Jim Falbe – Modern Value Investing at Saguaro (Capital Allocators, EP.320)

23:24They're never going to come out and say, oh, we're a monopoly. They don't even like to use the word dominant. Safra Katz says, oh, we like the term popular. I'm like, okay, that's nice. But if you read through their documents, there are two, three, four word combinations that would imply the existence of this market structure. And in natural language processing parlance, a two, three, four word combination is called an ingram. So it's a bigram, trigram, quadrogram. And in essence, what you're doing is you're looking for these word combinations that imply the existence of some other concept. And so for us, yes, we're looking for economies of scale.

23:56We're looking for dual-sided network effects. We're looking for IP. We're looking for some form of government-granted license. And then also, just as important, on the negative side, there are things that we're trying to avoid. So if you've gotten a Wells notice from the SEC or you have asbestos exposure, et cetera, over time, we're able to build up this type of dictionary where anytime you've identified one of these two, three, four work combinations you put in the machine, it can then identify it forever going forward. We create this. And now this thing, which understands the difference between a good company and a bad company can go out, look across the entire globe and help us find things.

24:30And so it's really helpful. One in niches that you otherwise might not play in, or you might overlook. It's very helpful in geographies that you simply wouldn't get to, or it's helpful in areas where you might have a preconception that something is bad or wrong, but it's changed. I actually had an example of this a week ago. There's this company called Masonite, and they actually make the skins of doors that you would buy at Home Depot or Lowe's. And obviously, contractors or large construction companies will buy them in mass. But historically, that industry has just earned their cost of capital.

25:03That's a return. That's it. So we weren't really that interested in it, but the machine said, hey, no, listen, you got to take a look. And when we did, what happened, Mason and I actually got a new CEO about two years ago. He came in and there was this pricing study done where he found that customers actually expected doors to cost a lot more than they do. So he was like, all right, well, he raised prices across the board, 25 % and said, take it or leave it. What happened is his biggest competitor, Jeldwin, three days later, followed suit, raised their prices. Between the two of them, they own 80 % of the market.

25:34So all of us are thinking, oh, this is just a door business that earns their cost of capital. Well, no, actually what's happened, the market has consolidated and now they actually have pricing power. But if you look at what's happened on their returns in the past two, three years, everyone just thought, well, everyone was at home. They're spending a lot more money because everyone's redoing their house right now. But that's not actually the case. If you look at the units, what's happened is just this pricing differential that they've been able to get. Units have actually been in decline for the last 18 months, but they're doing so much better because pricing is better.

26:01And we're like, wow, this is now a great company where you've got a consolidated industry with pricing power. We would never have found it had we just gone off the way we think about the industry. But the machine didn't have that preconceived notion. It was looking at the reality today. That's where it's really helpful for us on idea generation. When you're sitting at Vulcan, it's$20 billion. You said some large firm is going to be able to capture this opportunity. You're starting to mine for it. What's the impetus for leaving? Well, we have to go back in time, I think four or five years into my tenure at Vulcan.

26:32Vulcan had the opportunity to build out this affiliated manager program. So we had several different groups who had a track record, but they weren't very large. And they were looking for somebody to handle their back office operations, maybe some of the business front office, and then really client development. And we had a debate, is this something we want to do? Because we actually had three groups. And we're like, man, we could really do something here because Vulcan did not have a lot of external service providers. we had built our entire back office ourselves. And we thought we could really leverage this with other affiliated managers.

27:02But after an extensive discussion, CT follows the Greek maxim of know thyself. And I think he knew himself pretty well. He thought, if we do this, I'm gonna be very involved. And if my ultimate goal is to produce the best possible returns that I can for our clients, I wanna stay focused. And so we made the decision at that time to not do affiliated managers. And the AI system that we built was adding so much value and we really had vision of where we wanted to go with it, we kind of got to the point where if we kept going, we risk upsetting the investment mandates we already had. So we've got this really great$20 billion apple cart.

27:39Now, are we really gonna push that over, top all the apples out just because we're chasing some shiny object and made the decision that if we're gonna do this, it probably needs to be independent of Core Vulcan. And CT was gracious enough, the team was gracious enough to say, well, let's have another debate about, do we want to do affiliated managers with internal people? The firm was really kind of split 50-50. There were people like, oh, we got to do this AI stuff. And other people like, ah, I don't know if it's worth it. And ultimately, they made the correct decision for them, which is to do the best we can for our clients.

