WEBVTT - Needham Funds’ Barr on Hidden Quality Compounders 0:00:14.480 --> 0:00:18.000 Welcome to Inside Active podcast about active managers that goes 0:00:18.079 --> 0:00:21.920 beyond sound bites and headlines and looks deeper into their processes, 0:00:22.160 --> 0:00:26.560 challenges and philosophies in security selection. I'm David Cohne, i 0:00:26.680 --> 0:00:30.280 lead mutual fund and active research at Bloomberg Intelligence. Today 0:00:30.440 --> 0:00:33.479 my co host is Michael casper, Us, small cap and 0:00:33.520 --> 0:00:37.040 sector strategist at Bloomberg Intelligence. Mike, thank you for joining 0:00:37.040 --> 0:00:37.479 me today. 0:00:37.840 --> 0:00:38.520 Thank you, David. 0:00:39.479 --> 0:00:43.240 So you've recently published a note on the Russell two thousands. 0:00:43.920 --> 0:00:46.400 I guess we should say not so great December. Can 0:00:46.440 --> 0:00:48.800 you give our listeners a brief overview of just what 0:00:48.920 --> 0:00:50.040 went wrong last month? 0:00:50.520 --> 0:00:53.280 Yeah, pretty much everything. So the Russell two thousand and 0:00:53.360 --> 0:00:56.080 December down about eight percent or so a little bit 0:00:56.080 --> 0:01:00.760 over eight percent for the month. Every single sector in 0:01:00.800 --> 0:01:04.840 the red, led by declines and materials, healthcare and financials, 0:01:04.880 --> 0:01:07.600 so some behemoths in their healthcare and financials obviously two 0:01:07.680 --> 0:01:11.800 of the bigger sectors in the in the index, Tech 0:01:12.240 --> 0:01:16.479 and consumer staples actually fell the least, but still everything down. 0:01:16.880 --> 0:01:19.480 What was interesting though from our standpoint is we have 0:01:19.560 --> 0:01:22.760 a sentiment indicator called the bi Market Pulse Index. It 0:01:22.880 --> 0:01:27.640 looks at risk taking across equities and bond markets, and 0:01:27.680 --> 0:01:33.080 it actually ticked higher, kind of led by low volatility 0:01:35.000 --> 0:01:40.160 outperforming high volatility stocks for them, or high volatility stocks 0:01:40.319 --> 0:01:44.479 performing low volatility stocks for the month caused the market 0:01:44.480 --> 0:01:46.360 Pulse index to tick a little bit higher. So we're 0:01:46.360 --> 0:01:49.360 still watching that it is showing a little bit of concern. 0:01:49.480 --> 0:01:52.640 Especially some of these factors that we look at are 0:01:52.640 --> 0:01:56.800 smooth out over a three month timeframe, so picking up 0:01:56.840 --> 0:01:59.520 some of that November rally, but still moving higher. But 0:01:59.560 --> 0:02:01.960 I think really what wereent wrong under the surface was 0:02:01.960 --> 0:02:04.640 the moving rates. We had highlighted at the end of 0:02:04.720 --> 0:02:08.200 last year that the Russell two thousand was pretty fairly 0:02:08.240 --> 0:02:11.400 priced on the multiple given where consensus expected rates to 0:02:11.440 --> 0:02:14.120 go over the next year. And obviously what we're hearing 0:02:14.120 --> 0:02:16.040 from the FED and what we're seeing from the Tenure 0:02:16.160 --> 0:02:21.160 is that there's a healthy dose of skepticism that the 0:02:21.440 --> 0:02:25.560 original rate cut intention will actually be followed through in 0:02:25.960 --> 0:02:28.960 twenty twenty five. So a lot of that volatility I 0:02:28.960 --> 0:02:34.280 think was driven on the multiple side from Fed unease 0:02:34.520 --> 0:02:37.919 or unease about where rates might go. Obviously, consensus for 0:02:38.919 --> 0:02:41.960 revenue growth not going to change too much on a 0:02:42.000 --> 0:02:44.000 month on month basis. So it was really driven a 0:02:44.000 --> 0:02:47.560 lot by the multiple in sentiment and where rates are 0:02:47.600 --> 0:02:48.880 expected to go over the next year. 0:02:49.680 --> 0:02:52.240 Well, hopefully the next few months will be a little better. 0:02:52.680 --> 0:02:54.840 But on the topic of small caps, I'd like to 0:02:54.840 --> 0:02:58.519 welcome our guest, John Barr, Managing director and executive vice 0:02:58.560 --> 0:03:01.920 president of need and Funds, portfolio manager for the Needam 0:03:02.160 --> 0:03:06.440 Aggressive Growth Fund tickern eag X. John, thanks for joining 0:03:06.440 --> 0:03:07.120 Inside Active. 