Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: their processes, challenges, and philosophies and security selection. I'm David
Speaker 1: cone I, lead mutual fund and active research at Bloomberg Intelligence.
Speaker 1: Today my co host is Michael Casper, sector and small
Speaker 1: cap strategist at Bloomberg Intelligence. Mike, thanks for joining me today.
Speaker 2: Thanks dude.
Speaker 1: So you wrote a note last week talking about small
Speaker 1: caps in the election, and so you know, I think
Speaker 1: our audience would probably love to hear or how the
Speaker 1: election has affected small cap stocks.
Speaker 2: Yeah. So from a technical standpoint, I'll go over that first.
Speaker 2: The Russell two thousand has broken out of pretty much
Speaker 2: it's twenty twenty four range and is approaching all time
Speaker 2: highs pretty much. That's the only resistance that we're seeing
Speaker 2: in the chart for the Russell two thousands to the upside.
Speaker 2: RSI is still a little bit shy of where it
Speaker 2: tops out, typically above a seventy handle. We're currently sitting
Speaker 2: at about a sixty seven handle on RSI, and mac
Speaker 2: D has crusted over the signal line and positive. So everything,
Speaker 2: at least from a technical standpoint looking pretty good. We
Speaker 2: did a little bit of analysis though on Trump's first
Speaker 2: term and how small caps did. Of course, his initial
Speaker 2: election back in twenty sixteen caused some hope for the
Speaker 2: Rust of two thousand going into his first term about
Speaker 2: tax reform and maybe some protectionist policies that could help
Speaker 2: a reshoring effort towards small caps. We really saw that
Speaker 2: play out from twenty sixteen into early twenty eighteen, where
Speaker 2: small caps had a big cycle of outperformance, but from
Speaker 2: then on it was a bit more rocky for the
Speaker 2: Russell two thousand. Fundamentally, this definitely did show up in
Speaker 2: revenue growth numbers. They exceeded the S and P five
Speaker 2: hundreds revenue growth for a pretty good stretch from twenty
Speaker 2: seventeen to twenty eighteen. So kind of hoping that some
Speaker 2: of that comes back, But again a bit of a
Speaker 2: bumpy ride at least from when Terra started getting announced onwards,
Speaker 2: and of course there was a lot of monetary policy
Speaker 2: and other stuff going on at the same time, so
Speaker 2: it can't be all attributed to Trump's trade and fiscal policies.
Speaker 1: It'll be interesting to watch, but I think we'll talk
Speaker 1: a little bit more about small caps with our guest today,
Speaker 1: and with that, I'd like to welcome David Green. David
Speaker 1: is a principle of Hotchison Wiley and a portfolio manager
Speaker 1: on the small cap value, value Opportunities and international value portfolios. David,
Speaker 1: thanks for joining us today.
Speaker 3: It's my pleasure great to be here.
Speaker 1: I'm sure our listeners would love to hear how you
Speaker 1: got your start in the investment business.
Speaker 4: Well, I got my start at a very young age.
Speaker 4: My dad was a physicist by trade, but he loved
Speaker 4: to invest in the stock market. And I grew up
Speaker 4: here in Los Angeles, and the market opens about six thirty.
Speaker 4: It opens at six thirty in the morning here, and
Speaker 4: he would have me sit in front of the TV.
Speaker 4: It wasn't there was no CNBC, there was no Internet.
Speaker 4: But when he was getting ready for work and before
Speaker 4: I went to school, he would say, can you just
Speaker 4: watch these tickers and tell me you know what g
Speaker 4: is when it comes by, or what Coca cola is
Speaker 4: when it comes by.
Speaker 3: And so before I.
Speaker 4: Knew it, I went from not only following the box
Speaker 4: scores of all my Major League of the Major League
Speaker 4: Baseball teams, but the stock quotes and the newspapers the
Speaker 4: next morning, and I got very interested. I then went
Speaker 4: on to college at Berkeley and I studied economics, and
Speaker 4: then I went first to Potential Investment Corp, then to
Speaker 4: Goldman Sachs, and then to Hotchkison Wiley, were I've been
Speaker 4: for twenty seven years now, and all but one year
Speaker 4: of that time I've been on the public market side.
Speaker 4: So I was able to turn what cultures started as
Speaker 4: a as a spark from a hobby that my dad
Speaker 4: had into my own passion and make.
Speaker 3: A career out of it.