28:09We need to stay focused. So they still have the AI system that we built, but they said, we want to go this far. And we just don't think we can go any further. We love you. We support you. We're for you. And if you want to go do this, that's great, but we just can't do it here. We felt there's this tremendous opportunity. So five previous people at Vulcan who are all co-founders of this thing, principles, that really believed that we think we can do something that's going to add value for that next generation of value investors. So really interesting story, just kind of going back to how life has this weird way of working out.

28:39My mom, after she worked at Carl Karcher Enterprises, she moved on to do corporate cash management. And she ended up working at this firm called Winrich Capital Management. Unfortunately, after she passed away, kind of lost touch with the people there. I tried to find the Winrich capital management people saying, hey, maybe they could help me understand what I need to do and prepare like you're asking so that I can do this at a high level. After I had made the decision to leave Vulcan and I was actually listening to your show, Ted, at that point, I was like, man, I really wish I could find those Winrich Capital Management guys and heard a podcast that you were doing with a guy named Paul Black from WCM Investment Management.

29:15And I'm like, okay, this is interesting. It feels familiar to me. And then a couple of weeks later, I listened to another show by you where you had Paul Black and Mike Trigg from WCM Investment Management on the show. And I was like, man, this just feels so crazy. I was like, WCM couldn't be Winrich Capital Management. I mean, nobody would name their firm Winrich Capital Management Investment Management, would they? After the show, I went and I Googled them, I looked them up, WCM Investment Management, and lo and behold, there it is, Kurt Winrich and Paul Black, these guys that my mom had worked with that I had never been able to find again when I tried to go back to business school.

29:45And then when I tried to get a job afterwards, and lo and behold, when I'm trying to start my own firm, ended up getting reconnected with them because of you and listening to your show. So thank you for that. It ended up being a really great thing for them and anyone who knows them. I mean, they were just blown away by the story and were so gracious saying, hey, your mom was a big part of starting this in the early days when we were trying to get off the ground and they've tried to support us. And Paul's actually on our board now because of that. And so just a tremendous story and feel like this coming full circle, getting to talk to you today and being able to say thank you to you for that.

30:14Really phenomenal. Thanks, Jim. That's awesome. Love hearing stories like that. So when you set out to form Saguaro, you mentioned the importance of having values that you really live by and work by. What were those values for your firm? So for us, there's five things. We want to build trust. We want to act courageously. We want to give generously or live generously. We want to pursue joy. And we have this phrase that great isn't good enough. It's really just the idea of continuous improvement or continuous learning. And for us, trust is everything, right? If we don't trust you, we don't want to do business with you.

30:47And I think if we're not trustworthy, people aren't going to want to do business with us. I think living generously, again, it's about that idea of giving back and serving. The way I visualize this is like you have a cup, right? And if you fill that cup up with water, well, you now have the choice. Are you going to pour that water back out? Or are you just going to try to hoard all that water in? And if you pour it out, you get filled again. But if you're already full and someone tries to pour more water in, it just kind of flows out. And we've all found in our life from the time we were children, growing up, that as we give, we receive.

31:17And so for us, that's who we really want to be. Acting courageously is just about, okay, if we follow this process, whatever, life is hard. Sometimes things are challenging, but it's in the midst of those trials and those tribulations. Do you follow your process? Do you continue to execute? Do you continue to move forward? And if you do, we think that's the right way to achieve the best possible investment results, but also the best way to achieve the results we want in life. So pursuing joy, we have a lot of fun. We play disc golf and run around and do crazy things. And ultimately, we think that by building that relationship and that trust, it's easier for us to then speak truth when it needs to be spoken and have the tough discussions.

31:53Continuous learning, continuous improvement, I think we're all kind of driven and that's who we are. We want to be better tomorrow than we are today. Let's turn to the investment side of what you're doing. What is that set of investment beliefs that you have that drive what you're doing at Saguaro? Our philosophy is we want to take the best of everything that's come before, that classic investment discipline. And we want to fuse that with hyper-modern technology. So the latest and greatest, the things that are out there that could make us better at what we do. Every human analyst, better, faster, or hopefully both.