0:03:07.480 --> 0:03:09.720 Great. Thank you, David, it's great to be here. 0:03:10.960 --> 0:03:14.640 Well, let's start off by talking about your career. You 0:03:14.680 --> 0:03:16.480 know we've met and so I you know you've got 0:03:16.480 --> 0:03:19.520 an interesting career trajectory. Can you tell our listeners how 0:03:19.520 --> 0:03:21.000 you got your start in the investment business. 0:03:21.120 --> 0:03:24.680 Yeah, they're really three parts to my career, And the 0:03:24.800 --> 0:03:30.840 first is that I had a whole first career in industry, 0:03:31.280 --> 0:03:37.000 and it was predominantly in electronic design automation, which is 0:03:37.480 --> 0:03:42.760 CAD software used to design semiconductors and printed circuit boards. 0:03:42.800 --> 0:03:48.040 And so fourteen years in that industry at marketing, sales, 0:03:48.200 --> 0:03:53.200 sales management, product management. I lived in Japan and set 0:03:53.280 --> 0:03:58.960 up distribution, so lots of industry experience, and I also 0:03:59.480 --> 0:04:06.000 worked for or predominantly small companies but been through small 0:04:06.120 --> 0:04:11.880 venture backed companies, conserving cash through an IPO, through friendly merger, 0:04:12.000 --> 0:04:17.479 hostile takeover, white night layoffs being and then finally being 0:04:17.480 --> 0:04:20.600 the last person out the door. So I've kind of 0:04:20.640 --> 0:04:24.120 been in the shoes of the companies that I look 0:04:24.200 --> 0:04:30.560 to invest in. So yeah, lots of industry experience, and 0:04:30.640 --> 0:04:34.880 then just mentioned the second part is other financial industry 0:04:35.000 --> 0:04:40.080 experience and leaving industry, I had the chance to go 0:04:40.160 --> 0:04:43.240 to the cell side and follow the industry that I 0:04:43.320 --> 0:04:47.800 came out of for a number of years, so had 0:04:47.839 --> 0:04:53.080 that additional experience. And then also venture capital has been 0:04:53.200 --> 0:04:57.880 something that has been a strong interest for a long time. 0:04:58.400 --> 0:05:05.080 And as on the cell side, I worked with sourcing 0:05:05.160 --> 0:05:09.200 ideas for Needham's Venture Fund at the time, and then 0:05:10.240 --> 0:05:12.440 I was on the board of a private company that 0:05:12.560 --> 0:05:18.799 successfully sold and have maintained that interest and involvement since. 0:05:19.279 --> 0:05:24.280 So significant other financial industry experience too, and now been 0:05:24.320 --> 0:05:27.720 a portfolio manager slash analyst for over twenty years. 0:05:29.240 --> 0:05:31.920 So you know that brings us to the Aggressive Growth Fund, 0:05:31.960 --> 0:05:33.799 which is, you know what we really want to focus 0:05:33.839 --> 0:05:37.040 on for this episode. Can you kind of walk us 0:05:37.040 --> 0:05:39.040 through the investment process for that fund? 0:05:39.880 --> 0:05:44.480 Yeah, so it we look for I call it hidden 0:05:44.560 --> 0:05:51.040 to quality compounders, and when we look to purchase a company, 0:05:51.279 --> 0:05:55.640 it's in a stage that I call a hidden compounder, 0:05:56.120 --> 0:05:59.760 and then we look to hold it while it transitions 0:05:59.839 --> 0:06:05.320 to strong to strong financial performance, and then hold on 0:06:05.680 --> 0:06:09.440 even more while it becomes a quality compounder. And I 0:06:09.560 --> 0:06:12.400 like to joke that even the quants can find it 0:06:12.839 --> 0:06:17.279 when it's a quality compounder. But in the early stages, 0:06:17.360 --> 0:06:22.919 we're looking for some specific characteristics that aren't readily apparent, 0:06:25.800 --> 0:06:30.520 so that that's the process from a high level. Some 0:06:30.560 --> 0:06:34.000 of the characteristics of it are very long term holding, 0:06:34.600 --> 0:06:40.640 so turnovers about ten percent, so averaging a ten year 0:06:40.920 --> 0:06:46.440 holding period. And so we're looking to find those small 0:06:46.560 --> 0:06:52.159 