Value After Hours S06 E21: Brian Bares on Moats, Analytical Edges, and the Importance of Growth

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ABOUT TOBIAS CARLISLE
Tobias Carlisle is the founder of The Acquirer’s Multiple®, and Acquirers Funds®.
He is best known as the author of the #1 new release in Amazon’s Business and Finance The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, the Amazon best-sellers Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014) (https://amzn.to/2VwvAGF), Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012) (https://amzn.to/2SDDxrN), and Concentrated Investing: Strategies of the World’s Greatest Concentrated Value Investors (2016) (https://amzn.to/2SEEjVn). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law.

Prior to founding the forerunner to Acquirers Funds in 2010, Tobias was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions he has advised on transactions across a variety of industries in the United States, the United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New Zealand, and Guam.

He is a graduate of the University of Queensland in Australia with degrees in Law (2001) and Business (Management) (1999).

this meeting is being live streamed I am Tobias carile joined as always by Jake Taylor this is value after hours and our special guest today is Brian Bears of bears Capital Management Brian’s one of the biggest and best uh growthy small cap uh investors around we’re going to learn all of his Secrets over the next hour how are you Brian doing well thanks for having me good to have you bro have I have I accurately described you I know you’re not you wrote a book called the small cap Advantage but I know that you’re not purely small cap or you’re that’s you’re not you’re not small cap alone but you still have some interest in small caps I assume yeah I mean I think the characterization is is roughly accurate um you know we started the firm uh almost 24 years ago we’ll celebrate our 24th anniversary here in a couple weeks that’s no small feet yeah yeah yeah it’s uh you know still feel like the gritty startup but uh here we are out decades later um yeah so the uh the characterization is roughly accurate we started in in micro cap and then sort of moved up the cap Spectrum um we have two strategies small micro and mid-large mid-large is really a midcap strategy uh where we’re trying to have sort of an uncapped ability for the businesses to grow if we find the next great compounder and let it grow into small caps so while we pay attention to the mag s for obvious reasons competitive reasons the companies we own that sort of thing we’re not doing really anything in that sort of ultra llarge cap space so you can kind of think of us as a small cap manager that spans from micro to Mid so what’s your definition of micro and small and mid how do you how do you break this up yeah we um so the the you know the easiest and simplest thing to say is which is accurate as we just take the Russell 2000 Russell 1000 split as of the late reconstitution and anything below that is uh on limits for small micro anything above that is on limits for mid-large um you know kind of interesting that when I started Bears Capital our original strategy was a 10 Stock micro cap strategy and you know I looked at the crisp the center for research and securities prices uh data set and the ninth and 10th desiles representing the smallest 20% of the market by market cap the top of the ninth desile was about $176 million and today that’s more like 600 million and so these definitions you know change what does that come from the the expense of being public or is it more the just everything’s little like more global scale now is more achievable for businesses what what do you think that that or is it just there’s less businesses total that are publicly traded yeah it’s kind of kind of a lot of those things so the um you know what I’ve witnessed over you know my time at Bears capital is that the you know the cost of being public has gone up and so do Frank and and the you know Associated regulatory yep sarbanes um they uh you know it’s basically made it less and less appealing for the ultra small companies to to stay public and then obviously you have this Dynamic where you know it used to be advantageous to actually go out of the capital markets the public Capital markets and raise money earlier as a venture-backed firm and now obviously the swath of institutional money flowing into Venture um they’re allowing these businesses to raise money in various uh series that that allow them to sort of grow in terms of value and then finally go public you know probably you know 30 40 years ago Uber would have been public in the micro small cap space and then you know now with the Advent of VC they’ve just delayed and delayed and delayed until they’re larger companies um you know it it’s kind of interesting the Wilshire 5,000 which is the broadest definition of market cap or it was when I started the firm I think it had like 7600 companies or something like that um you know 25 years ago00 now or something yeah 4,000 or something like that and so um you know so so I think people look at that and by by the way the obviously the you know the um you know it it getting smaller is coming from the bottom up and so um people look at that say well micro cap is is less numerous and therefore less opportunity rich than it once was but the Practical implications of this are that you know when I started the firm I tried to sort of hand select those businesses in the Russell 2 the top of the Russell 2000 market cap or below that were truly investable for us and there were a lot of two three four five million do companies at that time that were just off limits even for for me with a small amount of capital um and so the real Universe was around 1,800 to 2,000 companies that made sense to us and that number is actually not that different today so like sort of legitimate companies that look investable to us um is that opportunity set really hasn’t changed all that much in fact actually just ran these numbers a couple of months ago over the holiday break while everyone else is you know celebrating I’m sitting here going through you know micro cap biotechs but um yeah the the um you know the roughly 1,00 companies that are kind of on limits for us um about one and seven is a micro cap Banker Thrift and that’s about the same number I think it was one and six when I started um the biotech space and one of the reasons I was focused on that is has actually grown significantly um as a percentage of smaller companies um and so now it was like 300 change uh biotech companies where that used to be probably 100 to 150 when I started 25 years ago and then there’s a bunch of commodity driven businesses and so if you sort of aggregate those up the investable universe we sort of pitch out another call it four to 500 companies that just don’t meet our basic criteria for uh our our process that is we can’t go into a regional Banker Thrift and gain some kind of variant perception the Returns on Capital in that space are pretty average and we’re looking for something that could compound at a more exceptional rate um you know we don’t have views despite our you know cus in Austin Texas on oil and gas or commodity based businesses so we we typically throw those out and um and then you know biotech one of the reasons I was sort of going through this is there’s a lot of pick and shovel businesses in biotech that are you know very researchable for us and I wanted to isolate those versus the ones that are you know sort of outcome business where there’s an FDA trial and it’s either thumbs up or thumbs down and and we