32:24And we believe that that's the way to really produce exceptional results for the next 10 years is to make us better. And technology can accelerate that. The way we approach investments is ultra simple. One, we're trying to find the best businesses on earth. So we have a list of 100 companies. For something to get on that list, something else has to come off. So we're constantly searching for these super high quality businesses. Two, once we have them on that list, we're waiting for a true opportunity to buy that company at a discount to what we think it's really worth. We know from experience and also from academic research that even the best companies out there, they tend to experience a 50 % drawdown from peak to trough at least once every decade.

33:06And that's really what we're waiting for is that type of opportunity. And then finally, once we have a great business that also gets discounted and we own it, we want to own that thing as long as possible. We want to find these truly great businesses and allow them to compound and to do what they do. I wish we could own them forever. We're a public equity manager. So at some point, if something gets egregiously overpriced, we do need to make a change. Or if we have another opportunity, we need to do that. But we want to hold them as long as possible. How do you define what a great business means for you to make it to that hundred list?

33:39First off, we want free cashflow. We're a big believer in free cash lag. I don't care if you're going to disrupt the world in five to seven years. If I am not 100 % confident, you're not going to be able to make it between today and there in the future. I mean, there's a lot of great people in the VC space or other parts of the market where they can make money doing that, but that's not our game. We always hear the moat analogy. Obviously, we're looking for moats in terms of competitive advantages, but I think we're different in that we spend a ton of time thinking about what's inside that moat.

34:08Do you actually have Rumpelstiltskin in some back tower up there who's spinning straw into gold. You have a king and queen who in essence are good at capital allocation. Are they using that gold to bolster the moat and make their defenses bigger and take care of their people inside the kingdom? Or are they just enriching themselves and throwing lavish parties and doing whatever? And then finally, I want to give a real shout out here to Pat Dorsey. He wrote a little book on value investing. And he had one idea in there, which I've never heard anybody else talk about, but it's this idea of, yeah, we want companies that grow, but really, is that growth inside the moat?

34:43There's a lot of businesses where people will get excited about that business and they'll be like, oh, look at this. They've got this core here. It's uber well-defended and they're growing, but the growth is actually taking place in a new business line or something that's outside of the moat. That's not exciting for us. We want that moat where the growth is inside. So you think of like Visa or MasterCard, Market Access or TradeWeb or something. These companies are, it's going to be 30 years where they're going to continue growing and that growth, it's all inside the moat. So obviously, we're looking on great returns on invested capital, returns on tangible asset, strong balance sheets, proclivity to buyback shares, all those things, which I think you would standard look for, but that's how we visualize quality.

35:17When you're looking at a prospective business to add to the list, how do you assess management's ability to foster all those things you think are necessary in a quality business that stays that way over time? I'm just going to steal from the greats. Charlie Munger always says that the best predictor of future performance is past performance. Obviously, if it's somebody who's newer to the seat, and there are times where we will get excited about a new management team, there's this meeting of the minds where you can tell, okay, this person is viewing it long-term. This person is taking responsibility.

35:48This person believes that they can allocate capital in a way that will generate excess returns. And you quickly start to see it through their actions and the way that people either get energized or people get de-energized. Once you've decided that the business is good enough quality to be on your list, there's a big gap between something that's trading at your assessment of fair value and 50 % below. So what rubrics do you use to figure out when you might want to start buying something? One of the things that makes us different from other people I know in the industry is we think in terms of ranges of values around businesses versus point estimates of value.

36:25For instance, at Vulcan, we use point estimates of value and it works great if you have businesses where the value is stable and you can size your position according to the discount that you think is in that stock. That works wonderfully. But if I have high quality businesses, oftentimes they also grow. The perfect example is Amazon. And at Vulcan, we spent a year trying to figure out what is the appropriate valuation rubric to use for this company. because if my assumption is they're going to grow at 10 % versus 15%, I get a radically different outcome in my value. We asked the question, we're like, well, is Amazon too good to own?

37:01Because it's hyper growth and the value fluctuates, can we not own it? Because it doesn't fit the process. That experience made me feel, it's like, well, I'm not fully confident what Amazon is worth exactly. I am very confident that it's worth more than X. And I'm also very confident it's worth less than why. So we're trying to have that humility to say, listen, if these are truly great businesses that are kind of once in a decade type opportunity, yeah, I don't necessarily know what it's worth. But man, if it gets down here to the low end, I really want to own it. And once I own it, I want to hold on to that thing because these truly great businesses, they're so rare.