cap companies that the market hasn't yet discovered, hold them 0:06:52.200 --> 0:06:57.360 through that transition, and then hold them even longer to 0:06:57.720 --> 0:07:02.039 point where some of them become mid and even even 0:07:02.120 --> 0:07:07.640 large caps and we were able to hold on to them. 0:07:08.640 --> 0:07:12.520 So I might just mention the criteria that we look 0:07:12.640 --> 0:07:15.960 for when we first purchase one of those companies, and 0:07:16.000 --> 0:07:20.320 they're four key criteria. The first is that the company 0:07:20.360 --> 0:07:25.160 has an established business, but then is investing in something 0:07:25.240 --> 0:07:28.920 new that the market doesn't yet recognize, and it can 0:07:28.960 --> 0:07:33.080 be a product or a service, and the established business 0:07:34.080 --> 0:07:39.000 maybe not so exciting, not growing rapidly, but profitable or 0:07:39.040 --> 0:07:44.360 generating cash to support the new thing. So while we're 0:07:44.400 --> 0:07:48.080 growth investors, we're not growth at any price. We're not 0:07:48.280 --> 0:07:51.120 looking for companies that just have the new thing. We're 0:07:51.160 --> 0:07:55.040 looking for companies that have that established business and that 0:07:55.200 --> 0:07:59.960 helps us with downside protection as well. And we're prepared 0:08:00.240 --> 0:08:03.960 to look beyond the typical Wall Street model of a 0:08:04.040 --> 0:08:09.560 year or two to give the new thing time to develop, 0:08:10.240 --> 0:08:14.400 and that can be a year or two or even 0:08:14.800 --> 0:08:19.480 three or four. And so that's the first thing that 0:08:19.520 --> 0:08:22.960 we look for. And then secondly a big market. Can 0:08:23.000 --> 0:08:25.040 the company grow to be five to ten times its 0:08:25.040 --> 0:08:27.200 current size, because if we're going to be invested for 0:08:27.280 --> 0:08:32.200 ten years, the company with success needs to grow. And 0:08:32.240 --> 0:08:36.800 then third, great management. Every investor says they invest in 0:08:36.840 --> 0:08:42.120 great managers. To me, the shortcut is founders, family or 0:08:42.240 --> 0:08:46.679 long tenured, because they tend to think long term. Like 0:08:46.960 --> 0:08:50.400 we want to be invested, we need to be careful 0:08:50.960 --> 0:08:57.079 that they're not just self dealing and controlling management team. 0:08:57.480 --> 0:09:02.520 But we've had great success with that class of management 0:09:02.640 --> 0:09:05.880 and then the final criteria is investing in a margin 0:09:05.920 --> 0:09:09.920 of safety price and that can come from the balance sheet, 0:09:09.960 --> 0:09:12.680 it can come from the value of the established business 0:09:14.080 --> 0:09:20.000 or other areas as well. So ideally it's it's it 0:09:20.000 --> 0:09:23.760 looks like a boring stock, it's got a flat stock chart, 0:09:24.760 --> 0:09:28.320 the market's not excited about what they're doing. But it's 0:09:28.360 --> 0:09:31.480 also not something that's been cast aside. That's a that's 0:09:31.520 --> 0:09:34.200 a falling knife. So that's that's what we look for, 0:09:34.280 --> 0:09:37.040 and then we look for the for the transition, and 0:09:37.120 --> 0:09:39.319 then then the further transition. 0:09:39.640 --> 0:09:41.400 And what do you think might be in store for 0:09:41.480 --> 0:09:44.640 small cap stocks as a whole going into twenty twenty five. 0:09:44.679 --> 0:09:46.640 Do you see any catalysts on the horizon that might 0:09:46.640 --> 0:09:48.319 help narrow the gap with the S and P five 0:09:48.400 --> 0:09:50.360 hundred Michael. 0:09:50.080 --> 0:09:54.680 That's a great question. I tend not to pay much 0:09:54.760 --> 0:09:59.199 attention to the macro side of things and very focused 0:09:59.320 --> 0:10:08.599 on on the companies and a few specific tailwinds sector tailwinds. 