we don’t have you know phds and biochemistry on staff to analyze those companies and there are specialist managers that do a great job in that area and so um so we were was kind of sifting through to see what we could feed into our our research pipeline so it’s really interesting like you hear people lamenting about the quality of the Russell like degrading but that composition shift kind of explains a little bit of like you know the financial statements from some of these biotech companies they’re going to look rough right I mean it’s it’s all losses it’s all until something big happens it’s all you know it’s this very binary outcome so it sort of makes sense why if you aggregate all these numbers they kind of look shittier than it did you know whatever 10 20 years ago yeah you know bi biotech had an awful 2023 as everybody knows um you know what when I was doing this work a couple of months ago was really interesting is I found seven net Nets like true Ben Graham net Nets where the you know the the market cap um adjusted for the you know for debt and cash was you know Le less than the net cash on the balance sheet and and I found I found seven of those that also had growing Revenue hold on I’m going to get a pen can you uh tell us what those names were give those yeah yeah just buy 100 chairs and cross your fingers um but you know it’s it’s it reminded me very much of the uh you know the story that I’d heard of what about a decade ago and Buffett did this similar exercise in Korea I think somebody sort of sent him a city city group compendium of of of Korean businesses and he just sort of sifted through there like turning the pages of value line and and found some net Nets and bought a baset of them and and it was it it very much sparked some pattern recognition in my mind in that time so Brian you’re probably best known for the work that you’ve done on Moes and finding an edge talk a little bit about that and also just smaller cap companies are always going to be a little bit earlier in their development they’re small a little bit earlier in their development can you just s sort of talk about the differences between your approach when you’re looking at the small and micro versus your approach when you’re looking at the mid and large should be a little bit more established a little bit further down the road sure so I should start by saying that you know as a as an investor you can have you know an edge in your information you know the actual data that you’re getting uh you can have an edge in analyzing that data differently than other people and then you can have some sort of Behavioral Edge that tries to take advantage of you know m in Market or human psychology expressed in the market and um you know what what I think people tend to get wrong when they think about smaller companies is that that there that the that the universes is ripe for information mispricing and I think that even when I started 25 years ago that is a generally incorrect statement that is um the market has been getting more efficient for a long time um and we can talk a lot about this if you want to which I think is one of the reasons why things like a rudimentary Price to Book value ratio has probably stopped working in the F French three Factor model for the last you know two and a half decades it’s just a a recognition that um you know the paramutual aspect of the market is incorporating uh investor expectations more and more efficiently over time and therefore a business that’s trading at a low multiple in relation to its Book value is more likely indicative of a business that’s under earning on its capital base in an economic decline than it is a sort of Ben gram indication of contan investment value which I think was always just a marker for a behavioral potential psychology contrarianism uh indicator in the market and so um so so we don’t think that that like there’s you it’s very rare let’s say that we come up with a true informational asymmetry where our work is uncovering you know some uh you know something in the footnotes that’s indic that’s nobody else has noticed or we did have a situation about 20 years ago where we went to a company in Fort Worth and they were like yeah I think you know we’re doing some exploration on company headquarters here and we may have hit the jackpot where there might be some natural gas under underneath the land or something thought you know like this might be the classic you know we we never invested but that was one of those in informational things where I was like okay maybe there is you know some shoe leather informational Advantage still available to people be coming back though a little bit Brian with like so much indexation and you know a lot of investors lamenting no one’s really doing the work anymore do you think it’s possible that that in that particular that information information uh asymmetry might be pendulum swinging back a little bit yeah you think about going to some of the meetings and like you know there’s nobody there hardly right nobody’s calling in on the meeting like it’s nobody’s paying attention yeah you know it’s funny I just this morning got a text from our uh one of our analysts at a um uh a company micro cap company annual annual meeting in Dallas and we are doing research on it and um he was one of two analysts there and they turned them both away because they don’t we don’t own shares and so they like the lawyer was like you know you can’t come in and so you know it’s stuff like that that makes me think well maybe there’s some information a symetry still available to people that have a resourced effort and are doing the hard work and so so I think you know I think the answer to your question is probably but um I think the broader answer is that there are so many people looking in this space compared to 25 years ago and the uh information dissemination is so much quicker uh with the Advent of all of these technology platforms that allow us all to collaborate and and share research and information and so um you know so the market adjusts and reacts much more quickly um and yeah and I absolutely reg FD and and what I would say is that um you know a true information a symmetry is usually illegal and we wouldn’t want to trade on it anyway and so um you know we we don’t obviously try and figure out what next quarter’s earnings are anything we’re we’re buying hold and we’re trying to get a qualitative assessment of a business that would allow us to have a differentiated view about the future prospects of a business and then to allow intrinsic value for share compounding to out in stock price over time and so so we’re really trying to figure out is what the competitive position is of the business what the people are like running it and what the potential is for the growth of the business business and so those things you know um we we can get competitive information and that would fall into that second bucket that analysis that you know we’re we’re sort of taking existing information we’re trying to process it a little bit differently and we’re trying to get an edge in qualitative information that isn’t related to sort of next quarter or a year out or whatever um and then TR finally trying to get a variant view on the potential growth prospects of the business is there a potential step function change through initiatives that the business is taking in its total addressable Market Market are they um you know are they maybe acquisitive which a lot of people will correctly say that you know we don’t buy acquisitive companies because you know the uh 80% of of Acquisitions fail to meet their intended Synergy targets um you know that’s something that we just leave