Speaker 1: Great. Well, you know you mentioned Hodgkisson Wiley, and you
Speaker 1: know that's what we're going to be talking about today.
Speaker 1: Could you kind of give us a brief overview of
Speaker 1: the equity investment philosophy of the firm?
Speaker 3: Sure?
Speaker 2: So.
Speaker 4: Hotkinson Wiley was founded by John Hotchkinson George Wiley in
Speaker 4: nineteen eighty and they founded on it on a value philosophy.
Speaker 4: And if you go back, you know, well before Hotchkinson
Speaker 4: Wiley's founding, we have data that goes back actually to
Speaker 4: nineteen twenty six, almost one hundred years now. Value has
Speaker 4: been a very powerful force of outperformance in the market.
Speaker 4: Notwithstanding sort of the recent past but even if you
Speaker 4: include that recent past and you still go back, it's
Speaker 4: still significantly outperforms. And the idea is that if you
Speaker 4: buy a stock with a at a low price, you've
Speaker 4: got a built in margin of safety and it's very
Speaker 4: hard to predict the long term future. But when investors
Speaker 4: are paying very high prices for growth, oftentimes that growth
Speaker 4: does not materialize. And if you're buying something at a
Speaker 4: low valuation, you have you know, you have better chance
Speaker 4: that your downside is supported. And so that was the
Speaker 4: philosophy that originally started with the firm, and it's the
Speaker 4: DNA which continues to the firm. In the firm to
Speaker 4: this day, forty four years later. I would also say,
Speaker 4: as the firm has matured, we have spent an inordan
Speaker 4: amount of resources and investment on the research process. Today
Speaker 4: I I I. If you think about Hotchkisson, while I
Speaker 4: always say there's three things to think about. The first
Speaker 4: is value, the second is research, and the third is culture.
Speaker 4: And each one of those is integral and important to
Speaker 4: sort of who we are as a firm. But the
Speaker 4: research on the research side, we have twenty three people
Speaker 4: focused exclude on research, and this is a firm with
Speaker 4: under seventy people in the total firm, and in addition
Speaker 4: to those twenty three people, we also have six research associates,
Speaker 4: so we've got twenty nine people. Were almost half the
Speaker 4: firm focused exclusively on research, and it's really how we
Speaker 4: define ourselves. And when you think about a value stock,
Speaker 4: you always want to be careful that just because something
Speaker 4: is a low price doesn't necessarily make it a value.
Speaker 4: You don't want to end up with newspaper stocks that
Speaker 4: have a very bleak future. You don't want to end
Speaker 4: up with retail stocks that Walmart could be coming into
Speaker 4: their neighborhood. So the research side is very important because
Speaker 4: it says just because something is trading at a low
Speaker 4: price doesn't necessarily make it a value. So we spend
Speaker 4: a lot of time thinking about quality. And then the
Speaker 4: third thing is culture, and culture is very important and
Speaker 4: culture at our firm, and we have a very collegial firm.
Speaker 4: As I said, I've been there twenty seven years and
Speaker 4: the average employee ten year is very very long. People
Speaker 4: rarely leave Hotchkisson whilely. In fact, when we interview new people,
Speaker 4: one of the things they always ask is what do
Speaker 4: you do that you keep your people so long, and
Speaker 4: I think there's a couple of things. First of all,
Speaker 4: we spend a lot of time on the front end
Speaker 4: making sure we get the right person. But who is
Speaker 4: the right person? It's somebody who is very intellectually curious,
Speaker 4: wants to spend a lot of time doing research and
Speaker 4: thinking about things, but also is willing to work in
Speaker 4: a collegial team environment and understanding that if you have
Speaker 4: a long term view and you can keep your emotions
Speaker 4: at bay and always be respectful, that will lead to
Speaker 4: very good investment decisions over long periods of time.
Speaker 3: That's great.
Speaker 1: So I like to dig a little deeper. I know
Speaker 1: you're manager on three funds, but I think for the
Speaker 1: purpose of this discussion, we'd kind of want to focus
Speaker 1: in on more than domestic strategies. So if you could
Speaker 1: kind of give us kind of an idea of what
Speaker 1: the investment process is for the value opportunities and small
Speaker 1: cap value funds.
Speaker 3: Sure.