0:10:09.520 --> 0:10:11.680 I think there's one thing that we can point to, 0:10:11.880 --> 0:10:16.640 which is small companies have have typically benefited from M 0:10:16.679 --> 0:10:23.040 and A and with the change potential change at the FTC, 0:10:24.000 --> 0:10:28.559 there may be more opening for small companies to be acquired, 0:10:29.880 --> 0:10:33.920 and it's been even our small companies that really it's 0:10:33.960 --> 0:10:38.400 hard to imagine any kind of market dominance or monopoly 0:10:38.520 --> 0:10:43.079 kind of situations. The M and A has just been tough. 0:10:44.360 --> 0:10:48.000 But I think that that's one element that could could 0:10:48.080 --> 0:10:51.920 help small small caps. But we see lots of opportunity, 0:10:52.320 --> 0:10:55.640 plenty of companies that meet our criteria that we think 0:10:55.679 --> 0:10:57.600 will provide great returns over time. 0:10:58.480 --> 0:11:00.240 What did have a follow up? You know, one of 0:11:00.280 --> 0:11:02.760 the things you mentioned was, you know, having kind of 0:11:02.760 --> 0:11:05.800 that margin of safety in terms of valuations. Are there 0:11:05.800 --> 0:11:09.319 are specific metrics you use when you're looking at valuations. 0:11:12.160 --> 0:11:14.440 There are many things that we look at. So we 0:11:14.480 --> 0:11:17.000 will when we first enter, we'll look at the balance 0:11:17.040 --> 0:11:21.280 sheet and potentially we can find hidden real estate value 0:11:21.400 --> 0:11:24.360 or something that's not recognized. I'll look at some of 0:11:24.400 --> 0:11:28.240 the parts because we'll have the established business and then 0:11:28.640 --> 0:11:31.440 project what we think the new thing can look like. 0:11:32.200 --> 0:11:36.680 We will look at enterprise value to EBIT. Enterprise value 0:11:36.679 --> 0:11:41.000 to revenue, particularly useful for a company that's under earning, 0:11:41.200 --> 0:11:43.920 which many of ours will be. When we first purchase 0:11:44.520 --> 0:11:50.920 enterprise value to EBITDA. But then as Charlie Munger says 0:11:50.960 --> 0:11:56.280 about EBITDA. It is something bulld ebit DA, and you 0:11:56.400 --> 0:11:58.520 have to be very careful that it's not all just 0:11:58.600 --> 0:12:03.080 getting plowed back into to stock comp or cap X. 0:12:03.679 --> 0:12:08.360 But a unique thing that I look at is a 0:12:08.480 --> 0:12:14.000 Berkshire Hathaways, a form of Berkshire Hathaways owner's return on 0:12:14.120 --> 0:12:20.760 capital which takes into account capital spending, maintenance capital spending, 0:12:20.840 --> 0:12:28.360 and expansion capital spending, and major movements in cash flows. 0:12:28.440 --> 0:12:33.320 So we're not so much looking at an annual cash 0:12:33.360 --> 0:12:38.120 flow as cash flow over the cycle of this investment 0:12:38.160 --> 0:12:39.000 that we're looking at. 0:12:42.240 --> 0:12:45.520 Did the election or any of the proposed policies of 0:12:45.559 --> 0:12:48.520 the incoming administration change any of your investment thesies. 0:12:49.000 --> 0:12:53.400 I mean, we're really looking out longer term, and I 0:12:53.440 --> 0:12:57.840 think this changed in the FTC maybe something, but other 0:12:57.920 --> 0:13:01.480 than that, not really so much. I might just mention 0:13:01.600 --> 0:13:07.840 though that. So I described the strategy tactically for I've 0:13:07.880 --> 0:13:12.760 managed the fund now for fifteen years, and we've really 0:13:12.800 --> 0:13:19.920 been focused on infrastructure broadly defined. And yes we're growth, 0:13:20.080 --> 0:13:25.680 so we have some elements of physical infrastructure concrete, roads 0:13:25.720 --> 0:13:29.520 and construction companies, small bit of that, but lots of 0:13:29.640 --> 0:13:35.760 technology infrastructure and that has meant data centers and semiconductor 0:13:36.440 --> 0:13:41.640 manufacturing going back for fifteen years and even before that 0:13:41.679 --> 0:13:47.000 in my previous experiences, those have been important areas, and 0:13:47.040 --> 0:13:52.400 I just mentioned data centers. It was a good business, 0:13:52.520 --> 0:13:56.280 somewhat cyclical, we really liked the business. And then in 0:13:56.360 --> 0:14:00.679 twenty seventeen the hyperscalers started to build out, and then 0:14:00.760 --> 0:14:06.040 in twenty twenty one came AI and we think we're 0:14:06.040 --> 0:14:10.000 still in very early stages of data center build out 0:14:10.360 --> 0:14:18.280 and semiconductor manufacturing has lots of tailwinds and it happened. 