aside and we sort of believe in that too however you know Berkshire haway is obviously you know example a of businesses that can do it well there’s the daners of the world we owned hio for a long time which was a real great example of that and so those businesses can have acquisition events that themselves are unpredictable both in size and timing and therefore a traditional DCF analysis of those companies fails to capture what will likely be the main story of the business going forward and so um it’s it if we can if we can discern that the range of outcomes for those businesses is not normally distrib distributed but heavily skewed to the upside then that can be a source of continual variant perception for us in analyzing a buiness business like that and then you know sort of trying to calculate what the growth prospects could be and so um so we sort of play in those second that that second bucket that analytical bucket then the behavioral bucket is is interesting because I it was a real Hot Topic when I started in the business this you know behavioral economics and there were firms that were starting you know that had their entire strategies built around um these you know the psychology of misjudgment and things like that and I I love all of that work and I think it’s really interesting um and to the extent that it is there and available to us we will obviously take advantage of it but um I I don’t think it’s a continual source of edge for us over time and so we sort of always come back to that kind of second bucket and the type of information we’re trying to glean is qualitative in nature so the two pillars of our firm Are that we’re very qualitative in our analysis and underwriting and in our portfolio construction um and we’re very con concentrated conviction waiting our bets and that qualitative really comes from first principles it’s like how how what are stock prices well neutralizing for dividends and distributions and multiple expansions and contractions stock prices simply mimic internal compounding of business value per share okay well if you want above average stock price performance you got to be looking for above average business compounding per share how do you get that well you can’t get that in a purely competitive environment you have to have some competitive Advantage for the business you have have to have exceptional people running the business and then you have to have good growth prospects and so those are the three buckets of qualitative exceptionalism that we’re looking for and so we have 10 analysts here and they’re running around the country in rental cars and airplanes trying to sort Exceptional from average in these three areas and so that’s kind of the that’s kind of the bulk of our work given that that’s your process the and the outcome seems to me to be you tend to buy things that are bit higher growth um perhaps a little bit earlier in there they’re not they’re not the free cash flow machines that they perhaps will be at some point you’re sort of buying them earlier in their life cycle that how how do you characterize the portfolio and the kind of companies that you you tend to buy because we have that Mo management growth framework growth is clearly a piece of that and tends to be an area where there’s more potential for variant perception that is um you know the m&a sort of unpredictable size and timing uh concept that I talked about but also just the the runway for growth um you know what you’re seeing in the market today it it’s very interesting actually in the last 18 to 24 months a lot more activity has tended towards what you would call the short end of the alpha curve because multi-manager firms have been really garnering lots of institutional allocations and so for those of you that probably that may know this it’s probably redundant but if you don’t you know a pod shop is basically you know a group of portfolio managers are given a Sandbox to play in they’re pretty much equally long and short um net neutral in in that sandbox and they’re trying to you know glean three four five points of Alpha perom and then that’s leveraged uh to get the sort of mid teens return to the investor that that they’re looking for um what that means is as more Capital goes that direction the uh risk management parameters around that Ma that portfolio manager activity cause all sorts of grossing and degross issues with short-term stock prices especially more liquid companies and so a lot of the names that we have you know we would if they were beat on earnings by a penny or by a nickel you know we’d see an up two three four per day 20 years ago today it’s up 15 20% or down 152 there just wild swing yeah the punishment for being wrong in the shortterm is just extreme uh and the pun and the reward for being right in the short term is is also extreme and you know for us that in a concentrated portfolio can kind of be an optical nightmare sometimes for our clients but um but it’s you know obviously provides opportunity for the long-term investor and if you’re patient you know you you get a much rockier path but hopefully the result uh is even better because there are there are times when you can buy your favorite names on discount and knowing that these pod shop compensation Cycles are usually about a year um you know that’s like this annual you know Rank and yank sort of process of the of the PMS there um you know they got to be right in the short term and they’re looking for very different things than we are and so that qualitative Focus can be an enabler um it does it does make that smooth line up and to the right more difficult if you you’re looking at businesses that have kind of more intrinsic value uh uh out in the in the long duration part of the of the of the growth uh equation and so it’s been a little bit more difficult for us recently like 2022 was an awful year for us 2023 was a great year we’re doing well this year but you have these Cycles where if duration is getting punished it’s just it’s really bad um and so you know we think there’s variant perception in the growth elements of our process and so um we all all things being equal want growing companies we want big Tams and we want to take these bets and if uh we’re right about something and we have been right about them they can grow very very nicely I mean we’ve we’ve discovered a lot of long-term Compounders and I think you know one of our mistakes has been that we haven’t held on to them as long as we should have and we can talk about that that’s I think the hardest thing in professional investing but I me we’ve owned co-star and hio and aligned Technologies and all these and we’ve identified all these when they were when they were smaller companies and so um you know so those have been winners and and then we have some that were the stair stepping of intrinsic value is happening but the stock price is just super super volatile along the way um i’ you know been joking internally that if we were a private Equity Firm we’d just have this nice smooth because the the uh the underwriting of the businesses has been largely correct and we’re seeing the expected economic growth that we want um it’s just that we’ve lived especially through covid this just super volatile multiple expansion contraction story and so um and and we largely have the same portfolio that we did four or five years ago and so it’s just kind of been this this interesting ride and and my career has been marked by you know being you know at the top of the Heap and then the village idiot and then the top of the Heap and The Village Idiot and it just sort of we we just cycle through that uh every couple of years and I remember what what do you do in 21 