Speaker 4: So it's interesting, especially when you include small cap, because
Speaker 4: there's literally thousands of stocks out there to choose from,
Speaker 4: and so oftentimes when we're trying to find a stock,
Speaker 4: it will start with screens and we'll be screening on
Speaker 4: valuation things like priced to earnings, price to book. I
Speaker 4: would say the most important screen in my mind is
Speaker 4: something called enterprise value to operating income. Enterprise value being
Speaker 4: the market cap plus the debt minus the cash, because
Speaker 4: that will take into account sort of the entire balance sheet,
Speaker 4: and so we look at screens. In addition, we have
Speaker 4: these analysts who are so well versed in their individual
Speaker 4: coverage universe that they're constantly meeting with management teams, they're
Speaker 4: talking to suppliers, they're talking to competitors. So there's oftentimes
Speaker 4: stocks that will come that for some reason, it falls
Speaker 4: through the screens at bad data or whatever, and it
Speaker 4: will come in through the analysts will say, this is
Speaker 4: actually something that I discovered on my own, and so
Speaker 4: that will augment stocks that we add to the process.
Speaker 4: Once we've identify certain candidates that we think are interesting,
Speaker 4: the analyst will be tasked with putting In the short term,
Speaker 4: maybe it's under earning because the cycle is against it,
Speaker 4: and we expect that cycle to normalize.
Speaker 3: But over five years.
Speaker 4: Time, we think that we can normalize the earning's power.
Speaker 4: And also by looking out five years, it's long enough
Speaker 4: that we can normalize the cycle, but short enough that
Speaker 4: we have pretty good visibility. After five years, it gets
Speaker 4: tougher and tougher to project out, so the analysts will
Speaker 4: project that earnings for five years. In addition, we have
Speaker 4: built a proprietary scoring system called our Fundamental Risk rating system,
Speaker 4: and we look at three different things. In our fundamental
Speaker 4: risk rating system, we look at the quality of the business,
Speaker 4: we look at the balance sheet, and we look at
Speaker 4: the governments. And so the analysts will also be tasked
Speaker 4: with scoring according to this fundamental risk grading system. And
Speaker 4: there's a huge matrix that goes with each one of
Speaker 4: those individual components, and they will bring in that sort
Speaker 4: of deliverable to one of our six sector teams depending
Speaker 4: on where I it's in. And the six sector teams
Speaker 4: we have are capital, goods, consumer, healthcare, Energy, financials, and tech.
Speaker 4: So wherever it fits in, they'll bring it in and
Speaker 4: that sector team will then review peer review the financial
Speaker 4: model and the fundamental risk ratings. And I think what's
Speaker 4: unique here is the ANALYSI is not coming in with
Speaker 4: the recommendation. They're not saying you should buy X Y
Speaker 4: and Z stock. They're coming in they're saying, I think
Speaker 4: X Y and Z stock is going to earn you
Speaker 4: three dollars a share, and my margine assumption is they're
Speaker 4: going to do a ten percent ten percent operating margin
Speaker 4: and that will be what the debate is around. And
Speaker 4: because of the debate is all around sort of the
Speaker 4: financial projections and the matrix according to for the fundamental
Speaker 4: risk ratings, it doesn't end up being an emotional you
Speaker 4: should buy you should not buy. It ends up being
Speaker 4: a very almost like intellectual exercise, if you will, with
Speaker 4: some very healthy debate. And so once that is done,
Speaker 4: and once the earnings power is established by the sector
Speaker 4: team and the fundamental risk ratings have been established, it
Speaker 4: will then be up to the portfolio manager to decide
Speaker 4: where and how much that stock fits into the portfolio.
Speaker 2: So lots of people right now are worried about multiples,
Speaker 2: especially in the S and P five hundred. Do you
Speaker 2: share that concern or are you more in the camp
Speaker 2: that you know maybe the max seven gets add some
Speaker 2: productivity gains to lower that multiple. And kind of a
Speaker 2: second part of that is how do you think about valuations?
Speaker 2: Are there any specific metrics you like to use? I
Speaker 2: know you mentioned pees and price to books, but like
Speaker 2: to pick your brain on that one.
Speaker 4: Yeah, So when you look at the Magnificent seven, and
Speaker 4: first of all, we group and men I think there
Speaker 4: each one has its own individual story on individual.
Speaker 3: You know, opportunities and risk.
