Talk Your Book: Conviction in Growth Investing

0:00Today's Animal Spirits Talk Your Book is brought to you by Motley Fool Asset Management. Go to fooletf.com to learn more about the Motley Fool 100 Index ETF, ticker TMFC. Again, that's fooletf.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:37Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:45Welcome to Animal Spirits with Michael and Ben. On today's show, we talk with Charlie Travers, the Portfolio Manager at the Motley Fool Asset Management. Ben, I heard one of the Gardner brothers years ago talking on a podcast. Maybe it was Patrick's. I can't remember. And one of the things that stood out to me or stuck with me was their ability to think long-term. And I guess it didn't stick because I don't have the ability to stick with the stocks for the long run. I mean, index stocks in the long run, but not individual names. And do you think that you could learn how to do that? I feel like that's something that you're probably born with.

1:25I can't imagine my personality just buying and holding winners and letting them run and just being like, yeah, what? The stock's down 40%, but I still believe in it for the long term. I know I'd just be like, you idiot. We said 100. You bought it at 10. Now it's at 60. You dumb idiot. I just know that my personality is not suited to that sort of investment because all of these names, pick any of the big winners over time. Literally, it doesn't matter which when it was, they've all had a monster drawdown, even like something as boring as Walmart. Well, imagine holding Nvidia, Netflix, or Facebook in the last three or four years, and you essentially lost two-thirds of the value of your money in all of those stocks.

2:03But it's even worse than that. Because let's say that you put$100 or$1 ,000 or whatever it is into Netflix 15 years ago, and you're up 37x. I'm making that up. Could you imagine that two-thirds drawdown that we experienced over the last couple of years? Right, from a higher asset level. So in dollars, you might have lost 13 times your original investment. So to your point, I think this is why it's so important to find a - Only pick the winners. Oh, never mind. Find an investment strategy that really fits your personality, right? If you try to run a - This is why I think the people who've tried to be the next Warren Buffett and probably don't have the same temperament or style as him, just the ability to stick with something for seven decades or however long he's had.

2:46No one has that ability, I don't think. If you're on FanDuel, you're probably not holding a stock for 16 years. So maybe the point is that you figure out a fund or a strategy that will hold them for you. Right. So you don't have to do it individually. And so I think that's what, so the Smotly Fool 100 Index ETF, they basically said, we're taking the best stock picks of our analysts. and people probably said, like, I don't want to go through the role of figuring out which ones of these I'm going to pick. You do it for me. And then they market cap weighted this. Well, guess what? At$1.24 billion in this fund, clearly people are saying that.

3:28Yeah. So the idea, yeah, makes sense. Like have, I'm going to buy a fund of someone else who's going to make sure that I hold these stocks for me. Yeah. So anyway, interesting conversation. We talked to Charlie Travers today from Motley Fool Asset Management. Here is our talk with Charlie.

3:45We're joined by Charlie Travers today. Charlie is a portfolio manager at the Motley Fool Asset Management. Charlie, welcome to the show. Thank you guys for having me. Of course. All right. So we're here today to talk about the Motley Fool 100 Index ETF, the ticker is TMFC. But before we dive into the methodology and the backstory and all that good stuff, what is the linkage between Motley Fool Asset Management and Motley Fool? Because I'm very familiar with Motley Fool. You guys have been around forever, have created an incredible brand in the industry, but are less so familiar with Motley Fool Asset Management?

4:18Yeah, that's a great question, Michael. A lot of people know the Motley Fool LLC, the publishing business, which has been around for 30 years now with its subscription investment newsletters, podcasts, radio show, et cetera. They are our parent company. So we are a wholly owned subsidiary of that business. And we manage six ETFs. Three of those are passive ETF products based on indexes created by the parent company and their investment intellectual property. And then three of our ETFs are actively managed. But yes, so that we are set up as a regulated business that allows us to manage money for individual investors who are fans of the Motley Fool.

