:32.800 --> 0:04:36.760 meat and potato semi business into a business that had 0:04:36.800 --> 0:04:40.800 some recurring revenue healthcare associated with it. They acquired these 0:04:40.839 --> 0:04:45.800 businesses and then he took another step to acquiring a 0:04:45.920 --> 0:04:49.880 freight matching software business, so kind of a hybrid between 0:04:50.640 --> 0:04:55.520 industrials and software, and then progressively into software, transitioning this 0:04:55.960 --> 0:05:01.520 cyclical industrial business into a more recurring revenue software and 0:05:01.600 --> 0:05:04.799 services company. And that stock was one of the best 0:05:04.839 --> 0:05:10.640 performing businesses in the industrial sector for the time period 0:05:10.640 --> 0:05:13.560 that I'd covered industrials at tc WE, approximately eight years, 0:05:13.800 --> 0:05:16.000 eight years or ten years or something like that. So 0:05:16.160 --> 0:05:23.000 these experiences and my discussions with him really influenced my 0:05:23.600 --> 0:05:28.560 style as an analyst, and I began to gravitate to 0:05:30.800 --> 0:05:34.560 more predictable businesses. Oh you know, I think one other 0:05:35.360 --> 0:05:41.400 experience also was very certainly shaped me. I looked at 0:05:41.440 --> 0:05:45.960 performance of Nvidia in twenty twenty two, not that long ago, 0:05:46.120 --> 0:05:51.040 just four years ago, and in twenty twenty two, Nvidia's 0:05:51.120 --> 0:05:55.120 insiders sold several hundred million dollars worth of stock as 0:05:55.120 --> 0:05:58.960 the stock declined about fifty percent that year. They were 0:05:59.000 --> 0:06:04.560 coming off demand that was falling off on kind of 0:06:04.560 --> 0:06:07.880 an overbuild of the bitcoin complex, and so they were 0:06:07.920 --> 0:06:12.480 taking it. In twenty twenty two, one year later, and 0:06:12.640 --> 0:06:18.800 videos shares were up tenfold, tenfold. So management had been 0:06:18.839 --> 0:06:22.479 selling hundreds of millions of dollars of shares as the 0:06:22.480 --> 0:06:25.640 stock declined fifty percent in twenty two, and in twenty 0:06:25.680 --> 0:06:29.520 three the stock was up tenfold. The smartest management team 0:06:29.720 --> 0:06:32.760 in the world, or at least one of them, couldn't 0:06:32.839 --> 0:06:37.719 foresee where its stock would be just one year later. 0:06:38.279 --> 0:06:42.120 It was a reminder to me and to many others 0:06:42.480 --> 0:06:46.000 that this business is very difficult, and predicting where most 0:06:46.040 --> 0:06:51.839 businesses will be is a very very difficult approach. In 0:06:52.080 --> 0:06:57.240 twenty fifteen, taking all of my learnings as an analyst 0:06:57.520 --> 0:07:01.919 and my evolution as an investor. We launched a fund 0:07:01.920 --> 0:07:06.400 at TCW which focused on investing only in predictable businesses. 0:07:06.560 --> 0:07:10.080 We called it Predictable Growth Businesses, and over that nine 0:07:10.160 --> 0:07:13.680 year period of managing it, we found that this approach 0:07:14.120 --> 0:07:19.000 could generate really, really strong returns for investors and do 0:07:19.120 --> 0:07:22.960 that in a very risk controlled way. Our thesis was, 0:07:23.560 --> 0:07:28.160 if you invest in businesses where the business model itself 0:07:28.800 --> 0:07:35.520 is geared toward recurring revenue sources, management is more likely 0:07:35.560 --> 0:07:40.440 to manage this business in a way to where they 0:07:40.440 --> 0:07:46.120 can accurately match expenses to revenue and they can appropriately 0:07:46.800 --> 0:07:50.640 put together a capital structure for the business because they 0:07:50.680 --> 0:07:53.600 can kind of see where revenue and cash flows will 0:07:53.600 --> 0:07:57.080 be over the next couple of years. So inherently the 0:07:57.120 --> 0:08:02.680 business is less prone to being disrupted and it's less 0:08:02.720 --> 0:08:10.800 prone to having management mismanage expenses or the balance sheet. 