37:38Another great example is when I first started at Vulcan, we owned Apple. And at the time, I mean, it was just unbelievably cheap. This is like 2013. And the iPhone that they'd released that year was not as popular as the Samsung Galaxy, which is hard to believe today, but everybody was kind of poo-pooing it. And we had a multiple on that thing of like 10 times, and it was incredibly discounted, even at a 10 times multiple. We owned it, and we'd go to meeting after meeting where people say, what's wrong with you guys? How can you be so dumb that you own Apple? And lo and behold, over the next 18 months, the stock actually doubled.

38:09And we were so excited, patted ourselves on the back, it hit the fair value estimate, and we exited the position. Well, on a split adjusted basis, the stock was$33 at that point in time. Today, it's almost 180. And we're so proud of a double, which is great. No one's ever going to get upset at you about that. But we missed out on another 6X. And if we'd held it from 2013, if we could still hold it today, that would be a 12X. What we've tried to do is say, hey, if we've got one of these really rare, truly great businesses, it's okay if it kind of gets to our midpoint of value, our fair value estimate.

38:42Unless we have some other opportunity that's just so much more compelling, let's allow this thing to compound over the long run because that's why we bought it in the first place. We're holding ourselves to only these truly high quality businesses. And the opportunity to get one is so rare. We try to be ultra long-term. We're going to have very low turnover. We've got some great LPs. And I think future LPs are going to be people who understand and share that long-term time horizon. But if we have one sell or one buy in year, that's not going to surprise us at all. How long do you think long-term ends up being for the portfolios that you run?

39:16I am guessing we're going to have less than 20 % turnover. So I don't know exactly, but I'm very hopeful it's longer than five years. Love to hear about how you make decisions on the portfolio. So we've got four people on our research team today. I will put a plug out here. We're looking to add a fifth. So if you know anybody or anyone out there is interested in what we're doing, We're very picky about who we bring on to the team, but we'd love to talk to anyone and everyone. Everyone on our team knows what we're looking for. So we've got Bruce Donnellan, myself, and then my partner, Brian Chow, and then Brian Wagman, who joined us more recently.

39:48But everybody knows what we're looking for. They have the opportunity when they're looking at something, if they can find a reason why it isn't going to qualify, that bar is really high, top 100 in the world. They can quickly just say, okay, it doesn't qualify. Here's why. I reviewed it on this date. It doesn't make it for this reason. We have a list and we keep that and we feed that in the machine. But we do this qualitative analysis first. So before we do valuation on a business, we evaluate it strictly from a qualitative perspective. And I'm sure some people out there have fallen guilty to this, but we've also experienced in our past that if a company looks cheap or it feels cheap, sometimes we'll view it as more attractive than it really is.

40:24I'd say when I have cash in the portfolio, it kind of reminds me of high school where if I didn't have a date for a long period of time, suddenly people who I didn't use to find attractive started to look a little bit more attractive than they did in the past. For us, if we have a lot of cash, it's the same way. It's like, well, maybe that business makes it. But by taking valuation out of the equation and just evaluating a business from a qualitative perspective and doing financial analysis, it helps us to be a more objective. But we bring it in, we evaluate it, and we think it makes it. The second step is we do this blind vote, which has been really helpful.

40:55Because we found historically, we'd bring a company in, and then we'd start debating whether it qualifies. And we'd get mad at each other for 30 minutes or an hour, only to find out that we all actually agree that it belongs on the list and at the exact same spot. So now we come in and we actually vote on whether it qualifies and where we would rank it on the list so that we can kind of see where we all are to begin that conversation. What does your portfolio look like in terms of number of names and position sizes? We're very concentrated. Our technical limits are five to 20 names. Realistically, each one of our portfolios will probably be more 7 to 14.

41:27Today, we've got 12 in all three of our portfolios. Our portfolio sizing is very simple. If an idea is new to us, i.e. we haven't followed it longer than 12 months, we're going to limit our position size to 5%. If there's a company that's not quite selling at the low end of our valuation range, but it's drifting down, we've talked to a lot of our clients and they would prefer for us to be fully invested if we can be. So we don't always have companies selling at the low end of the range that we can allocate capital to. For us, a core position is the 10 % weight. And that's, we followed something for longer than 12 months, it's on the list, and it's selling at or below the low end of our valuation range.