0:14:18.400 --> 0:14:24.760 It also somewhat cyclical still but major tailwinds for leading 0:14:24.880 --> 0:14:30.640 edge and for regionalization and really helping the data center 0:14:30.680 --> 0:14:35.040 build out too. So infrastructure broadly defined, and then we 0:14:35.120 --> 0:14:40.320 have some labs and fabs for other industries too, but 0:14:40.840 --> 0:14:44.040 that's a major area of focus. So it's the companies 0:14:44.080 --> 0:14:47.480 that are behind the scenes supplying the engineering tools and 0:14:47.520 --> 0:14:55.640 the manufacturing tools and manufacturing services that we're invested in, 0:14:55.920 --> 0:14:59.120 which means we're going to miss the hot new consumer 0:15:00.320 --> 0:15:05.880 app but we've found that the cap X and where 0:15:05.880 --> 0:15:09.840 we invest there's there's more durability to it and it 0:15:10.000 --> 0:15:14.920 matches what Needham is strong at and it also remembering 0:15:14.960 --> 0:15:19.800 my background for chip design software matches my background too. 0:15:19.920 --> 0:15:21.880 And what do you see is maybe the biggest risk 0:15:21.960 --> 0:15:24.440 of stocks or maybe your portfolio and some of the 0:15:24.440 --> 0:15:26.960 calls that you have in there in the coming year. 0:15:27.280 --> 0:15:31.200 We really try to look beyond a year. So uh, 0:15:32.320 --> 0:15:36.160 we're currently I mean, what has what what hurt a 0:15:36.280 --> 0:15:42.480 bit last year? Two elements. First, the industrial economy is 0:15:42.680 --> 0:15:47.960 not robust and UH, you know we've we've seen weakness. 0:15:48.440 --> 0:15:55.760 There's housing and autos are two areas that then ripple through. UH. 0:15:55.880 --> 0:15:59.560 And then the other element is consumer and UH in 0:15:59.600 --> 0:16:05.880 particular killer the lower income consumer has also been suffering. 0:16:06.560 --> 0:16:10.160 And I don't know that either of those is there's 0:16:10.320 --> 0:16:15.240 tailwinds in the next six months. So those those are 0:16:15.320 --> 0:16:18.840 those are probably the biggest concerns. UH. And then if 0:16:18.840 --> 0:16:20.720 you want to if you do want to look at macro, 0:16:20.840 --> 0:16:24.800 you probably have to look at the increasing the tenure 0:16:25.840 --> 0:16:31.080 as it's creeping up at four seven and potentially heading higher. 0:16:31.120 --> 0:16:35.000 There's there's a lot of depth to to to refinance. 0:16:36.160 --> 0:16:39.880 But I try to look forward now the five to 0:16:39.960 --> 0:16:43.840 ten years and assume that everything that things will be 0:16:43.960 --> 0:16:46.640 normal when you look out there. 0:16:48.880 --> 0:16:52.120 Yeah, and are there any sectors you find particularly compelling. 0:16:52.160 --> 0:16:54.720 I was looking through a little bit of your portfolio characteristics. 0:16:54.760 --> 0:16:57.800 I know you're you're have you into tech, So maybe 0:16:57.840 --> 0:17:00.320 outside of tech, are there any you know, sectors that 0:17:00.320 --> 0:17:01.520 that you really like at the moment? 0:17:02.040 --> 0:17:07.359 I like so as I described infrastructure, broadly defined picks 0:17:07.400 --> 0:17:15.120 and shovels that enable the big, high profile industries. An 0:17:15.240 --> 0:17:18.520 area where we added a few new investments last year 0:17:18.840 --> 0:17:25.000 relates to skilled labor, and I can highlight a couple 0:17:25.080 --> 0:17:27.480 of companies that were new additions in the last couple 0:17:27.480 --> 0:17:32.280 of quarters. One is Lincoln Tech and the others Universal 0:17:32.480 --> 0:17:37.800 Technical Institute UTI. And these are the skilled labor trade 0:17:37.840 --> 0:17:44.879 schools and small market penetration, big big need for the 0:17:45.000 --> 0:17:51.239 country and strong growth prospects, and they were kind of 0:17:51.280 --> 0:17:57.520 thrown away in the mid two thousands when with all 0:17:57.560 --> 0:18:02.840 of the for profit institutions. But these companies provide a 0:18:02.880 --> 0:18:07.399 real service and value. They could also benefit from a 0:18:07.600 --> 0:18:11.800 change in administration. So those are a couple. And then 0:18:11.880 --> 0:18:15.320 we have a small company that provides hazardous gas detection 0:18:16.080 --> 0:18:21.679 companies called black Line Safety that has strong growth, gaining 0:18:21.720 --> 0:18:26.080 market share and provide safety for those for those workers. 