5:01That's where our origins came. And we started this side of the business right in the aftermath of the financial crisis, where a lot of the subscribers were looking for some help with their portfolios. One of the gotcha moments that people always have when they talk about indexing versus active, for the S &P, they'll say, hey, the S &P is not actually a passive product because there's a committee who chooses the stocks that come in and out every year, right? Then there's also other passively managed funds that are more quantitatively based. Where do your passive indexes fall on that? Do you have a group of people who are making decisions on these, or is it more rules-based?

5:37So the three index-based ETFs we have are all created from the Motley Fool's publishing group and their analysts who are making stock recommendations. So stock picks that are going out to the subscriber base, like in their flagship product, Stock Advisor or Rule Breakers, et cetera, are assembled into a market cap weighted index. And there's three of those indices, the Motley Fool 100 being the top 100 companies weighted by market cap. And then the Motley Fool next would be a small and mid cap version, so be companies number 101 down to 300. And then there's a capital efficiency overlay as well, which is more of a large cap product as well.

6:20It's not just looking at companies based on if it's an active wreck and it's got a large size, but it's also tying in the profitability growth relative to the assets that the company has. So it's kind of layering fundamental metrics on top of just size and whether or not somebody at the company likes it. It makes sense that you all package this into an investable product because for decades, people have been reading the fool and for stock picks or whatever. And the idea that, hey, wait a minute, why am I picking all the stocks that you guys are recommending? Just wrap it up and I'll just buy that.

6:56So for sake of ease, it makes a lot of sense. Can you share a little bit about the success in terms of size of the assets that you all manage? So in total across our six ETFs, we are at about$2.2 billion. And the flagship TMFC, the Motley Fool 100, is at$1.2 billion. So it's coming up on its seven-year mark in January. So we're a month away from that. So to get to that asset level in seven years is a mark we're pretty proud of. It is funny. We're about to talk about the methodology and the construction. And I understand for compliance purposes, you have to say what you have to say in terms of this is a passive index or it's an index tracking, right?

7:37Because it is an index, I guess. But of course, the idea that it's passive and there's not actual decisions being made is kind of, I guess it is what it is. I'm not here to set regulations, but this is a strategy that's not literally actively managed in the sense that it's not discretion. You're not turning all over the portfolio a lot, but certainly it's not passive. You're making decisions. Yes, it's correct. And so the point you made a minute ago about newsletter subscribers getting two picks a month from Stock Advisor, maybe another two from Rule Breakers, et cetera, over a course of a year or two, that's dozens of stock picks.

8:12And so the idea of what does somebody do with all of those names, and it gets hard to manage. So when we package those into an index that somebody could buy with one ETF ticker, it brings a lot of simplicity. but it also gets to the point of how is that index created? And it is off of all of those stock picks. If it's a buy rec that goes out to the public, it's index eligible. But there's also an internal database that our quant team manages. So we've got 40 analysts on the publishing side of the business following these stocks, making recommendations. And internally, they can flag what do they like, what do they not like?

8:51And then the system is also like, OK, is this analyst good at consumer names? Are they good at tech? Are they good at energy? And then it's internally weighting their conviction on those names based on their track record in the space that they're flagging certain companies as buys and sells. And the end result of all of that, plus the public facing recommendations, allows to create this index, which is kind of actively managed. No client monies directly be managed, but it is an index that is forward looking based on fundamental stock research. It's based on conviction of what the analysts like today.

9:27And that differentiates it from a lot of indices, which are just based on size or other factors. My sense of the types of stocks that have been associated with Motley Fool, especially with the Gardner brothers going back to when they started it and reading some of their stuff, is they've always been looking for growth stocks. So are these products similarly growth-oriented in that they're looking for growth stocks? Or is there a different bent here? You are right. The Motley Fool is known, I think, mostly as a growth investment philosophy. But that said, there's been a lot of influence by Warren Buffett over the years, less so on the valuation side, but more on the side of owning high quality value compounding businesses for the long term, you know, even out to decades and letting those businesses and the ownership of them create wealth over time.