0:08:11.240 --> 0:08:16.520 We also found that these businesses, because of their inherent characteristics, 0:08:16.640 --> 0:08:19.720 were easier for us to value. It was harder for 0:08:19.800 --> 0:08:23.160 us to screw up. Valuing businesses where you could see 0:08:23.160 --> 0:08:25.680 the cash flows over the next couple of years, you 0:08:25.720 --> 0:08:30.560 could more accurately forecast what the businesses should be valued 0:08:30.600 --> 0:08:34.200 at and they therefore make an investment conclusion. And so 0:08:34.360 --> 0:08:37.520 these businesses had these inherent advantages. I think that the 0:08:37.600 --> 0:08:41.800 last advantage that we identified is that recurring revenue businesses 0:08:42.520 --> 0:08:46.440 give the management team the ability to play offense in 0:08:46.480 --> 0:08:49.600 a way that most companies can't. When you know where 0:08:49.640 --> 0:08:52.480 your cash flows will be over the next couple of years, 0:08:52.760 --> 0:08:56.440 it gives you the confidence to make investment decisions in 0:08:56.480 --> 0:09:00.680 your business, maybe more aggressively, and to make inquisitions of 0:09:00.760 --> 0:09:06.880 synergistic businesses that can help you both improve the moat 0:09:07.080 --> 0:09:09.920 that you've that you've built with your company and maybe 0:09:09.960 --> 0:09:14.000 expand your moat into the future as well. So those 0:09:14.000 --> 0:09:18.080 were some of the advantages that we see with recurring 0:09:18.120 --> 0:09:22.880 revenue businesses. And you know, there was a an update 0:09:22.920 --> 0:09:26.199 to the famous Hendred Best in Binders study that came 0:09:26.240 --> 0:09:28.000 out a couple of days ago, which I think is 0:09:28.040 --> 0:09:31.040 also important to point out. Obviously it's a very famous 0:09:31.040 --> 0:09:33.840 study by Best in Binder And you know, a couple 0:09:33.880 --> 0:09:36.480 of the conclusions were, number one, four percent of all 0:09:36.520 --> 0:09:41.079 stocks generate all of the markets returns in excess of 0:09:41.559 --> 0:09:44.840 the of the of I think the tenure treasury. That's 0:09:44.880 --> 0:09:47.160 one of the interesting conclusions. But I think the second 0:09:47.240 --> 0:09:51.640 interesting conclusion is he looked at and I think we 0:09:51.640 --> 0:09:53.480 could post this of course, or share this with you. 0:09:53.760 --> 0:09:57.360 He looked at the stocks over the last one hundred 0:09:57.480 --> 0:10:03.400 years that had the highest cumulative returns compounded returns, and 0:10:03.480 --> 0:10:07.200 if you look at the top three, they happen to 0:10:07.240 --> 0:10:14.480 be Altria, Vulcan Materials in Kansas City, Southern All three 0:10:14.640 --> 0:10:18.280 businesses compounded at sixteen and a half percent, fourteen percent, 0:10:18.360 --> 0:10:22.280 and fourteen percent over very long stretches of time one 0:10:22.360 --> 0:10:25.120 hundred years, one hundred years, and ninety six years. And 0:10:25.240 --> 0:10:30.920 all three of these businesses have substantial amounts of recurring 0:10:30.960 --> 0:10:34.560 revenue associated with them. So it's an approach that I 0:10:34.559 --> 0:10:39.440 think has been tested over time, but there hasn't been 0:10:39.440 --> 0:10:43.960 a strategy that has exclusively focused on only investing in 0:10:44.000 --> 0:10:45.280 recurring revenue companies. 0:10:46.480 --> 0:10:48.880 So if we go deeper, how do you actually define 0:10:48.960 --> 0:10:51.240 recurring revenue? You know? In other words, you know what 0:10:51.679 --> 0:10:56.600 truly separates a recurring revenue from a company that just 0:10:56.800 --> 0:10:58.120 simply appears stable. 