42:06And it's going to be that core position where we size it at 10. If something just gets unbelievably discounted or is an incredible conviction of ours, we can take a 15 % weight. And we do have a couple of those. Those would be our really high conviction ideas. We don't tend to trim things. We're just It's going to allow them to compound. We do have limits where we're going to hard trim 20%, 25 % weights. But for the most part, the reason we sell something is because the reason we bought it changes. There's some other opportunity that's just so much more compelling, or hopefully at some point, someday it hits the high end of our valuation range and we're forced to exit the position.

42:40As you look at your list of the 100 best companies, are there biases in terms of sectors and market cap? We have three strategies. We have a SMID strategy, an all-cap strategy, and a large-cap strategy. We kind of cut the difference between SMID and large at around$20 billion. So there's no overlap. As far as industries, there are some areas that we avoid. So for us, with our long-term time horizon, we don't know what the price of a commodity is going to be five to 10 years into the future. So if the value of a company is dependent on the underlying price of a commodity, that's probably not going to work for us.

43:16We tend to stay away from things that are highly levered because it makes those values really unstable over time. And then we tend to stay away from things that are highly regulated by various government entities. And so while we're global in nature, we're willing to look anywhere, there are certain countries where if there isn't the rule of law or we don't have recourse to the assets, probably not going to invest. And how do you think about those different risk factors in your portfolio? We ultimately think risk is not knowing what you're doing. We're going to have controls, right? So there are certain limits on how much we'll have in an industry exposure, how much we'll have in an individual position.

43:49But really, by focusing on a few things and knowing those things really well, we limit ourselves to what we believe to be only the best businesses in the world. So we do get some of the benefits of diversification. I think you get most of them in eight or 10 names. But again, it's that quality bias that if you combine long term and quality, it really tends to bail you out in the long run. If bankruptcy risk is almost zero and you have a company with some form of dominant competitive advantage in its niche, it tends to do pretty well over the long run. You mentioned at an early age learning from your mother about covered calls, and that's something that you add to your investing.

44:25So how do you think about using covered calls in the approach? When we think in terms of these ranges, the wonderful thing that the public markets offer us is this product that allows us to kind of take advantage of those. So as a stock begins to drift down towards the low end of our valuation range, we, in essence, can make a pre-decision to purchase that company. On a day when we're calm and we're rational, we can actually write put options to enter that position. And what it does is, one, it solidifies our decision-making and it forces us to sharpen our pencils in advance. Two, it helps our team to have something to actually do so we get to write these options consistently over the weeks, which is really important, actually, in a shop where you have ultra low turnover, you wouldn't believe the human proclivity to just to want to do something.

45:12You feel like you're adding value because you're doing something. And so getting to write these options gives us that. And then ultimately, it helps us to generate a little bit of yield where we would just write limit orders. We're very hopeful in the long run to be able to look back and say, hey, we're more than covering our management fee with this options writing. Obviously not going to promise that and we'll see what happens, but that's helpful on entering positions. And then if stocks move towards the high end of the range, we can do the reverse. which is writing call options on these positions to exit.

45:42So again, we're generating that yield. And if it hits the high end, we'll exit. And we actually had the opportunity this year to do that. We were writing put options on Meta slash Facebook in November, and then the$90 or something, and then we turned around and we were writing call options once it got past 200 in March. And so we were able to kind of see the full investment cycle in the name where we earned a lot of excess yield, writing these options and got to take our position up and then got to exit the position. Never thought we would execute both sides within four months, but lo and behold, sometimes the markets do crazy things.

46:15How do you think about gap risk on writing these options? Meaning you write an option because that's a price you'd like to buy it, but something negative happens to the company and maybe you would have revised your estimate of where you'd want to buy it. And conversely, you're owning something, something really good happens that changes your assessment of what it's worth, but now you've pre-sold to that position? We think of it in the same terms if we just owned the business outright. That's risk, and there is risk associated with it. So we write very short-dated options, so the probability of something happening in the five or seven trading days that we have the option out there is lower.

46:51But again, if it happens, it would have happened if we'd owned the business in the first place. And we think most events are shorter-term in nature as opposed to destroying the thesis on these businesses over a five - to 10-year perspective. I'd say on the upside, that's probably rarer. I think the best example would be if you had some mid-cap company that suddenly there was an acquisition offer or takeout offer and it's way above your range. But I think our high-end range usually is high enough to where most companies aren't taken out. We kind of went back and historically looked at things. I think it was 5 % of the time acquisition, takeout offers were above the high end of our range.