10:16So we're not looking at quarterly earnings so much or trying to sector rotate or anything like that. It's find those great, high-quality businesses and then hold on to them. And I think that's really been the key to the success of the products over the years. But what did you guys do on Wednesday during the press conference? Did you get a little bit scared? Did you whack anything? I'm just kidding. So you mentioned Buffett. And I know that you don't share his investment philosophy that closely because you all are more aligned with the growth companies. However, one key characteristic that you guys have done a tremendous job of over the years is riding the winners, which is something that is not suited for my personality.

10:58I was talking recently about this. I think I know too much of the data and the literature on the history of stock market returns. And so I don't ever have the conviction to buy a stock and let it compound, compound, compound, because I get scared, right? I'm like, well, what if this is the next that or the next this? And where does that discipline and conviction come from? If you have something that you're up, I mean, literally 4X, 7X on, how do you not look backwards and continue to look forwards? I think one of the keys for an analyst is to not just look at the stock price and how much you're up or down, but look at it as your thesis playing out.

11:38Like, why did you own that company in the first place? Is the stock up because the things happened that you wanted to happen? Or is it up for just sector reasons, for example, or rate moves or whatever? And I think it's important as an investor to always check in on your company and how it's doing relative to the reasons you owned it in the first place. So yes, you could be up 5x and maybe that's a top if it's trading at 60 times sales or something crazy, I think you have to give that a hard look. But if the valuation remains reasonable because the business is increasing value along with the stock price increasing, that's a separate conversation.

12:15So how much turnover is in a fund like this? Are you looking at this once a year, kind of like the S &P does? Or is it a little more actively managed where on different periods you're looking into potentially replacing companies that analysts have either decided to buy or sell? Well, the full 100 index ETF constitutes quarterly. So that index has additions and subtractions every quarter. Typically, it's been about two names come in, give or take, and maybe two come out. So the turnover on a quarterly basis is not dramatic. And that's based on what new recommendations are being made right now based on analyst conviction.

12:51And then it's also what they might want to be selling out of. So it does keep the index fresh without churning it too much. So I'm looking at the top 10 holdings. And this is just a level sex we haven't spoken about. Maybe I'll just tell you. So what is the general philosophy here? Like if you had to describe at a high level, what investors can expect to get out of owning the Motley Fool 100 index? What is the overarching philosophy? I would say it is the 100 largest companies that are high conviction picks within the Motley Fool. It's how it's created. The actual methodology is the 150 highest conviction ideas right now.

13:31Then it's market cap weighted and it's just the top 100. So it's going to be from a style box perspective, domestic large cap, and it's typically going to be in the growth column. So Ben and I were talking earlier today that the top 10 names in the S &P are now 40 % of the index. That looks over diversified compared to you guys. The top 10 holdings in the Motley Fool 100 index are 57, at least as of September, the end of September 2024, are 57.7 % of the overall index. So you all are not shy about placing large bets and riding those bets. There's very much a let the winners run philosophy at play.

14:14But the index did have to put in place some RIC compliance rebalancing. rebalancing. NASDAQ has had to do the same thing in recent years, where the number of concentrated positions, which is 5 % weights or larger, cannot add up to be over 50 % of the ETF. And so index adjustment methodologies did have to come in place for the full 100, as it has for other providers as well, just because those mega cap names have run so much in recent years. So you had to trim not a macro shop and we're going to get into some of the individual stuff, but how surprised are you? I mean, 2022, people sort of in recent conversations have been talking about the market as if that wasn't just a few years ago and that we didn't just live through a really nasty reset.