where you it has to feel like gosh everyone is very optimistic about what all these businesses are going to be able to do and they’re paying up the the the business results that are implied by the price are kind of make you scratch your head a little bit like how do you especially if you’re kind of underwriting fur out and that’s where probably some of the most egregious uh assumptions lived you know what do you what do you do in that scenario I mean our our mid large strategy was up over 60% in 2020 and I mean that’s a that’s a Hall of Fame year for any money manager but this just to give you an understanding that this business is a recipe for unhappiness it’s like when you have when you have that sort of year especially during covid where the you know the small business around you is closing their doors and things like that you know you’re almost like you kind of hide about these things because you’re almost embarrassed about them for just societal reasons but even even having a good year you’re just like oh great more and more of the fature value is being P very quickly gonna give that back appraisal right and you’re buying hold and you’ve articulated that to your investors and we have a lot of taxable investors and so all of a sudden we’re just going to you know create this nightmare tax situation for our clients and so we did some trimming obviously not enough in that time period and then we got whipsaw in 2022 and then rebounded in 2023 and it’s just you know this this year-to-year you know sort of painful Rocky experience that certainly exacerbated from you know the the the ride that we’ve had earlier but I mean we we had similar things going into the financial crisis and coming out of the financial crisis and so it’s it’s not our first rodeo as I say but it’s also uh doesn’t make it any easier and I think you know for us just the the um the secret really has been just we so first of all we sell people philosophy process like this is what we do this is our philosophy if um if you like our philosophy and our process like please make an investment with us just know that like we’re not 100% of anybody’s portfolio we’re some small percentage of that portfolio we play some role in a broader asset allocation and then you know here’s what we own and we talk about what we own and here’s the economic progression of what we own and if this were a private business or a con we would all be sleeping very very well at night the fact that you know Mr Market is assigning these elevated multiples and discounted multiples occasionally is it can be opportunity but you know these are the businesses that we own and we want to keep owning them and we think they’re optionr we think they have great growth prospects um we think they’re competitively advantaged and we think the people running them are doing really rational things with the capital and so long as we just keep you know pounding the table on that Mantra through the good times and the and the and the bad times that we’ll you know we’ll get to where we all want to go so let me just give a quick shout out and then let’s talk about what has changed uh over the last 24 years since you launched uh Old Ocean Texas Warren Buffett’s called in from Winter Park Florida how are you Warren good to have you on again P Tifa Israel Bendigo Australia you must be uh must be early there Max in valara how are you m gothenberg Sweden Dubai London Miami Florida baressi India Niles Abu Dhabi Santa Domingo Dominican Republic Ottawa havat Town Tallahassee kosur Costa Rica Edmonton tomble Jupiter Hong Kong Jupiter again congrats You’ve Won oneway Boomerang Australia Helsinki Finland raik jic Iceland you might have come the first p winner so the question the question was uh you launched almost 20 24 years ago which is an amazing achievement it’s this is a tough business to to survive it and I think that the main marker of success as an investor is longevity or durability so congrats on that hopefully there’s another at least 24 to come have to check the uh my my my desk is wooden I’m knocking on it right now have to check the Actuarial tables to see if you’ve got it in here the uh the what has changed you say it’s become much more efficient than it was 24 years ago but you feel like there’s a lot of efficiency there and we’ve gone through some weird times you saw if you started in 2000 you must have seen the tail end of the dot or you saw the bust you’ve seen the dot you’ve seen the sorry the GFC and you’ve seen the co what’s changed what’s stayed the same well I think you know the thing that pops into my brain first is is the you know while the Market is a blended consensus and has gotten more efficient in terms of information dissemination that does stand a little bit in contrast to the money that is Flowing to the short end of the alpha curve and the sort of intraday volatility um I I read this I’m I don’t know the citation nor have I fact check it but I I suspect it’s correct that Citadel is now like 25% of daily volume and like a third of daily volume is now traded in the final hour of the trading day so all of that is to say like that you know that’s much different than you know I started my career in 96 at a small capat value shop and I called a $2 broker on the floor of the New York Stock Exchange to execute a trade who was talking to a specialist who was tasked with maintaining an orderly market and the security like that’s all out the window now right I mean uh the the you know the sort of Simplicity of yester year is gone and now it’s it’s obviously you know high frequency Trader and and pod shops that are making I think the incremental trades in the market that are you know creating price Discovery and that fundamental investors like us have to just be really patient because eventually value will out as Buffett says it’s there reasons why you know private Equity activity will take out your your company if it trades at a discount too long uh you know we’ve had instances where management teams would just come right out and say like this stock is cheap we’re going to do a tender offer you know there are ways of you know sort of forcing the value mechanism to get you know the market price to get closer to appraisal so uh we have to be patient but in the interim you know there are different forces that are that are creating I think uh incremental trades that that uh that are affecting pricing in ways that weren’t around 24 years ago um the institutional business is a little bit different you know in the 80s it was like 6040 stocks bonds and then the endowment model came out and the kind of late 90s popularized by David swensson uh who recently passed away uh at the Yale endowment and he wrote a book pioneering portfolio management was very in instrumental in prompting me to start my business because I sort of saw an ability to create a concentrated Equity strategy as all these you know 200 300 stock managers were getting fired the you know brand named Wall Street firms charging 1% for 300 stocks and being you know a 2% position in an alloc portfolio to me it was like you know this is all Bonkers everyone’s getting you know passive results and paying active fees and so concentration just made sense from a first principal’s investment standpoint but it also seemed to be fitting very very well in an Institutional portfolio and so I sort of made the life bet at 27 to create Bears Capital around that concept and that was a great moment in time and I think I was correct about sort of hitting the business side of of bears Capital at the right time and grew on this bow wave of concentrated manager adoption um that that’s a little bit different today you know people talk to me and