Speaker 4: But as a group, they clearly are well above the
Speaker 4: valuation both of the rest of the market and well
Speaker 4: above the valuation that they have been historically. And I
Speaker 4: think the biggest risk to that part of the market.
Speaker 4: They're clearly excellent companies. But the biggest risk is part
Speaker 4: of the market is you are pricing in a lot
Speaker 4: of growth for many, many years to come in order
Speaker 4: to justify that valuation, which means essentially that that's a
Speaker 4: very very long duration asset. And there's two things that
Speaker 4: could significantly upend the prospects for the for the valuation.
Speaker 3: There.
Speaker 4: Number one, the growth may not come come to fruition
Speaker 4: as people expect. And it's very hard to project out
Speaker 4: very long periods of time. I mean, it's hard to imagine.
Speaker 4: But in nineteen ninety nine, General Electric was the largest
Speaker 4: market cap, and you know, obviously there's you know, Cisco
Speaker 4: was one of the largest market caps. So things change,
Speaker 4: so trying to project out for long periods of time
Speaker 4: is difficult. In addition, if we do get a rise
Speaker 4: in interest rates when you have an asset that is
Speaker 4: that long duration, arise in interest rates will have a
Speaker 4: severe impact on the present value of that earning string.
Speaker 4: And so they'reible, They're susceptible from sort of two elements.
Speaker 4: And so I think that as a group, and again
Speaker 4: I'm speaking as a group, because each individual stock will
Speaker 4: have its own risks and merits. But as a group,
Speaker 4: I think I would say there is a lot of
Speaker 4: risk that in that part of the market. With regard
Speaker 4: to the rest of the market, the rest of the
Speaker 4: market in general looks like it's trading at about in
Speaker 4: line with its historical averages. So it's not which is
Speaker 4: very reasonable. And what is notable is not what the
Speaker 4: rest of the market is trading it relative to its
Speaker 4: own history. It's what the rest of the market is
Speaker 4: trading relative to the Magnificent seven.
Speaker 2: And do you think the election results changed the calculus
Speaker 2: at all for for small versus large? I kind of
Speaker 2: went to my shpiel before about the whole Trump first term,
Speaker 2: but interested to get your thoughts.
Speaker 4: Yeah, you know where I really think it's it's going
Speaker 4: to make a difference, is I think with regard to
Speaker 4: mergers and actuitions, and what you saw recently under the
Speaker 4: current administration was a really strict regulatory environment. Companies were
Speaker 4: either not allowed to merge or they saw what was
Speaker 4: going on and they chose not even to pursue an
Speaker 4: acquisition because they think they didn't think it would get
Speaker 4: through the regulatory agencies. So I think the fundamental difference
Speaker 4: be with the Trump administration is you're going to have
Speaker 4: much less regulation or much less onerous regulation with regard
Speaker 4: to companies merging. And for small caps that's important because
Speaker 4: when you think about how you can get your performance
Speaker 4: from small caps, one of the ways is if you
Speaker 4: have a stock that has a low valuation, there's always
Speaker 4: the opportunity that it can get bought and that a
Speaker 4: larger company can come by and say, you know, this
Speaker 4: doesn't make any sense. You know, I'm trading at a
Speaker 4: fifteen pe and this small cap stocks at an ape.
Speaker 4: I could buy it at a twelve pee and give
Speaker 4: fifty percent return to the small cap sharehold, and yet
Speaker 4: I can still buy something at a discount to my
Speaker 4: own stock price. So I think that's where will be
Speaker 4: one of the fundamental sort of opportunities for small caps
Speaker 4: that they really have not enjoyed in the recent last
Speaker 4: four years.
Speaker 1: I kind of want to go back to your process,
Speaker 1: and you know, kind of what you were talking about
Speaker 1: kind of sounds bottom up to me, and so I
Speaker 1: was kind of wondering, if you know, if you do
Speaker 1: consider macro themes as part of your evaluation or portfolio management.
Speaker 3: Yeah, it's interesting.
Speaker 4: So we don't start with the macro, but a lot
Speaker 4: of times the macro will drive certain themes within the portfolio.