0:10:58.960 --> 0:11:04.280 We bucket recurring revenue businesses into two categories. Number one, 0:11:05.040 --> 0:11:11.600 the traditional subscription recurring revenue company. There's a subscription associated 0:11:11.640 --> 0:11:15.760 with their business. That would be a business like Bloomberg, 0:11:16.400 --> 0:11:23.199 business like Netflix, a software business that has substantial maintenance 0:11:23.400 --> 0:11:29.000 associated with the product. That's the traditional definition of what 0:11:29.080 --> 0:11:34.000 a recurring revenue business is. The second type of recurring 0:11:34.000 --> 0:11:37.720 revenue business is what we would describe it as transactional 0:11:37.760 --> 0:11:45.280 recurring and transactional recurring businesses would be a credit bureau 0:11:46.120 --> 0:11:49.360 where there are only three credit bureaus in the United 0:11:49.360 --> 0:11:53.920 States and all of the economic activity in the United 0:11:53.920 --> 0:11:59.520 States essentially goes through those three credit bureaus. It's transactional 0:11:59.559 --> 0:12:03.560 because alums will fluctuate based on economic activity, but it's 0:12:03.600 --> 0:12:08.840 recurring because there are only three pipes, and if you 0:12:08.960 --> 0:12:12.439 want to get an answer, you've got to go generally 0:12:12.480 --> 0:12:15.720 to two out of three every time, and sometimes three 0:12:15.760 --> 0:12:19.480 out of three to get a decision. You could think 0:12:19.480 --> 0:12:23.240 of the ratings agency businesses in the same way. You 0:12:23.280 --> 0:12:27.920 could think of the aftermarket aerospace parts industry as a 0:12:28.240 --> 0:12:33.560 similar analog. You sell the original equipment part to Boeing 0:12:33.640 --> 0:12:37.880 or air Bus, and then the plane flies for thirty years, 0:12:38.520 --> 0:12:42.600 and you're the sole source provider of the replacement part, 0:12:43.200 --> 0:12:50.320 so as activity keeps going over the years. The airlines, 0:12:50.640 --> 0:12:53.640 the airline operators and the airlines have to come to 0:12:53.760 --> 0:12:58.200 you for that specific part and they can't go anywhere else. 0:12:58.880 --> 0:13:02.200 Those are the the two categories of businesses that we 0:13:02.280 --> 0:13:08.559 focus on that can also take the form of local monopolies. 0:13:09.240 --> 0:13:12.280 Is you could think of the waste collection waste management 0:13:12.320 --> 0:13:17.600 businesses that have local monopolies as being very very recurring, 0:13:17.640 --> 0:13:22.800 revenue oriented businesses. And I think a great example on 0:13:22.840 --> 0:13:28.960 the aftermarket aerospace parts industry is if you think of 0:13:29.400 --> 0:13:32.640 a very basic part on a plane, The most basic 0:13:32.720 --> 0:13:35.080 part of the plane, I would say, is the seat belt, 0:13:35.800 --> 0:13:38.520 and the next time you're flying, if you flip open 0:13:38.600 --> 0:13:40.959 to the back of your seat belt, you'll see that 0:13:41.520 --> 0:13:45.880 the provider of the seat belt is a company called Amsafe. 0:13:46.240 --> 0:13:49.800 Amsafe has been making seatbelts for many, many decades, and 0:13:49.840 --> 0:13:52.000 it was acquired by a company that is in our 0:13:52.040 --> 0:13:55.560 portfolio called Transdime. You would think that a seatbelt is 0:13:55.559 --> 0:14:01.280 a pretty i don't know, regular part on a plane 0:14:01.280 --> 0:14:05.040 that you could replace pretty easily, not particularly expensive, but 0:14:05.160 --> 0:14:09.360 it happens to be because of the way we regulate 0:14:09.400 --> 0:14:16.920 air travel, quite a established position and one that is difficult. 0:14:17.480 --> 0:14:21.400 It is very difficult to replace am safe position in 0:14:21.440 --> 0:14:26.000 the seatbelt market. The reason for that is that the 0:14:26.040 --> 0:14:30.440 seat belt needs to be certified with the FAA, the 0:14:30.480 --> 0:14:35.840 seat belt with the type of seat or the seat manufacturer, 0:14:36.400 --> 0:14:38.880 of which there are a couple, they have to be 0:14:38.960 --> 0:14:44.040 certified in a system, and the seat the seat I'm sorry, 0:14:44.080 --> 0:14:47.600 the seat belt, the seat itself and the position of 0:14:47.640 --> 0:14:51.480 the seat on the plane also has to be certified 0:14:52.280 --> 0:14:56.720 as well. So the cost of re certifying a seat 0:14:56.760 --> 0:15:03.880 belt is incredibly high. So amsafe has a very strong 0:15:03.960 --> 0:15:08.840 position on planes and has the ability or has substantial 0:15:08.920 --> 0:15:14.200 pricing power because of the way we regulate parts on 0:15:14.280 --> 0:15:19.000 planes and travel today. So as you can imagine if 0:15:19.040 --> 0:15:21.720 you look at other parts on a plane, they are 0:15:21.760 --> 0:15:26.640 also to the extent that they are sole sourced and proprietary. 