say I’m starting my hedge fund or I’m starting my single manager shop like you know what’s your advice I want to do what you did and and I say well I think that that endowment model story while still very relevant has been broadly adopted through the institutional space and now you’re sort of competing for replacement Capital but the tectonic shifts in Investment Management continue to happen and and you know my story starting today probably is not going to be as successful uh the the Brian Bears of 2000 and that strategy you know may not sort of Garner the institutional attention um that it did 24 years ago um interestingly and something I saw that Toby you you I think put out there on Twitter is that the disparity between small and large cap seems to be very similar today than at you know as it was 24 years ago when I started and so I did have a little bit of a Tailwind I think in in small cap when I launched which is very helpful and so uh we we launched a 40ac fund uh at the beginning of last year uh based on our small micro strategy so up to this point we haven’t had a retail focused uh distribution channel that people could invest with us and so um so we started that last year sort of thinking the same lines that like this environment actually kind of looks pretty similar as it did 24 years ago and is set up pretty well and and I in the middle of last year I was I was telling the guys in the office I was like wow I I haven’t seen like low te PE with debt-free good Returns on Capital you know in a really long time um and and we were seeing it you know kind of in the middle of last year and so that’s usually a pretty good sign that um you know that we’re we’re in for good forign returns so what do you think drive that is it return to normalization of interest rates something like that tough to say I mean and and 2000 um clearly it was the the bomb you know the backside of the dot era that that drove that I remember in the middle of the Mania uh in 2000 I W I was looking at the highest yielding names in the investment universe and there were REITs yielding like 13 14% that had you know cash from operations that were well covering all of their obligations that were conservatively capitalized and I was just thinking everyone was interested in the globe. net and outpost.com and all these different businesses and you had money lying in the street in our initial portfolio we owned Utah Medical Products and and landow and Aon and these were companies that were trading at 8 nine times free cash flow debt free with 40% 40% Returns on Capital and you know I’m like I probably will never see this ever again in my career and we uh we we didn’t get to that point last year in small cap but it was the first time where you know there were Echoes of that um and then contrast that with to just show you how difficult this business is uh in 2014 I wrote a letter to my partners here at Bears Capital saying I feel like the market is a little bit elevated you know it’s probably you know overv valued by traditional metrics and it did nothing but go up for the next seven years and so you know if you were you know wouldn’t you be a fool if you were just you know waiting around patiently on cash for seven years while the world’s passing you by and and so you know the good newss about us is we’re we have a fully invested mandate and we’re paid to invest we have a qualitative um uh approach which means that you know that qualitative plays into the portfolio management construction a little bit too because we recognize that a DCF or intrinsic value calculation can’t capture everything about a business ABC at 80 cents on the dollar is not the same as Xyz at 80 cents on the dollar different management different prospects different compe aspects Etc so we make conviction weighted bets where we will sometimes pay what looks like an optically high price you know com for to other more traditional value investors and that actually you know saved us candidly in that sort of latter part of the last decade where you know the entire Market was you know I think in retrospect probably a little ahead of itself but we were able to participate in you know relatively good performance during that time period by you know by owning some very high quality names that sort of stayed elevated I think we’re seeing a little bit of that today and many of these sort of consensus Compounders where you know you’ve got 4050 times earnings and and names that you know I’m sure we all know costos of the world yeah I was thinking that exact name and uh and and you know I don’t know how much of the forward value is being pulled into the uh into the current price in some of these names but it’s a lot and so the the hardest portfolio management question in our business is you know at what point do you capitulate you move on to something with a better uh better risk adjusted returns you know and and so Buffett spoke to my class and at University of Nebraska you know 1994 I think it was excuse me and he uh he said somebody asked him when’s the right time to sell a stock and he said if you have the right business the answer is never you know like you just let let great things happen yet uh you know somebody I think just posted that his average holding period is like two years right is that right in the Burkshire portfolio well I haven’t fact that’s true but there’s a lot there’s a lot of turnover in the non Coca-Cola American American Express you know areas of the portfolio and so we are in the public markets um you know we lived a very acute version of this where we had the massive runup in 2020 2021 and then the whip song in 2022 and so um you know it’s it’s just hard to know when you know if we were Believers that you should sell a business at 100 cents on the dollar buy 60 cents wash rins repeat we would have suffered a horrible stretch of underperformance for the better part of the last decade right I mean it would have been it would have been absolutely awful and so you know thank God we were hanging on to these companies and and some you would argue that we didn’t hang on long enough the high go of the world we owned Aon AA the heating and air conditioning business in Tulsa which has been a long-term compounder but we only caught part of it middle bee was another one and so we’ve had these stories where you know it’s like hey this is getting ahead of itself and we sell and we think we’re in inning eight or nine but we were actually in inning two or three right yeah and and those are that’s a horrible uh feeling of remorse because we did the work we nailed it we got it right we in many cases got it before it became a consensus long for everybody else and we didn’t get the full benefit of the compound okay so then take that mental model and Port it onto you know 2020 2021 2022 and and we do we do hang on to those names and then the the you know ultimate come up and out the wood yeah so it’s just I mean it’s just this is the sausage being made right this is very very difficult there’s no quantitative approach that I know of that addresses these problems uh correctly um and so if you’re a long-term investor where your view stocks as business ownerships uh I think as Monger said sometimes you just got to stomach you know this awful volatility in order to get where you all want to go so Jake can I Jake wrote an article in 2015 that I reposted so I I think I think we all we would have all agreed in 2015 that the market or certainly our part of the market was definitely getting ahead of itself and Jake’s article in 2015 said uh the spread between the most overvalued and the most under value in the market is as tight as it’s been in 25 years so it’s the worst