47:25It's a rarer event, but it could happen. So what's that fundamental assessment has gone? and you've talked about idea generation using AI. What are some of the other ways you're thinking about this more modern way of applying technology tools to value investing? Well, obviously we're doing the easy stuff. So we capture all of our internally generated data. So we record and transcribe our research meetings. We try to record and transcribe as many calls as we can. Every research report that we're doing, we're trying to do the next step of making those reports machine readable. So if we reach a conclusion, we're actually putting in, well, here's the source document where I reached that conclusion.

48:01Here's the paragraph. Here are the actual words that I used that inferred that this existed so that we can then take that, feed it back into our AI efforts to make us better in the long run. So even if we're looking at something like Amazon, no machine is going to find another Amazon out there because it doesn't exist. But it's still valuable for us to do the human work on that because as we learn, as Amazon discloses things, that goes back into our models. Obviously, we're going to try to use it to evaluate our own decision-making. So sometimes we're like, oh, who said this? Who said that? Why did we think this?

48:32And we can go back and we can review that. And it's very objective because you can actually not just read it, but see and hear what someone said and try to improve our decision-making over time. But I think the real thing for us is kind of these next steps, which is one, every company produces this incredible long tail of information. And there's no human analyst out there, if they're looking at a company that's been around for 10, 20 years, who can read every 8K and every piece of information that that company's put out, but the machine can. And so as we teach it, what are the things we're really looking for that are positive or what are the red flags?

49:06It can go through that long tail of information and ensure we're not missing something. I think if you take it a step further, the really nice thing is we tend to look at the best businesses in the world. However, disruption tends to occur in the weaker businesses first. So if we have the machine watching for changes in these weaker businesses, it gives us a leg up to hopefully avoid disruption before it would impact one of our companies sooner. So that's really where we're going. We have a longer term plan, but I think it's one step at a time. Obviously, I think ChatGPT has brought a ton of attention to this space.

49:40We obviously use that in parts of our process, and we're looking for ways to apply large language models to what we do, and we'll have that. but I don't know if that's going to be a differentiator. So to take a step back from the investment program, as you're going to build a new business, everyone could look at the asset management business and say, wow, it's a crowded landscape, you're a new entrant, it might not be the type of business that you would have on your list of 100 best businesses. How have you thought about building a business in that landscape? Yeah, that is a great question. So we're very aware that it's only one out of three that kind of even make it to a certain point.

50:16That sounds like rolling the dice, but for us, there were a couple of things. One, we truly asked the question, are we going to build something of value that we think humanity needs? Because humanity does not need another asset manager, right? I mean, we need that. We need another hole in the head. There's just too many of them trying to extract value. We said, if we're going to do this, one, we want to have values that we think are worth reproducing. Two, we want to have a product where we think we're properly incentivized to do what the client wants, which is ultimately perform. Incentives really matter.

50:50And for us, we've seen too many firms that they become very successful, but they have a simple management fee and the incentive to really perform isn't necessarily there. And so we said, well, how do we combat against that? And so we have a different structure. We want to be performance fee based. We want to make sure that we're capacity constrained. And over time, as we grow, we actually want to drive our management fee down. So there's a lot of operating leverage in this business, if we happen to be in the 33 % of firms that do succeed over the long run, if we go from$100 million to a billion dollars in AUM, we don't up our costs by 10 times.

51:23So we want to be able to give that back to other people. It's having values. It's building products that we think are designed in a way to perform. It's properly aligning incentives to where people are going to want to do this for the long run. And then it's trying to get great people. I mean, one of the things I'll tell you is I can't do this by myself. I know that. And so I've said, who can I get around me that I want to be in that foxhole with who I think is tremendous And so we've built an incredible team. And then our board that we've been able to recruit. One of the things, Falcon had a board of advisors.

51:50We just said, wow, what if we were to take this board of advisors concept and try to find people who we thought were the best in the world at what they do that could help us navigate and do this at a really high level? Paul Black is on our board who's done this. If we could build something even a sliver as meaningful as what they've done, not from an AUM standpoint, but from the impact they have on their people and their community and the world, we'd be thrilled with that. We've got Stacey Havener, who has raised a lot of money for emerging managers, who we think is going to help us. Our board is amazing.