Speaker 4: There was a time I remember when in the top
Speaker 4: ten we had three trucking stocks. Again, we weren't trying
Speaker 4: to buy trucking stocks, but that was what the macro
Speaker 4: was causing that part of the market to be out
Speaker 4: of favor. You might have a situation where let's say,
Speaker 4: like oil, is oil price as well normal. Let's say
Speaker 4: it's a forty or fifty dollars a barrel. It's not
Speaker 4: there today, but if it were, and people were investors
Speaker 4: were pricing oil as if it was going to stay there,
Speaker 4: when we would do our normal, which would be our
Speaker 4: normal right now assumption for oil as seventy five dollars
Speaker 4: a barrel, so at forty we would expect the price
Speaker 4: to come up because at forty people wouldn't invest. Likewise,
Speaker 4: if oil was one hundred and twenty dollars, we would
Speaker 4: expect it to revert down because people would invest and
Speaker 4: bring a lot of supply in. So when it's when
Speaker 4: the market is somehow divorced from its normal kind of
Speaker 4: where equilibrium, that will lead to situations where multiple stocks
Speaker 4: can get interesting. And so you might have if everybody
Speaker 4: was pricing in energy stocks at forty for a long
Speaker 4: period of time, you might have a situation where that
Speaker 4: part of the market would be. Energy stocks in general
Speaker 4: will be interesting to us. And it's not again that
Speaker 4: we would start with the macro, but it's that we
Speaker 4: would be led there by what the market is giving us.
Speaker 2: Are there any sectors right now that you find particularly compelling?
Speaker 3: Yeah, there's a couple. It's interesting.
Speaker 4: So, you know, when I talked about the research team
Speaker 4: and what we look for, we're looking for as high
Speaker 4: quality of business, we're looking for new things. We're looking
Speaker 4: for low valuation and high quality business. And it won't
Speaker 4: surprise anyone probably that the highest amongst the highest quality
Speaker 4: businesses we found are software businesses. Once you have a client,
Speaker 4: if it's if it's the right, software which is hard
Speaker 4: to get off of you tend to have very low
Speaker 4: schurn and very high gross margins. And interestingly enough, there
Speaker 4: are a couple of software companies that we own, Workday
Speaker 4: and F five, which we think are really interesting because
Speaker 4: people are not appreciating the fact that even though they
Speaker 4: have very high gross margins, they're operating margins are understating
Speaker 4: where they will be in normal and why is that.
Speaker 4: That's because they're spending a lot of money on marketing,
Speaker 4: so they're selling their product and they're spending a lot
Speaker 4: of money on sales, and they're also spending a lot
Speaker 4: of money on research and development. Both of those costs
Speaker 4: are going through the income statement. They're not being capitalized.
Speaker 4: If it was a chemical plant, you'd put it, it
Speaker 4: would be capex and it would be capitalized and it
Speaker 4: wouldn't go through the income statement until the plant was
Speaker 4: up and running.
Speaker 3: It was being depreciated over time.
Speaker 4: So this sort of quirk of accounting, if you will,
Speaker 4: has led us to an interesting part of the market,
Speaker 4: and I think that that is not totally understood. And
Speaker 4: then I would say the other area that is also
Speaker 4: interesting to us is there are certain energy stocks which
Speaker 4: right now, given how weak oil has been and how
Speaker 4: much the rest of the market has gone up, that
Speaker 4: are also interesting to us right now.
Speaker 2: And are there any signposts that you're looking for to
Speaker 2: signals shift from tech leadership to broaden to the rest
Speaker 2: of the stocks.
Speaker 4: So I think if the economy stays strong general economy,
Speaker 4: because tech has the leadership in tech has been a
Speaker 4: little bit of its own sort of sub sector, driven
Speaker 4: in many cases by AI. But if it brought if
Speaker 4: the economy stays strong in general, that will allow sort
Speaker 4: of the rest of the market to do well. And
Speaker 4: then the other thing I would say is if you
Speaker 4: want to look at where it could cause the multiples
Speaker 4: to compress relative to each other. Again, if you have
Speaker 4: interest rates increase, I think that will put pressure on
Speaker 4: the Magnificent seven relative to the rest of the market.
Speaker 1: I think I saw in the perspectives for their funds
Speaker 1: it did mention ESG, and so I was curious, you know,
Speaker 1: if ESG factors into the research at all.