15:07Like, oh, it's been up only. Oh, really? What about three years ago? So, but in fairness, the market bottomed on December 31st, 2022. And when I say the market, And I'm saying specifically the large cap growth names that you all focus on, bottomed on the last day of 2022. And really since then, it has been for the most part up only. There's been a few hiccups and a few shakeouts along the way as there always are. But are you surprised that part of the reason that these stocks fell in the first place was the tightening cycle? And obviously we're on the other side of that now, but the long duration yields are still at the same place they were when these stocks got crushed in the first place.

15:43So part of the story is obviously AI, right? Like had ChatGBT not come to market in November of that year, who knows where these names would be, right? Maybe they are a lot lower. So I'm rambling without a question. So I guess to ask a question, are you surprised at the strength in these names, specifically large cap growth over the last call it 24 months? I'm going to waffle and say yes and no. The reason I am surprised is because the idea that we have two and three trillion dollar market cap companies is almost insane to me. Like, that's just like such a large number that one company could be worth that much money.

16:26We have many of them now. And now we have many of them. Yeah. Like, that is kind of a crazy thing. But on the flip side, that's where the earnings growth has been. The competitive advantages for those companies seems almost insurmountable. Like the old Warren Buffett adage of, can you take a billion dollars and replicate the business? Almost seems quaint relative to the scale of those big tech names. Yeah, how much did OpenAI just raise? Like multiple billions? Yeah, something like that. But then if you look outside the big tech names in the S &P, it's not like the consumer staples and the other blue chips are necessarily cheap either.

17:02You've got companies growing less than 5 % a year with 30 and 40 PEs on them. I think Costco is probably the poster child for that. Yeah, yeah, yeah. So it's like, OK, I can understand if someone's squeamish about large tech valuations, but where are you going to go? And that would be like my follow up question. So what do you say when people say so? Yeah. So I think where we're at is we're not trying to time the market around whether it's valuations or recession concerns or is our rates going to actually go up next year? They could. I don't know. But I think it's folly to try and guess what the stock market is going to do next year.

17:39any year. Like if we were sitting here a year ago, we would have the same conversation about mega cap tech, how much it is in the index, what are the valuations, and then boom, look at the year we just had. That's right. Exact same conversations. You're right. Yeah. So if you look at just the sector components of the fund here, you know, you're overweight tech, you're overweight consumers, communication services basically is also tech for all intents and purposes. And then you're underweight more of the defensive names, the consumer staples and energy and materials and utility. I guess it's almost like an overweight the new era and an underweight the old era in terms of these asset-heavy companies.

18:17You tend to be underweight there. Is that more of a forward-thinking viewpoint, you think, that your analysts are taking? Yeah. A big part of the fundamental research process is what's the five - to 10-year trajectory of the business. Against the competitive landscape that those businesses have, pick the winners and hold on to them. So what could change, I'm asking you a hypothetical, what would have to happen for some of these names to turn over given how long-term a view you guys hold? Disintermediation. You mentioned OpenAI, a big private company coming out of nowhere into the public markets and disrupting things.

18:57I think some of those names, I've always been a little squeamish about hardware-based companies, so I don't necessarily want to mention any names, but you can think of who I might be referring to there. It's just hardware has traditionally not been as competitively advantaged as software tends to commoditize, et cetera. So something like that, I'm not, again, I'm just the passive ETF manager on this. I'm not picking these stocks, but that might be something that could change sometime in the future. So there's a lot of different routes you can take, analysts that cover these companies. Some of them are like forensic accountants that really dig into the numbers and the financial statements and look for things that are maybe mispriced.

19:39Others like to talk to management teams and talk to suppliers and talk to competitors. What is the general way that your analysts approach following these companies? I think one thing that is maybe a little more unique for our group here is focusing on the people, the culture of the company. Why do people want to come work at a business? Why do they stick around once they're there? for a lot of these companies, you know, it used to say it'd be the folks walking in and out of the door every day are who make your business, what's the source of your competitive advantage. And now that we're mostly remote, that's a little different.