52:17Jim, I'd love you to take me through an investment example from the sourcing, through that work, how it got off your list, and it has a place in your portfolio. I'll give you a couple examples of things that have gone through our process. And I'm going to explain why they've made it or why they haven't made it. The interesting part probably is what has been sourced from our AI efforts, as opposed to traditional human efforts. If you look at our portfolios today, they're rife with some of the best businesses in the world that are also really well-known. Amazon and Google and MasterCard and Visa all happened to be discounted when we launched.

52:51And so we actually weren't excited about that because we said, oh, well, our portfolio is not that differentiated. And I think the best thing if you're a new manager is having that differentiated portfolio and it makes you look unique. But ultimately, we're trying to generate returns, not just have a differentiated portfolio that we can market. And on the AI side, at this point, we've got about 20 names that we've actually gotten onto the SCM 100 list, taking them through our process. But unfortunately, none of them to this point has also hit the low end of that valuation range. So some of them are kind of down there.

53:22And I think with our next round of flows, we may have a few that get in the portfolio. We may have one very soon where we'll be like, hey, this was generated by our AI list. But just to give you some real examples, so there's a company that's called Games Workshop. It's based in the UK. they make the game called Warhammer 40 ,000. And there is no nerdier thing in the world than Warhammer 40 ,000. It is a board game that's like World of Warcraft. We were just like, this is the craziest, dumbest thing we've ever looked at. But the machine just kept saying, hey, it's amazing. And so we go and we start looking and first thing you notice is, wow, they are 90 % plus gross margins on producing plastic.

53:58That's pretty amazing. Okay, these returns are just off the chart, but we don't get it. is there a competitive advantage here? We ended up going to some of their shops and visiting them to see what they do. And we quickly realized, okay, this is the only publicly traded religion in the world. Like I can take an ownership stake in a religion. These people are obsessed to the point where to play this game, if you've never played it, you actually have to spend hundreds or thousands of dollars purchasing these little models that you use to kind of move around the game board. And you have to build them yourself.

54:31You can't buy these models pre-assembled. So one, you're putting in tons of money. And then two, you're putting in tons of time and effort to craft this army to play this game. And you have this huge investment. It's almost like rushing a fraternity or a sorority. You have to put so much in to kind of get to a base level. You're very committed. And once you've got the thousands of dollars and hours put into it, those models aren't good for anything else other than playing Warhammer. But it's this community where people come together to do the same thing you do with video games, but you do it in person.

55:03and for these people who love it, it's a really exciting thing. It's their adult hobby that they love and again, we heard so many comments from people like, well, do people ever leave this? And they're like, yeah, sometimes people leave when they get married or they have kids but they always come back and their comment is, it's like, well, they're just so mad if they got rid of their stuff because then they have to buy it all again or oh, now this guy's a lawyer and he's like, now I can really do this. I can spend the money and finally build my great army. We didn't get it but when we got in and realize it's like there's almost this network effect of this game is amazing because they've opened these stores and they'll just build this community around the store and the numbers there.

55:41I mean, go look at Games Workshop and you'll just be like, these numbers are insane. The real question is, do they have staying power? And I think if you look at it, well, they've been playing this game for almost 40 years now. Maybe that's long enough for a staying power. And I think, again, we had a bias against it because we're like, we don't play the game. We don't understand it. I think that's a great example of one, both from a numbers perspective and qualitative. So when you've done your work on that, but it's not cheap enough for you to buy it, do you then have to conclude, well, the market's already known what you figured out?

56:10That's a great question. Frankly, I don't care because I'm hoping for a point in the future where we do then have a divergent view. I think it's a great business and hopefully one day we'll have the opportunity to buy it at a discount and then we can own it for a long time. So whether the market's figured that out or not, no skin off our teeth. If we have a full list of 100 names, We only need one or two to have that type of a discount each year for us to have a really successful investment philosophy and process. So that's our goal. We know a lot of names on that list. They're never going to get discounted.

56:40These are some of the best businesses on earth, and they don't always trade at huge discounts. So that's fine. We don't need them. We just need a couple. All right, Jim, I want to turn to a couple of closing questions. What is your favorite hobby or activity outside of work and family? I've got a lot of hobbies and activities, but if you look at what I spend most of my time doing. It's playing chess. I guess I love it because it's perfect information. There's not as much uncertainty as what we do day in, day out. It's kind of nice because there's always a right move in chess. The question is just, can you find it?