0:15:27.280 --> 0:15:30.960 They have really really strong long term businesses and very 0:15:31.080 --> 0:15:36.160 very strong pricing power and not surprisingly, very very strong 0:15:36.200 --> 0:15:39.280 recurring revenue for many, many years. That's the type of 0:15:39.680 --> 0:15:41.840 business and type of part that we really like. 0:15:42.960 --> 0:15:46.760 So when you're finding these businesses, what other characteristics do 0:15:46.800 --> 0:15:49.560 you look at that basically have to be present before 0:15:49.600 --> 0:15:50.840 it makes it into your fund. 0:15:52.680 --> 0:15:55.880 Well, we only invest, as we talked about, in recurring 0:15:55.920 --> 0:16:01.400 revenue businesses that generate substantial free cash flow and have 0:16:01.520 --> 0:16:07.400 a dominant market position. The businesses have to be selling 0:16:07.480 --> 0:16:12.360 a critical part or service, critical product or service, so 0:16:12.800 --> 0:16:17.880 you won't see us invest in any discretionary businesses. Generally 0:16:18.880 --> 0:16:23.880 we avoid consumer facing businesses, and so we're trying to 0:16:24.000 --> 0:16:30.640 build this durable compounder of free cash flow that over 0:16:30.760 --> 0:16:36.480 time will create a snowball of free cash flow which 0:16:36.680 --> 0:16:42.840 physically moves the value of stocks and the underlying portfolio 0:16:43.600 --> 0:16:48.600 forward over time. Our view is that stocks are driven 0:16:49.320 --> 0:16:51.640 at the end of the day by the free cash 0:16:51.640 --> 0:16:54.720 flow that they generate, and our view of free cash 0:16:54.720 --> 0:16:58.000 flow is what physically moves stock prices. It isn't revenue, 0:16:58.480 --> 0:17:01.520 it isn't earnings, it's not but at the end of 0:17:01.520 --> 0:17:04.240 the day, it's the free cash flow that the company generates. 0:17:04.760 --> 0:17:07.680 And so we're looking for businesses that sell something that's 0:17:07.960 --> 0:17:11.480 very important to the customer, have very very few competitors, 0:17:12.200 --> 0:17:18.159 and generate substantial amounts of free cash flow. The second 0:17:18.200 --> 0:17:22.240 element of what we look for is we really believe 0:17:23.000 --> 0:17:27.359 that management is incredibly important. I remember when I was 0:17:27.359 --> 0:17:33.480 at Fidelity, it was strongly emphasized to us as young 0:17:33.560 --> 0:17:39.080 analysts to stay close to our companies, and we spend 0:17:39.080 --> 0:17:41.639 a lot of time talking to management. And what I've 0:17:41.800 --> 0:17:47.040 found over the years is that being aligned with great 0:17:47.119 --> 0:17:51.600 management is as important as being aligned with a great business. 0:17:52.000 --> 0:17:57.120 I found that bad management can ruin a great business, 0:17:58.160 --> 0:18:03.440 and that great management can enhance even an average business. 0:18:04.240 --> 0:18:10.840 So for us, when we think about management and assessing management, 0:18:11.359 --> 0:18:14.040 we're looking for a couple of key elements. And I 0:18:14.080 --> 0:18:17.080 think that these elements are relatively underappreciated because a lot 0:18:17.080 --> 0:18:19.359 of people say, oh, we look for great management. But 0:18:19.480 --> 0:18:25.119 for us, we go back to a quote that Warren 0:18:25.160 --> 0:18:28.200 Buffett gave in a talk that he gave to the 0:18:28.640 --> 0:18:32.320 University of Omaha, I think in the early eighties, where 0:18:32.320 --> 0:18:36.240 he said when he's when he's analyzing or assessing a 0:18:36.280 --> 0:18:43.080 management team, he said he's looking for one word, a fanatic. 