Speaker 4: Yeah, So, you know, when you think about all of
Speaker 4: the risks that we're trying to compile, and we have
Speaker 4: our fundamental risk rating system, ESG is embedded in our
Speaker 4: fundamental risk rating system in the sense that if you
Speaker 4: have environmental consc NS. If a company is polluting, that
Speaker 4: is a true cost to the business and a true
Speaker 4: risk of the business. If a company in social is
Speaker 4: not treating its employees properly, that's true that business will
Speaker 4: have a difficult time sustaining itself if a company has
Speaker 4: bad governance. In fact, interestingly enough, in our fundamental risk
Speaker 4: rating system, governance is one of the three pillars that
Speaker 4: we actually it has its own pillar, and that's especially
Speaker 4: true when you talk about small caps, because governance is
Speaker 4: so varied.
Speaker 3: In small caps.
Speaker 4: You have the founder who started the company and took
Speaker 4: it public and he's still working, you know, twelve or
Speaker 4: fourteen hour days. He's taking a small salary, and he
Speaker 4: owns a lot of stock, and he's doing all the
Speaker 4: right things. To the founder who's cashed out, he's at
Speaker 4: the golf course, his children are running it and he
Speaker 4: may they may or may not be competent. But the
Speaker 4: point is you've got and he yet he still controls
Speaker 4: the board. And you have to do your due diligence
Speaker 4: and find out where each company fits in along that
Speaker 4: governance spectrum.
Speaker 3: And so we spend a lot of time doing.
Speaker 1: That, I also do want to ask about another type
Speaker 1: of risk. You know, the portfolios don't have you know,
Speaker 1: a huge amount of stocks in them, so I guess
Speaker 1: I was just wondering how you handle concentration risk.
Speaker 3: Yeah, that's a great question.
Speaker 4: And when we think about concentration risk, so what you
Speaker 4: want is when you do find a really compelling idea,
Speaker 4: you want to put a lot of capital into it.
Speaker 4: But what you don't want if you have a lot
Speaker 4: of capital in is you do not want to take
Speaker 4: a company specific risk when that exists. So there's really
Speaker 4: five things that we look at that we have to
Speaker 4: get comfortable with when we want to take a concentrated position.
Speaker 4: So the first is are we going in the stock
Speaker 4: at a significant discount to intrinsic value? Do we have
Speaker 4: good valuation? Because good valuation itself will serve as a
Speaker 4: margin of safety. So that's the first thing we look at.
Speaker 4: The second thing we look at is does the company
Speaker 4: have financial strength? Doesn't have a good balance sheet? I mean,
Speaker 4: just in the recent past, we've been through a financial crisis,
Speaker 4: we've been through a pandemic. Things can happen, and what
Speaker 4: you don't want is you might have a really undervalued stock.
Speaker 4: You might have a high quality business, but if it
Speaker 4: has a bad balance sheet and it comes into a problem,
Speaker 4: you still might get diluted significantly at the bottom, in
Speaker 4: which case you're going to lose a lot of money.
Speaker 4: So we want to make sure that the company has
Speaker 4: financial strength. The third is does the company have a
Speaker 4: high quality business model? If we turned off our Bloomberg's
Speaker 4: for five or ten years and came back and didn't
Speaker 4: look at a quote, what would the business look like?
Speaker 4: If we can't really figure that out, if we're like, well,
Speaker 4: they've got one or two customers and those customers could
Speaker 4: possibly go elsewhere, or they don't have the business they're
Speaker 4: competing in has ten competitors and right now they're in
Speaker 4: fourth place.
Speaker 3: That could be in sixth place, whatever it is.
Speaker 4: If they don't have a high quality business model, then
Speaker 4: we don't want to put a lot of capital into
Speaker 4: it because we won't have confidence of where they're going
Speaker 4: to be. The fourth thing is is management doing the
Speaker 4: right thing with the capital? Are they investing wisely? Are
Speaker 4: they thinking about a high cost merger or buying somebody
Speaker 4: else that will destroy our undervaluation. Are they investing in
Speaker 4: a plant that maybe is very risky, or are they
Speaker 4: husbanding their capital buying backstock using their capital with it
Speaker 4: they're not using to buy backstock to invest wisely?
Speaker 3: Are they doing the right things?
Speaker 4: And then the fifth thing is is there liquidity in
Speaker 4: the underlying security? So as we think about small caps,
Speaker 4: the further we go down in the market cap, the
Speaker 4: less liquidity we usually have buying and selling that stock.