0:18:26.280 --> 0:18:33.520 So that's that's one area, as you earth. Yeah, just briefly, 0:18:33.520 --> 0:18:36.520 I'll mention another that's related to that, which is construction 0:18:36.800 --> 0:18:44.240 services and a data center of semiconductor manufacturing, life sciences manufacturing. 0:18:45.560 --> 0:18:49.720 Lots of we in the country need a lot of 0:18:51.320 --> 0:18:56.680 new manufacturing facilities. So we have invested in a couple 0:18:56.680 --> 0:19:01.639 of spinouts from utilities. One is the Everest Construction Group, 0:19:01.680 --> 0:19:07.280 which spun out of the Montana Dakota Utility MDU, and 0:19:07.400 --> 0:19:12.280 another is Century which spun out of Southwestern Gas. And 0:19:12.359 --> 0:19:19.719 so these these are construction services companies. Jacob's Solutions is 0:19:19.760 --> 0:19:24.399 a third. Matrix Services is another. So I think that 0:19:24.680 --> 0:19:29.320 construction services are an important area that we've invested in 0:19:29.359 --> 0:19:30.000 the last year. 0:19:30.520 --> 0:19:34.400 Earlier, you kind of alluded towards, you know, helping kind 0:19:34.400 --> 0:19:36.959 of protect the downside, and so I'm just curious if 0:19:37.000 --> 0:19:40.320 you had any processes in place to, you know, in 0:19:40.400 --> 0:19:42.400 terms of handling risk or volatility. 0:19:43.480 --> 0:19:47.120 Yeah, it's it's really around the companies. When we buy them, 0:19:47.119 --> 0:19:52.320 we're buying them with that margin of safety and and 0:19:52.680 --> 0:19:56.080 that that has helped. This leads to the question of 0:19:56.119 --> 0:20:01.240 portfolio construction too. So when we first purchase, we will 0:20:01.760 --> 0:20:06.520 buy a fifty thirty to fifty basis point position, and 0:20:06.560 --> 0:20:10.359 we can take a year to build a position small cap, 0:20:12.200 --> 0:20:15.680 maybe not so liquid. If they run away from us, 0:20:15.760 --> 0:20:20.760 it's unfortunate, but oftentimes we have that time to take 0:20:21.560 --> 0:20:26.440 and so we'll get our entry price, and that will 0:20:26.760 --> 0:20:30.960 those entry level those hidden compounders may grow up to 0:20:31.119 --> 0:20:35.360 two hundred basis points, and then in the transition they 0:20:35.400 --> 0:20:38.639 may go up to three to four hundred. And we'll 0:20:38.640 --> 0:20:45.920 be adding purchases in the late hidden and early transition phases, 0:20:46.359 --> 0:20:50.240 and once they're into the quality they may be a 0:20:50.320 --> 0:20:53.399 larger market cap, so we're not purchasing anymore, and the 0:20:53.440 --> 0:20:56.760 market is more recognizing, so we're not purchasing more. So. 0:20:57.000 --> 0:21:02.760 The risk protection comes from the valuation sensitivity at the beginning, 0:21:02.840 --> 0:21:06.480 and then the portfolio construction, which keeps those early stage 0:21:06.520 --> 0:21:12.800 companies small in the portfolio so damage is limited. About 0:21:12.840 --> 0:21:15.840 half of the hidden make it to the next stage, 0:21:16.680 --> 0:21:20.400 and then we do have some doozy of losers in 0:21:20.480 --> 0:21:23.879 the tail of those hidden that don't make it, but 0:21:24.040 --> 0:21:27.520 most of them we're getting our money back or a 0:21:27.560 --> 0:21:31.919 significant portion of it, or making a small game. But 0:21:32.440 --> 0:21:37.160 the real returns from the portfolio come from those half 0:21:37.240 --> 0:21:42.440 that make it to transition and then the twenty five 0:21:42.520 --> 0:21:45.240 to thirty percent of those that make it into the 0:21:45.359 --> 0:21:53.240 quality stage. And over half of the outperformance has come 0:21:53.359 --> 0:21:58.240 from about twenty companies that we've invested in over this 0:21:58.440 --> 0:22:05.200 fifteen years. It ranged from five to one hundred baggers 0:22:05.680 --> 0:22:10.400 based on the first purchase. So the risk control really 0:22:10.440 --> 0:22:17.440 comes from that valuation sensitivity, but then letting the real 0:22:17.520 --> 0:22:22.639 winners go and produce outside the returns. 