opportunity set in 25 years what neither of us did was think smart as Brian yeah go go into the go into the better companies cheap optionality in that other nice half of the dummy so well well done there well well so we we what we what we do is we qualify businesses based upon these qualitative factors and so we’re qualifying on moat management growth and if we if if we find something that’s truly exceptional one of our analysts brings it back we do some more vetting we do you know site visits we’re training on software we’re going to the industry trade shows we’re doing a lot of qualitative field work that our competitors are not and if it truly is one of say the 50 best companies in say small micro we’ll present it internally we’ll have a debate where the youngest analyst in the room starts to prevent bureaucratic bias and then give their opinion on up to myself and our company president Jak Kel and we will you know if if it’s a thumbs up around the room and this is truly one of the 50th best businesses then we’ll appraise it and put it on our Focus list and so appraisal is done at the end of the process because we don’t want to get sort of suckered into a value Trap by you know knowing that it’s a low PE business going into it we just want to pre-qualify best businesses best people with the best Prospect for growth but the reason I’m bringing this up is that our Focus list that’s appraised we have the cheapest and the most expensive and through that period you’re talking about that 2014 to 2021 period the most expensive on our Focus list radically outperformed the cheapest radically outperformed and so you know even having a kind of a minor value discipline that we did candidly um we there was some there was some serious performance leakage there that had we just you know invested in the whole thing and you know but it was just really hard to pay you know 10 times sales for you know Tyler Technologies or whatever that we know is obviously a great business that we love and we would love to we had identified as a micro cap and we never owned because it was just consistently too expensive um you know that those are those are the conundrums that we face every day it’s the it’s the true param Mutual system you know that horse is super fast and is probably going to win but it only pays you know eight to seven or whatever the the ratio is so it so it definitely grew into its that 10 times sales valuation it grew in y well look at look at Salesforce when Salesforce came public I think it was about 10 times sales and it was been a great long-term compound and is just sort of permanently traded at 10 times sales and so you know we’re not averse to owning those types of companies if the growth is there um but you’re penalized very heavily if that growth doesn’t materialize obviously now in the perfect world is we want a b we want you know we want to buy a business that can be rated at 10 times sales uh at some point in the future but is not today and so that’s you know that’s the qualitative work that we do so we uh we usually do some veggies from Jake at the top of there we’re running a little bit late you got some Vig for us today JT I do c so and I’d be curious to hear your take on some of this stuff Brian because uh especially like when it gets when we start talking about culture and what maybe what you’re looking for sometimes culturally in these really high quality businesses uh and this is uh Abraham maslo and the Blackfoot Indians uh so most of you have probably already heard of of Abraham maso’s hierarchy of needs this famous pyramid uh but there’s actually an interesting backstory uh which which led to an incredible foresight by maslo and uh you know just a little background on him he was a a prominent American psychologist and he had this hierarchy of human motivation in the form of this PID and it s suggests that there’s five levels of needs the first is at the very bottom is the physiological needs which are air water food shelter reproduction uh safety the next one up is like safety needs so security employment Health uh property the next one above that is love and belonging so friendship intimacy family above that is esteem so respect status recognition and at the very top of his pyramid was self-actualization and that’s like kind of becoming the the most that you can be um now according to maslo like each individual must then satisfy the lower level needs before they can get to the higher level right like you can’t be starving and then also self-actualized perhaps uh brand new yeah I was gonna say wa does wasn’t that what uh is that what the Buddha did H anyway so what’s what’s less commonly known about maslo is the influence of the Blackfoot people on maso’s work and the the Blackfoot Indians are this group of Native American indigenous tribes that were traditionally residing in the Northwestern Plains of North America and maslo spent six weeks in 1938 on a reserve with them basically conducting like anthropological research and during this time observed and interacted with their community and it really impacted his understanding of human behavior and motivation um and they the the blackl have their own model of human needs and societal structure and it actually contrasted quite a bit with maso’s hierarchy so their model emphasized a communal approach to well-being and fulfillment like their Central philosophy was the concept was actualization but but a different context it wasn’t individual Centric um so their actualization was like Community oriented process and it was deeply connected the collective well-being and and really spirituality of the community so they believe that one person’s development and fulfillment were intertwined with the health and the well-being of community and this holistic view of self-actualization uh was in contrast to to maslo which was a very individual version like a very Western version um and so they’re they’re the the black foot’s top uh tier represented cultural perpetuity actually so focusing on the preservation and continu continuation of of cultural knowledge tribal knowledge and practices for future Generations which is kind of interesting to like stretch out maso’s hierarchy not only kind of upward from you as the individual but also temporarily through generations um and so his experience then influenced his later thoughts so after he’d already kind of published his work that was very simal in his later work he he introduced this concept of like self Transcendence which goes beyond self-actualization includes a more holistic interconnected view of humanity um and so he he took this integrative View and then he started exploring the corporate world and I read this book it was called Balon management and it really just like a series of notes and journals that he had taken to himself about what he was seeing and and what else he wanted to research in the corporate set setting and he wrote this in the early 1960s and he’s like way ahead of his time like at that point you know American corporate uh culture was like very very still Industrial Age like here I’m the boss you go turn this wrench you know that was that was how it was run um it wasn’t like oh I want to make sure my my guy on the Ford line was uh was self-actualized right while he’s turning the wrench um so anyway in this he he delves much deeper than into the Force for good that that business can represent and can harness and you know he’s talking about enlightened employees delighted customers rewarding shareholders happy communities that the businesses are operating in and he thought that that the business world was actually the best laboratory for conducting experiments and and observing human