Speaker 4: And so if we're going to have a big position
Speaker 4: in something, we want to make sure there's sufficient liquidity
Speaker 4: for us to get out of it if we change
Speaker 4: our mind, if something changes, So you know, it's more
Speaker 4: risky to be a big have a big weight in
Speaker 4: a small cap which is less liquid than in a
Speaker 4: large cap. So those are the things that we look
Speaker 4: at when we think about concentration. But if we do
Speaker 4: find a situation that really meets all of our criteria,
Speaker 4: then it becomes very interesting, and then you want to
Speaker 4: have concentration there because then you've you've looked at the
Speaker 4: risks and when it's not it's very difficult to find
Speaker 4: the things we're looking for, which is a very high
Speaker 4: quality company trading at a very low valuation. When you
Speaker 4: do find that, and your risks are somewhat mitigated or
Speaker 4: mostly mitigated.
Speaker 3: That's when you want to take a big position.
Speaker 2: So as a as a fundamental strategist myself, you know,
Speaker 2: I have some fair value models and basically looking out
Speaker 2: and putting in economist estimates, you get the rustle somewhere
Speaker 2: around twenty three fifty or so, so a little bit
Speaker 2: north of today's price. I'm just interested to get what
Speaker 2: your thoughts might be on where small caps might be
Speaker 2: going into twenty twenty five.
Speaker 4: Yes, so I think it's funny if you look back again.
Speaker 4: We've done this where you look back going back to
Speaker 4: nineteen twenty six, and we've broken it into quadrants, which
Speaker 4: is the value and growth, small and large by far,
Speaker 4: by a long ways, including again up until recently, so
Speaker 4: it includes all the growth out performance that you've seen recently.
Speaker 4: By far, small cap value is the best performing asset class.
Speaker 4: Now it hasn't been recently, but I think again that
Speaker 4: valuation discount relative to the large cap market the SMP
Speaker 4: is quite large today, quite large relative to history, so
Speaker 4: we think it's a very interesting place to be. In addition,
Speaker 4: small cap companies tend to be focused more on the
Speaker 4: domestic markets and the dollar has been very strong, so
Speaker 4: that will benefit them as opposed to a lot of
Speaker 4: these large cap multinational companies which are selling into Europe
Speaker 4: and selling into Japan, and the dollar has weakened, so
Speaker 4: those sales coming back into dollars are going to be
Speaker 4: more challenged.
Speaker 1: You know, we've kind of talked about where you think about,
Speaker 1: you know, how you invest in a stock. What would
Speaker 1: need to happen for a company to become a candidate
Speaker 1: to sell.
Speaker 4: Yeah, so's there's a few things. The ideal scenario is
Speaker 4: you invested in undervalued security, you had a thesis, the
Speaker 4: market wasn't recognizing what you saw. The thesis played out,
Speaker 4: the stock reached its value or close to its full value,
Speaker 4: and you sold it. So the first thing is does
Speaker 4: our discount to intrinsic value fall away? And when it does,
Speaker 4: that's a sale. The second time we might sell is
Speaker 4: we invested in a stock we had a thesis, and
Speaker 4: as time has gone on, we've realized that the thesis
Speaker 4: we originally bought it under is not coming to fruition.
Speaker 4: And basically, either things changed or we were wrong, and
Speaker 4: we no longer have confidence that the thesis will play
Speaker 4: out as we originally thought. And the third reason we
Speaker 4: might sell a stock is maybe maybe the we bought
Speaker 4: the stock at ten and still at ten, and maybe
Speaker 4: we think that thesis is still intact, but maybe the
Speaker 4: rest of the market got cheaper and all of a
Speaker 4: sudden we had other opportunities for our capital, and since
Speaker 4: capital is limited, we might we may decide to sell
Speaker 4: it because something else got more interesting. So those are
Speaker 4: usually the reasons that we would sell a stock.
Speaker 2: And what do you think the biggest risks are for
Speaker 2: stocks going forward?
Speaker 3: So I would say there's there's two risks.
Speaker 4: One of them is, you know, the the geopolitical situation
Speaker 4: throughout the world is tenuous. There's essentially, you know, two
Speaker 4: wars going on, and you know, we have been so
Speaker 4: insulated over here, but it's we have to recognize that
Speaker 4: there is a difficult geopolitical situation that could spiral at
Speaker 4: any time.
Speaker 3: Now it's hard to predict it.
Speaker 4: We don't think it will, but it certainly is a risk.