0:22:24.800 --> 0:22:27.360 So how do you handle CELL decisions? You know with 0:22:27.440 --> 0:22:30.119 both you mentioned you know there are some losers, but 0:22:30.200 --> 0:22:33.000 also when you have a company that hits that quality stage, 0:22:33.280 --> 0:22:34.920 how do you determine when to sell those? 0:22:35.440 --> 0:22:40.840 Yeah, and sometimes valuation can seem stretch. But for me, 0:22:41.200 --> 0:22:45.040 I've learned its best not to pay that much attention 0:22:45.200 --> 0:22:50.480 to it because sometimes, and in these twenty or so cases, 0:22:51.080 --> 0:22:56.760 the fundamentals catch up with that valuation that seems stretched. 0:22:56.760 --> 0:23:01.680 So Cell discipline. Once they hit ten percent of the portfolio, 0:23:02.200 --> 0:23:05.159 and we've had a few that have, we will we 0:23:05.200 --> 0:23:10.360 will trim and hold it back there. When we're also 0:23:10.400 --> 0:23:17.080 a diversified industry fund, so we're limited to you can 0:23:17.119 --> 0:23:20.280 have position. Once a position is over five percent, you 0:23:20.320 --> 0:23:25.080 really don't buy more of it, so that provides risk 0:23:25.119 --> 0:23:29.639 control as well. And then when we are a small 0:23:29.680 --> 0:23:33.160 cap fund, categorized as a small cap fund, so when 0:23:33.200 --> 0:23:36.720 they cross eight to ten billion in market cap, we 0:23:36.800 --> 0:23:40.679 can still hold them, but we're not buying any anymore. 0:23:41.000 --> 0:23:45.119 And so that's Those are some of the main elements. 0:23:45.200 --> 0:23:48.560 And do you have any major takeaways from the third 0:23:48.600 --> 0:23:51.399 quarter earning season or what are you watching maybe as 0:23:51.440 --> 0:23:55.320 the fourth quarter results roll in? Are there any concerns there, 0:23:55.560 --> 0:23:56.760 you know, anything specifically. 0:23:57.320 --> 0:24:00.280 I mean, as I mentioned before, we're looking for any 0:24:00.480 --> 0:24:11.160 type of turn in industrial economy, specifically autos chemicals, and 0:24:12.400 --> 0:24:17.320 any relief for the for the lower income consumer. So 0:24:17.800 --> 0:24:21.200 any any green shoots that we see there we're watching 0:24:21.240 --> 0:24:23.679 for in the portfolio and out of it, of course. 0:24:26.000 --> 0:24:27.480 And we talked a little bit about M and A 0:24:27.560 --> 0:24:30.159 already and how that might pick up a little bit 0:24:30.240 --> 0:24:33.639 in twenty twenty five and beyond. Do you see maybe 0:24:33.800 --> 0:24:36.040 the same happening for I POS or track I POS 0:24:36.119 --> 0:24:39.600 kind of as a long term Yeah, so flow into. 0:24:39.440 --> 0:24:43.240 Russell I love to me so my interest in the 0:24:43.320 --> 0:24:46.960 ventures side. We love to meet private companies. We like 0:24:47.000 --> 0:24:50.160 to get to know them when they're private. So we 0:24:50.440 --> 0:24:52.960 know what to do when they when they go public, 0:24:54.000 --> 0:24:57.520 and it also helps helps you understand what's going on 0:24:57.560 --> 0:25:01.000 in the market if you're actively in interested in private 0:25:01.080 --> 0:25:06.000 companies and then taking them into the public market. It 0:25:06.119 --> 0:25:11.440 has been it's been a tough time in particular. We 0:25:11.600 --> 0:25:15.280 love a great small cap I PO that the big 0:25:15.320 --> 0:25:18.320 guys aren't focused on and the headlines aren't focused on, 0:25:18.520 --> 0:25:22.600 and doesn't run away from you. We're optimistic that the 0:25:22.640 --> 0:25:26.760 new year will will bring some Yeah, and you know, Michael, 0:25:26.880 --> 0:25:30.080 just to add further on that, I think we're also 0:25:30.280 --> 0:25:33.920 probably in a good position for some more high profile 0:25:34.720 --> 0:25:41.960 I pos the of the larger caps, and we will 0:25:42.000 --> 0:25:46.159 follow them and be interested in them. But that no, 0:25:46.400 --> 0:25:51.480 that's not what we do. But freeing up the mag 0:25:51.640 --> 0:25:55.720 seven to to do M and A would be a 0:25:55.760 --> 0:25:58.840 good a good thing for small caps. 0:26:00.440 --> 0:26:02.000 So we you know, we still have a little bit 0:26:02.000 --> 0:26:04.359 of time left. So there's one question I wanted to 0:26:04.400 --> 0:26:06.560 ask as well as you know, if we talk about 0:26:06.600 --> 0:26:08.480 market caps, one of the things I've looked at with 0:26:08.600 --> 0:26:12.080 small cap funds is there are a lot of companies 0:26:12.080 --> 0:26:15.240 with larger market caps than we've seen historically. If you 0:26:15.280 --> 0:26:18.720 go back ten twenty years do you think small cap 0:26:18.760 --> 0:26:22.960 companies are just generally getting bigger compared to historical market 0:26:23.040 --> 0:26:25.600 caps or is this kind of, you know, the way 0:26:25.600 --> 0:26:27.879 things are going to be until there's more m and 0:26:27.920 --> 0:26:29.399 a activity in small caps. 0:26:30.480 --> 0:26:34.640 Yeah. I think Socks Sarvey inz Oxley when it was implemented, 0:26:35.119 --> 0:26:37.920 put extra expenses which made it hard to go public 0:26:38.520 --> 0:26:43.240 as a smaller company. And then this rise of capital 0:26:43.280 --> 0:26:51.240 that's available for late stage venture and private equity allows 0:26:51.280 --> 0:26:58.479 companies to stay private longer. So it's definitely a trend. 0:26:58.960 --> 0:27:03.639 But we still there's plenty of small caps. And the 0:27:03.720 --> 0:27:07.679 other element is that funds have gotten larger. Pools of 0:27:07.720 --> 0:27:11.040 capital are just larger, so they can't afford to spend 0:27:11.080 --> 0:27:14.840 the time to get to know the small and micro 0:27:15.080 --> 0:27:20.680 caps like we can. And so I think there's still 0:27:20.920 --> 0:27:25.800 great opportunity in small caps, despite the fact it's very 0:27:25.800 --> 0:27:28.879 different than when I started on the buy side over 0:27:29.119 --> 0:27:33.359 twenty years ago. And you'd have plenty of one hundred 0:27:33.359 --> 0:27:36.439 to two hundred million dollar market cap companies and at 0:27:36.440 --> 0:27:41.920 this point those are considered micro caps. But we'd love 0:27:42.640 --> 0:27:46.359 fishing in that pond because those are the ones where 0:27:46.400 --> 0:27:48.680 you can get the fifty to one hundred x if 0:27:48.720 --> 0:27:49.800 you get the right ones. 0:27:52.000 --> 0:27:54.919 Definitely. Well, we just have one question before we let 0:27:55.000 --> 0:27:57.919 you go. We'd love to know what some of your 0:27:57.920 --> 0:27:59.480 favorite financial books have been. 0:28:01.200 --> 0:28:04.920 Great question. I love that question. Well, so I'll start 0:28:05.000 --> 0:28:10.280 with the Berkshire Hathaway Letters, and I think they're essential 0:28:10.440 --> 0:28:14.520 reading for anyone interested in breaking into this business. And 0:28:14.560 --> 0:28:17.840 then I'll go with any of the Warren Buffett and 0:28:17.960 --> 0:28:21.320 Charlie Munger biographies, and I'll just highlight a couple of 0:28:21.320 --> 0:28:24.119 amonger ones because there aren't quite so many. One is 0:28:24.400 --> 0:28:29.840 Poor Charlie's Almanac, and then the second is Damn damn right, 0:28:31.320 --> 0:28:36.440 and there is only a third. So I would read 0:28:36.480 --> 0:28:40.120 as much about Charlie as about Warren. I think Seth 0:28:40.240 --> 0:28:45.000 Klarman's margin safety is important. But you can't buy the 0:28:45.040 --> 0:28:48.000 book because it is only an original print and they 0:28:48.040 --> 0:28:50.920 cost a thousand dollars, but you can find the PDF 0:28:51.560 --> 0:28:56.400 out there. I think Christopher Meyer's one hundred Baggers is 0:28:57.240 --> 0:29:01.200 a good one. And then there's a book called the 0:29:01.320 --> 0:29:05.360