0:18:44.240 --> 0:18:48.800 And when we assess management and management teams, we are 0:18:48.840 --> 0:18:55.320 looking for fanatics. Fanatics for us, I mean individuals or 0:18:55.400 --> 0:19:00.840 teams that are committed to their business. They're not just mercenaries. 0:19:01.440 --> 0:19:04.119 This business is a part of their life. It's a 0:19:04.160 --> 0:19:06.240 part of their psyche, it's a part of their makeup. 0:19:06.640 --> 0:19:09.320 And so when we meet with them, we're trying to 0:19:09.440 --> 0:19:15.639 understand is this business just something that they work on 0:19:16.359 --> 0:19:20.320 because it generates a nice stream of income for them, 0:19:20.720 --> 0:19:24.159 or is this business something that is really important to 0:19:24.200 --> 0:19:26.840 them and they are fanatical about it. One of the 0:19:26.880 --> 0:19:29.359 ways you can determine that is obviously looking at the 0:19:29.400 --> 0:19:31.800 track record, which we spend a lot of time looking 0:19:31.840 --> 0:19:35.400 at the track records of management teams, but we spend 0:19:35.400 --> 0:19:36.920 a lot of time meeting with them to try to 0:19:37.000 --> 0:19:41.000 understand that are they a fanatic. The second element that 0:19:41.040 --> 0:19:43.200 we look for, to the extent that we can determine 0:19:43.200 --> 0:19:47.920 that they are fanatics is do they have the right 0:19:48.480 --> 0:19:54.680 incentives in place to create shareholder value over time? And 0:19:55.680 --> 0:20:00.320 of course all management teams have incentives in place. Many 0:20:00.320 --> 0:20:04.240 management teams are highly compensated. But the question is is 0:20:04.280 --> 0:20:09.560 the compensation are the compensation metrics that have been laid 0:20:09.560 --> 0:20:13.240 out for the management team consistent with creating value for 0:20:13.280 --> 0:20:17.639 shareholders and for and for customers and and UH and 0:20:17.720 --> 0:20:22.840 for employees. And we find very often that the metrics 0:20:22.840 --> 0:20:25.679 that are laid out in the proxy really don't have 0:20:25.760 --> 0:20:29.520 a great deal of connection to creating shareholder value over time. 0:20:29.800 --> 0:20:33.199 In other words, there are very often UH in the 0:20:33.240 --> 0:20:38.400 types of businesses that we look for management is incentivized 0:20:38.560 --> 0:20:43.520 to grow revenue, maybe even to grow profit. But if 0:20:43.520 --> 0:20:48.440 there isn't a connection between growing revenue and generating higher 0:20:48.480 --> 0:20:52.800 returns on capital or compounding free cash flow over time, 0:20:53.359 --> 0:21:01.000 what you'll see is companies acquire revenue maybe in products 0:21:01.080 --> 0:21:03.919 which create revenue growth, but not a lot of profit 0:21:04.040 --> 0:21:08.679 or cash flow growth, and over time, those companies don't 0:21:08.680 --> 0:21:13.240 create as much value as companies that can link revenue, 0:21:14.400 --> 0:21:20.560 free cash flow, and returns together to create an incentive 0:21:20.600 --> 0:21:26.399 structure that incentivizes the management team to balance those elements 0:21:26.680 --> 0:21:30.879 and hopefully improve and grow them over time. And we 0:21:31.000 --> 0:21:35.920 think the growth of cash flow and return on invested 0:21:36.000 --> 0:21:40.760 capital and the top line is the combination that really 0:21:41.680 --> 0:21:45.919 is beneficial to the company and to shareholders. And the 0:21:45.960 --> 0:21:48.879 third element that we look for when we assess a 0:21:48.960 --> 0:21:55.919 management team is their capital allocation track record. Because we 0:21:56.040 --> 0:22:02.840 invest in these durable, recurring, revenue, cash generative companies, it's 0:22:03.000 --> 0:22:08.600 really important that the management teams have the capability of 0:22:09.080 --> 0:22:15.040 being great CEO investors, as we call them. Are they 0:22:15.080 --> 0:22:18.720 great investors because they're generating all of this cash flow 0:22:19.720 --> 0:22:22.879 and are they investing that well? You