Speaker 4: And the second risk is, you know, the government is
Speaker 4: running very large deficits and has a very large debt balance,
Speaker 4: and so up until now it really has not had
Speaker 4: an issue with funding that and with issuing debt. But
Speaker 4: if at some point trying to fund that deficit puts
Speaker 4: causes interest rates to go up because the government is
Speaker 4: borrowing so much. I think that would be the other
Speaker 4: thing that would put a big risk factor into stocks.
Speaker 2: Okay, and do you have any major takeaways from the
Speaker 2: third quarter earning season?
Speaker 3: Yeah, it was interesting.
Speaker 4: It was an I would call this one of the
Speaker 4: most mixed earning seasons I've seen in a while. It
Speaker 4: was so interesting. We had companies report some up ten percent,
Speaker 4: depth some down ten percent, and there were I would say,
Speaker 4: you know, like we have some chemical companies that were
Speaker 4: more challenged, which are really tied to the economy, and
Speaker 4: so I would say that that the sort of the
Speaker 4: depth of strength of the economy was somewhat challenged. But
Speaker 4: then we had other pockets where that was there was
Speaker 4: contradictory signals on that. So I would say this was
Speaker 4: probably one of the more mixed earning seasons that I've
Speaker 4: seen in a long time.
Speaker 1: Well, I actually just have one more question before we
Speaker 1: let you go. You know, I think I know I
Speaker 1: do it. I'm sure Mike does, and I believe our
Speaker 1: audience would love to hear what your favorite investment investment
Speaker 1: books are yeah.
Speaker 4: So when I started out in the business, and I
Speaker 4: think somebody must have given me this recommendation, but it
Speaker 4: was one of the best recommendations I had.
Speaker 3: Again, it was before the internet. They said, go.
Speaker 4: Call up Berkshire Hathaway and see if they'll send you
Speaker 4: all of their old annual reports. So I did that
Speaker 4: and they mailed all of their old annual reports to me,
Speaker 4: and I started reading them and now whenever, and it
Speaker 4: was an unbelievable education. I mean, Warren Buffett is, you know,
Speaker 4: the best investor there is. He's also in addition to
Speaker 4: being a great investor, he's also an incredible teacher, which
Speaker 4: you realize as you read these. And he's also a
Speaker 4: fantastic writer. So whenever a young person says to me
Speaker 4: what should I read, I say, well, now you've got
Speaker 4: it easy. You just have to click on a few
Speaker 4: links and you could download all these shareholder reports and
Speaker 4: read the annual letters. But I would literally start from
Speaker 4: the first one and go up till the present day,
Speaker 4: and that would be the first thing i'd recommend. The
Speaker 4: second thing i'd recommend, which is going in a little
Speaker 4: bit of a different direction, And I don't know if
Speaker 4: you would consider this an investment book or not, but
Speaker 4: it's one of my favorites because it has so many
Speaker 4: themes that are similar to investing. Is the book Moneyball
Speaker 4: by Michael Lewis, which talks about the Oakland A's and
Speaker 4: how they were able to build a very competitive baseball
Speaker 4: team and make the playoffs even though they had a
Speaker 4: very low payroll, and they did it by taking advantage
Speaker 4: of factors that other people weren't valuing properly. And I
Speaker 4: think that's so relevant to how we try to invest
Speaker 4: in stocks.
Speaker 3: And again, Michael.
Speaker 4: Lewis also is a fantastic writer and a great storyteller.
Speaker 4: And then the third thing that I really enjoy is
Speaker 4: I really enjoy reading books kind of on business titans
Speaker 4: who've created these great businesses. So there's the book on
Speaker 4: Warren Buffett called The Snowball. There's the book Steve Jobs
Speaker 4: by Walter Isaacson, and then there's Sam Walton's autobiography. So
Speaker 4: those three books I've really enjoyed because they give you
Speaker 4: insights into three individuals who created enormous companies from scratch
Speaker 4: and what their vision was and what their determination was
Speaker 4: and how they did it and how they thought differently
Speaker 4: and how are they able to do that? So those
Speaker 4: were those would be some recommendations I would give.
Speaker 1: Well, it's definitely a great mix. This is a great discussion.
Speaker 1: I really appreciate having you on.
Speaker 3: What was my pleasure?
Speaker 1: And Mike, thank you for serving as my.
Speaker 3: Co host today.
Speaker 2: Yeah, thank you both.
Speaker 1: Until our next episode, This is David Cohne with inside
Speaker 1: actor