psychology uh and these thoughts really like he anticipated so many management fads that came in over the next you know that became in Vogue in the next 50 years uh he actually coined this term called and I might be mispronouncing this but it’s it’s usia euu Psy c h i a and what that is is is a thought experiment basically like imagine a thousand self-actualized people on a sheltered island with no outside interference what would be the upper limit of what human culture was capable of them working together in a self-actualized way it’s like a Utopia that upper limit would be called usia um so one last little little piece that I got from the book that was kind of interesting he identified that that dignity and self-esteem in really stems a lot from one’s work and he said that that uh one really has to deserve the Applause and The Prestige and the recognition otherwise it actually creates this harmful side effects of like when you know it’s not deserved it causes guilt and self-doubt and all of which while I was reading this he said that all sorts of of psychopath ogenic processes may start from undeserved Applause and it which made me wondering like gosh all these participation trophies that we’ve been handing out for the last 20 years in society are like are there are there longer term ramifications to that uh but anyway lot we’re finding out now are we is that what college campuses right now I don’t know we better not go there my college campus was just as was just as bad as that I think I don’t think that’s changed what what that’s but that’s a good segue Brian what you culture is a very qualitative assessment how how do you go about assessing the people assessing the culture how do you sort of bring some sort of replicable scientific kind of rigor to it is that possible yeah I’m very very difficult obviously um so we do the table Stakes work that everybody does in terms of analyzing alignment of incentives through you know we prefer outside you know owner we we we prefer as outside passive minority shareholders for a Founder owner operator sort of dynamic or a great alignment of incentives in the proxy with the right types of um you know return on Capital based uh incentives um you look at the history of the actions of the people do they map to the incentives do they map to what we expect um we don’t always get this this part right um after after a while you know a lot of people will say um and I I read a bunch of research from Paul meal from the University of Minnesota that basically says that the that a computer can can you know read a radiological scan better than anyone radiologist and so you’re better off just not even trying because your you know all of your biases and misjudgments as a human when you’re trying to assess these sort of soft things are just going to lead you asay I I actually don’t believe that at all I think you know if you you know if you meet one manager you’ll you know you might be super impressed by the meaning you walk away then you meet 10 and then you might go back and say well that first one wasn’t quite as exceptional as I thought they were and then you meet a hundred you could start to tease out little patterns I mean life and especially our business is very much about pattern recognition it’s about sort of discovering these deep patterns and you start to see things in people’s backgrounds the way they behave the way they talk the way they interact with employees that start to give you an idea for what person is all about and whether they can be trusted with the capital that they have within the business um you get intuition now for that Brian like when you like so much pattern matching now or maybe it’s like almost a subconscious thing um I think so I think pattern recognition develops into intuition so I think that that is correct um I also I mean I love it when one of our research analysts comes back to the office and is like Brian you have to meet this guy right or you have to meet this woman they’re like they’re amazing and that’s happened a number of times and you know typically it’s a pretty rate after that yeah it’s a pretty good sign yeah and so you know they they’re just some people just jump off the page um I I tell people that now this can be you know you don’t get to the top of a business without having a silver tongue and being very persuasive and a lot of the people come up through sales and so you you end up you know being snowed by The People’s you know personality and their you know sort of uh the the elements of their character that made them success their Riz now is what the kids would say the RZ yeah they absolutely and and u i a great example of this is there’s a guy named Selen basul who’s one of our favorite CEOs of all time that ran a company called middleby which is a metal bending uh you know maker of of the hot side of equipment for restaurants and so they own Brands like turbo chef and Viking and things like that and he uh I saw his very first investor presentation when the company was like 250 300 million in market cap I don’t know today it’s we I’ve lost track but it’s eight nine 10 billion something like that um so he he gave this presentation and I was just completely wowed I mean I was like I just saw a combination of Thomas Edison and Steve Jobs like give a speech and I I was like I gotta I gotta just step away from this situation because I’m completely under this guy’s spell and so I just I just sat there sucking my thumb until it went to 800 million in market cap and we finally wisened up and bought it and you know I think it was a three or four bagger for for us but um you know he was just an like unbelievable Talent like I mean if he were in the room with us you would all walk away with a brand new pizza oven and have spent eight grand on it or something so he you know he he’s just an amazing amazing CEO and one of our favorites that would be you know in our Outsiders book which we could write on the small cap space he’ he’d be chapter one and so um so you know that the the degree to which he would stand out um is really really amazing and indicative of our ability to spot exceptionalism from average now you know made off stood out and you know a lot of these other people sit out and so you have to be very very careful and you have to check all of these um you know the enthusiasm with the data and you have to make sure what they’re doing is is rational and and stuff but you know we have a portfolio of positions and if you get say 10 to 12 Sims like I don’t care what business they’re in if they’re you know running hot dog stands you’re probably going to have a great result and so um so yeah it’s tough to element the to to underwrite these soft elements of culture and and and things like that but uh um yeah I found I found your maslo discussion really interesting I mean it it to to sort of Port that on Bears Capital you know I I’ve been working long Beyond where it makes rational sense for me to keep working and and I worry about in our business the younger Generations are sort of saying well I just want to you know I want to hit the lottery not pay taxes buy some crypto move to Costa Rica not you know like just you know get out of my community because America is awful blah blah blah and it’s like no no like what what creates meaning in your life is actually engagement it is the building of community it is for me especially the the duty the duty that I have to our investors the duty I have to my fellow employees to my wife to my kids to the community at large and by VA that voluntary acceptance of increasing amounts of responsibility actually provides you much more means meaning than the feckless pursuit of Freedom which I