know, today a 0:22:22.880 --> 0:22:27.200 lot of people are asking that question of Microsoft, in Amazon, 0:22:27.960 --> 0:22:33.200 and Google, the great hyperscalers of our time. They generate enormous, 0:22:33.640 --> 0:22:38.919 enormous operating cash flow, and the management teams today are 0:22:39.520 --> 0:22:45.480 allocating that enormous sum of freak or operating cash flow 0:22:46.200 --> 0:22:50.840 to building out their presence in AI, their presence in 0:22:50.880 --> 0:22:56.240 the cloud. And the question is will those companies generate 0:22:56.280 --> 0:23:01.240 sufficient returns on the hundreds of billions of dollars of 0:23:01.560 --> 0:23:06.400 capex that they're investing in just this year. And so 0:23:06.840 --> 0:23:13.480 it's very important as we assess our management teams to 0:23:13.520 --> 0:23:19.600 be aligned with great investor management teams who have a 0:23:19.640 --> 0:23:22.680 capability have a track record and a capability of being 0:23:22.760 --> 0:23:26.040 able to reinvest the free cash or that they generate 0:23:26.440 --> 0:23:32.479 into projects or capital investments that will create more cash 0:23:32.520 --> 0:23:36.280 flow for investors over time. So that's generally what we're 0:23:36.280 --> 0:23:41.160 looking for in businesses. And then once we found these businesses, 0:23:41.920 --> 0:23:44.639 we like to hold on to the winners for a 0:23:44.680 --> 0:23:49.040 long period of time. We've found that there's a significant 0:23:49.040 --> 0:23:55.480 amount of persistence for winning stocks, and because of that, 0:23:55.520 --> 0:23:57.960 we try to hold on to these businesses for many, 0:23:58.000 --> 0:23:58.840 many years. 0:24:00.240 --> 0:24:02.159 I do want to go back to cash flow for 0:24:02.240 --> 0:24:05.040 just a minute. You know, many growth managers focus on 0:24:05.160 --> 0:24:08.960 revenue growth. You know, you're obviously focusing on cash flow growth. 0:24:09.119 --> 0:24:11.680 Why do you think cashflow is actually, you know, ultimately 0:24:11.720 --> 0:24:13.879 the better north star in terms of growth. 0:24:14.280 --> 0:24:16.359 Well, I think that at the end of the day, 0:24:16.960 --> 0:24:20.800 the value of your business is the are the future 0:24:20.840 --> 0:24:25.440 cash flows that you will generate out into the out 0:24:25.520 --> 0:24:30.120 into perpetuity, discounted back to the present. I wouldn't place 0:24:30.200 --> 0:24:34.200 free cash flow as the driving factor for each business 0:24:34.760 --> 0:24:41.600 at different places in its maturation cycle. Obviously, early stage 0:24:41.640 --> 0:24:47.160 businesses must generate revenue and the cash flow hopefully will 0:24:47.160 --> 0:24:50.800 come over time. But for the types of businesses that 0:24:51.000 --> 0:24:56.080 we focus on, the companies I would say that have 0:24:56.200 --> 0:25:01.600 already won, they should be in the mode of generating 0:25:02.440 --> 0:25:06.680 cash flow and either returning that cash flow back to investors, 0:25:06.680 --> 0:25:10.399 which we generally don't favor, or doing something with that 0:25:10.520 --> 0:25:14.919 with that cash flow, which will be quite productive. I 0:25:14.920 --> 0:25:19.639 would also say that cash flow, unlike many of the 0:25:19.680 --> 0:25:28.919 other metrics that you cite revenues, EBITDA, earnings, adjusted earnings 0:25:29.480 --> 0:25:34.360 adjusted EBITDA, all of these adjusted adjusted metrics that management 0:25:34.600 --> 0:25:38.520 likes to put in front of us, cash flow is 0:25:38.600 --> 0:25:43.960 not adjusted. Cash Flow is just cash flow and It's 0:25:44.040 --> 0:25:47.879 one of the purer measures of how a business is 0:25:47.920 --> 0:25:53.160 performing and whether it's creating any value at all. Many businesses, 0:25:53.240 --> 0:25:56.560 or some businesses that don't generate much in the way 0:25:56.600 --> 0:26:00.240 of cash flow and don't generate much in the way 0:26:00.280 --> 0:26:03.800 of growth, you know, you kind of wonder what is 0:26:03.840 --> 0:26:08.119 going on there. But the businesses that do generate a 0:26:08.119 --> 0:26:10.960 lot of growth and generate a substantial matter of cash 0:26:10.960 --> 0:26:16.200 flow and reinvest that cash flow effectively are businesses that 0:26:16.240 --> 0:26:18.919 are going to create a lot of value for investors, 0:26:18.960 --> 0:26:22.680 particularly if they can continue to grow and make great 0:26:22.720 --> 0:26:24.200 investments with their capital. 