20:15But it's getting at some of the softer factors outside of the financial statements and trying to get a view of, does this leadership team have the vision? Are they executing? Are they attracting the talent to execute? So more qualitative instead of quantitative. Yeah, I would. Yes, for sure. I saw a quote yesterday. Benedict Evans, a technologist, did a presentation that he called AI eats the world. He does one at the end of every year for the following year. And for 2025, it's called AI eats the world. And there's a quote in there that has me thinking. It's from Michael Corleone. If anything in this life is certain, if history has taught us anything, it is that you can kill anyone.

20:58And as that quote relates to some of the tech giants today, on the one hand, yeah, to this quote, everything has cycles. Everything that once was at the top has peaked at some point. And I would never say that the environment that we're in today is so radically different than anything history has seen. But on the one hand, I mean, there's obviously the but. The but here is that what we're seeing today has never happened in terms of the moat, the run rate, the earnings estimates, and then keeping exceeding them. I was about to say new verticals, just new businesses entirely that these companies have gotten into.

21:45Amazon is now a full-fledged media company and an ad company on top of that. Michael is arguing this for John templeton right now yeah so i'm so will we be having these conversations in 10 years about the same companies or is history going to prove to be the same as it always is that there is always turnover i would say if we looked back at each decade say going back 30 years a small number stay you know maybe two three four stay and then six or seven of them turn over we don't necessarily really know what those new six or seven are. And if you do, you're going to have a great career as an analyst.

22:25But some of the ones that stay, you know, the ones that were there, say, in the dot com bubble and are still there today, the big tech names, how many times have they had to reinvent themselves to do this? How many times were they absolutely hated by the market? And I'll say specifically, I'll call out a name here, Microsoft was absolutely hated by the market for a long time, but they're either going to reinvent themselves, they're going to find these new market opportunities and succeed, or they're going to drop off the list. It just seems so hard to imagine Amazon being disrupted. And I know forever is a long time, but man.

23:01So there was a great chart that I think is from Ned Davis that showed$1 invested in the largest company versus the S &P. And investing in the single largest company had historically been a terrible idea. right? Because all of the future earnings had already been discounted by the time it got to the top of the mountain. And that broke once Apple took the throne. And it just seems that these giants, at the risk of sounding like, you know, permanent plateau, et cetera, these giants of today are fundamentally and structurally different than the giants of yesteryear. Certainly have a lot more profits to them.

23:39I think some of the giants of yesteryear, depending on when the measurements taking place could have just been big because of a hype cycle, you know, trading at 90 times earnings or something absurd. Didn't necessarily have the business growth to justify that. Charlie, to your point, I looked at that list too. I think I went back to 1980 and did it every five years, the top 10 names. And you're right, every 10 years, it was maybe two or three that would stick. Sometimes all 10 would be gone. Like if you look at the early 1980s, it was all energy stocks, right? Because the 1970s was so good for commodities.

24:10And that is the history of this, is that there'll be these companies that seem like they are invincible. GE was a perfect example. And then it fell out. And I know the one risk that people have been saying forever with these stocks is, well, what if the government comes and breaks them up? And it doesn't seem like that's happening anytime soon, right? That's the worry people have been having for 10 years. It seems that just they'd be getting stronger and more of a stranglehold on these industries. My question is, so these are the 100 largest stocks that you follow. It has a mega cap bent based on the market cap nature of it, right?

24:41Could you see a scenario where your analysts decide these mega cap big stocks, they've hit our targets. We're happy. It's going to be a hard hurdle to jump over. And you go down the cap table, micro cap table at all. And it is more mid caps or smaller stocks. Could you see that scenario happening? Or do you think this index will always have more of a mega cap? They only play 80s Joel. I think two comments there. First, small caps have underperformed for like eight years now. So I would understand if a group of analysts started sniffing around in smaller and mid-cap companies for opportunities.