fell into that trap it was like why was I an entrepreneur starting Bears Capital it’s like I wanted to get to the financial Finish Line quickly so no one could ever tell me what to do again and I could do whatever I wanted with my days but that thinking will will end will land you on the therapist couch I mean it just will it it’s not the end all Victor Victor Frankle had this great quote about um when a man can’t find or woman I guess uh can’t find meaning in in their life they’ll they’ll seek to fill that hole with pleasure yeah yeah and I mean people end up you know uh finding meeting in the in a bottle or in a shooting something in their arm or going to Vegas and doing the wrong things or whatever and so um so I I just think that like uh the oldest answers are probably the right ones which are to you know to you know to voluntarily accept more and more responsibility in your life and you know like Jordan Peterson says pick up a load move it from here to there and see if that doesn’t solve most of your problems right and it’s like just start working hard on something and I just happen to find a business that I really enjoy and I’ve been talking about this recently which I think is I haven’t heard it elsewhere but I think like investing is like fishing in that um it’s variable intermittent rewards and the dopamine snacks that you get from finding the next you know potential compounder are very similar to you know getting a strike on the line when you’re you know fishing for musky in Minnesota or whatever and and so I I think like there’s this variable intermittent reward aspect of our business that keeps me coming back that I really enjoy that is a sort of a psychological call it addiction and then I’m sort of I’m sort of sort of a you know the sort of guy that probably wouldn’t let other people manage my money and so I’m going to do this for the rest of my life anyway I might as well do it you know with a team of people that I I’ve really like and respect and with a group of clients that is you know I’m privileged to have entrusted me with money so I’ve got some questions here from the audience um Brian if you if you’re prepared to take them uh do you want to talk about I’ve got a question about individual name that you hold someone to where from your 13 no we don’t talk about those might be buy it fair enough uh here’s one that it’s unlikely that you hold here’s the uh uh Sam Alman spa moonshot or financial black hole let’s just broaden it out too AI you seeing is that of interest to you is it in your companies how how are you thinking about it dealing with it yeah I mean the who who would have thought that the you know the Google 10 Blue Links would be as vulnerable as they are today you know um you know the world’s greatest Monopoly now potentially disrupted by this and so I think it’s like a broader comment about the topple rate which is the rate at which companies leave the index is just increasing and it’s because technolog iCal disruption is an increasing threat on all fronts for all businesses and so we absolutely pay attention to this stuff um there’s a couple of business we hold that we think could be beneficiaries of that because the proprietary nature of the data that they have could be a a unique training set that could accelerate the growth prospects of the businesses um we don’t have any direct investments in AI but we have you know hopefully businesses that can that can um you that can benefit from that but you know we we’re paranoid about everything and that’s just one more thing we’re paranoid about yeah I always wondered if the uh the way that those companies were ultimately toppled was some you know the way that Microsoft lost its desktop Monopoly was by transitioning to the phone it’s a different completely different frame of reference for approaching the problem and they’ve they’ve got a lock on one but not the next one there that military garage isn’t it some accident in a garage that yeah it’s very it’s very rare like a head-on assault that you see coming right yeah it’s always oblique yeah yeah Little’s got that great Laine race says that the line of Victory or defeat comes along the line of least expectation yeah whatever I like the the line from Bruce Bruce Greenwald and competition demystified where he said in the end everything’s a toaster yeah right power everything everything just becomes commoditized in the end and it’s just about that competitive Advantage period and can you harvest economic profits and then Channel them back to outs side passive minority shareholders during that time the Innovation becomes table Stakes it’s amazing how many times that’s happened in you know in two in the 1990s like having a website was regarded like that was enough to make you a DOT and now just everybody’s got a website it’s just trivial yep um do you feel like that you underwrite shorter competitively Advantage periods now than you did 24 years ago yeah that’s a great question um you know I think we are more paranoid today than we ever have been about the threats for technological substitution were I’d like to think we’re quicker about you know just making it a position exit when we feel like that threat is is potentially materializing um but you know a lot of these things are you know they seem obvious in retrospect but in the fog of War it’s really really difficult where the bullets are coming from you know even then like there’s still can be long periods of cash flow that can happen on some even a business that’s declining if it’s not yeah I you think of I mean there was money printed in in uh telephone books for a really long time after you would have said like well that’s that’s dead and gone right yeah yeah well and and what’s really amazing is companies that can successfully pivot into the new paradigm you know I think Microsoft with Azure is like probably the prototypical example of a company that has like been really really successful and and adopting into a new paradigm that looked to be a competitive threat so Microsoft’s pivoted r on that has to be so low though right I mean yeah most of the time you don’t catch the next train leaving town yeah window innovators innovators dilemma right that’s there’s a whole book written about that is very accurate so hey Brun we’re coming up on time uh if folks want to follow along with what you’re doing or get in contact what’s the best way of doing yeah just go to our website Bears cap.com uh institutional investors and and uh and individual investors now get the same same strategy same access um we just launched this b a r by the way not uh yeah I don’t know I don’t know what you get if you go to B ARS nice nice nice curse of my last name going into our business where I’m a long investment manager um yeah the the fund company we we recently launched is BCM Focus funds so BCM Focus fund all the appropriate disclaimers you can go visit there uh we stood up our own uh series trust and so um will Thorndike who wrote The Outsiders is on our board Sandy Leeds who’s a professor at University of Texas and I are the the three board members and so um so that’s a new new effort and and growing so individuals can can look there institutions can reach out um I won’t give out my email for fear of that’s fun that’s getting duded but deluged but with uh with things that you know gum up the my time but um people we we have a Twitter presence um you can find be’s capital on Twitter I’m on Twitter but I don’t really post anything I’m just kind of lurker so well that’s uh that’s fascinating the podcast Brian once again thanks so much for joining us um fascinating stuff Brian bears bear Capital Management thank you very much and JT as always great