0:26:25.600 --> 0:26:29.320 You know another thing, I note your website frequently mentions 0:26:29.640 --> 0:26:33.240 fewer surprises. Do you think or do you believe avoiding 0:26:33.280 --> 0:26:36.840 negative surprises is ultimately more important than finding the next 0:26:36.880 --> 0:26:38.280 big growth company. 0:26:39.160 --> 0:26:41.199 I think they're both very, very important. When I was 0:26:41.240 --> 0:26:45.400 running the old fund, I talked about addition by subtraction. 0:26:45.640 --> 0:26:48.919 When we look back at, you know, our annual performance, 0:26:49.720 --> 0:26:54.040 we always think about, could we have made one less 0:26:54.080 --> 0:26:57.280 mistake that year? And if we had made one less 0:26:57.320 --> 0:27:00.000 mistake that year, you know, our performance would have been 0:27:00.000 --> 0:27:05.680 substantially improved. And so what we're trying to deliver for 0:27:06.520 --> 0:27:12.359 clients is a better better outcome relative to the to 0:27:12.440 --> 0:27:17.880 the broad market, with risks that are substantially lower than 0:27:17.880 --> 0:27:21.919 that of an investment in the broad market index. So 0:27:22.480 --> 0:27:27.840 because of that, we favor these businesses, which, in our experience, 0:27:28.000 --> 0:27:34.400 generate fewer surprises because they're inherently more predictable and more reliable. 0:27:34.880 --> 0:27:40.399 And they are generally managed by individuals and teams, which 0:27:40.440 --> 0:27:49.200 have incentives to constrain the animal spirit, influence or impulses 0:27:49.280 --> 0:27:53.840 that management teams can have, but also incentivize them to 0:27:54.000 --> 0:27:57.240 play offense and to grow the business. So hopefully they're 0:27:57.240 --> 0:28:03.840 not taking excessive with their recurring revenue company, but hopefully 0:28:03.840 --> 0:28:09.280 they're also incentivized to grow this business and therefore generate 0:28:09.800 --> 0:28:17.480 a more predictable outcome than most companies will over time. 0:28:18.960 --> 0:28:21.440 Okay, another thing that caught my eyes. You know, your 0:28:21.480 --> 0:28:25.879 willingness to hold meaningful cast positions when valuations aren't attractive. 0:28:26.400 --> 0:28:29.479 In today's investment world, you know, managers often feel pressure 0:28:29.520 --> 0:28:32.119 to stay fully invested. How difficult does it to have 0:28:32.200 --> 0:28:32.880 that patience? 0:28:35.359 --> 0:28:42.080 Not particularly difficult. We stay very disciplined in looking for 0:28:42.160 --> 0:28:47.400 the types of businesses that we've historically invested in, and 0:28:47.520 --> 0:28:52.120 there are times when we see great opportunities, and there 0:28:52.120 --> 0:28:54.800 are times when we're in between opportunities, and there are 0:28:54.840 --> 0:29:00.560 times when there aren't a lot of opportunities. Today, we 0:29:00.640 --> 0:29:03.560 think that there are a substantial amount of opportunities in 0:29:03.600 --> 0:29:11.360 the recurring revenue area of the market, and valuations today 0:29:11.440 --> 0:29:15.160 are probably more attractive than they've been in the in 0:29:15.200 --> 0:29:19.920 the ten years I've been a portfolio manager and operating 0:29:20.280 --> 0:29:22.640 UH this strategy. So I think there's a lot of 0:29:22.680 --> 0:29:26.640 opportunity UH in this area of the market. And I 0:29:26.680 --> 0:29:33.400 think that because the the the AI cycle has captured 0:29:33.440 --> 0:29:38.600 the attention of so many market participants. What's happened is 0:29:38.640 --> 0:29:46.680