57:11It's been a real, real obsession for about four years now. What did you dream about doing when you were a kid? I wanted to be the captain of the USS Enterprise. I need Elon Musk and Jeff Bezos to get their act together, move this thing forward and maybe I can have a late life crisis and pivot to something else. What's your biggest investment pet peeve? It's really that our private equity brethren don't have to mark to market. People want to compare private equity performance to public equity performance. And some people out there who I don't think understand the math actually use sharp ratios to compare them.

57:45That's just crazy. I'm like, for crying out loud, if I could value my own book, my sharp ratio would be a whole heck of a lot higher than it is since I have to mark the market. What's one investment mistake you made that you'll never make again? I think he gave you the example of Apple earlier that really changed it for us, which is this idea of if we truly have quality, valuation matters, but let's be humble and realize that the upside can also be much better than we think it's going to be, just like the downside. I mean, again, these ideas and opportunities are so rare. When you get one, just hold on to that rocket and ride it until it really gets to the point where you're like, okay, this doesn't make any sense anymore from a return perspective.

58:24Which two people have had the biggest impact on your professional life? Well, I already mentioned Rick Berman, who obviously played a big role. I'd say two other people. There's a guy named Bill McDonald, who's also on our board. He's a former professor at Notre Dame, really well known in the industry because he and another professor there named Tim Loughran actually created the bag of words approach for sentiment analysis. So, I mean, he's worked at places from Citadel on down, trying to help them really develop that. So for us, great member of our board, because he's the fusion of both classic investment discipline and artificial intelligence data science.

58:56But he taught the applied investment management class at Notre Dame. And when I was a part of that, he tore me apart. I mean, it didn't matter what work I provided to him. It was never good enough. I mean, just ripped me to shreds and forced me to do things at a level I had never done before. And frankly, have never really been forced to do a lot of other places. I thought he hated me at the time. I thought I was a terrible student. Only later I found out he pushed me so hard because he thought I really had something. And I'm so grateful to him, though, because a lot of the things I learned from him, I helped implement at Vulcan, and ultimately we've implemented at Saguaro.

59:30So I think if you look at our valuation, a lot of it comes from Bill McDonald. So real thankful for him. And then I have to call out C.T. Fitzpatrick. I just really admire him. Obviously, I would not have the opportunities that I have if it weren't for Vulcan Value Partners. and the ability to come in, learn from him, not just how to run a great investment process, be quality focused, but also how to build a great firm, how to treat your people the right way. We always talked about at Vulcan. It's like in the industry, there's the black area, there's the white area, and there's a little bit of gray.

1:00:03It's like, man, we want to be so far over in the white that we're not even close to the gray. And seeing someone live those principles out, I mean, obviously those principles were important to me, but I didn't know if people did that in the investment industry. and just seeing the way he acted and behaved, just tremendous. I just think Falcon and C.T. are set for a great second act, really cheering for them and just so thankful for the role they played in my life. What was the best advice you ever received and what context did it come to you? So actually, this is a funny one. I listened to a sermon by a guy named Tony Campolo, who for a long time was a sociology professor at Eastern University.

1:00:37And he had this one talk that he would give again and again and again on what can you learn from a 100-year-old? And I don't remember everything he said, but there were two key points. So they'd done this study where they interviewed, I think it was like 10 ,000 people who were 100 years old or older over a very long period of time. So it's just this incredible, can you get wisdom from these centenarians? Again and again, they came back saying the same things and they kind of grouped it into these core points. And the two that really stuck with me were, number one, these people said, I wish I'd paused and reflected more in my life, really given thanks and realized what I had.

1:01:12in the moment, the people, the relationships, et cetera. Really tried to take that to heart and through my life, pause and reflect and give thanks, be grateful for what I have. And then two, it was this idea, they all said, I wish that I had risked more. I wish that I'd gone for it. I wish I'd gone after that person I was interested in, or I wish I'd taken that dangerous opportunity. And I've tried to live my life that way. That's why I went overseas to do humanitarian work. And a lot of people thought that was a dumb idea, but I said, I want to do this. I'm going to regret it if I don't. That's why I went for my wife and she thankfully said yes.

1:01:47That's why I tried to transition back into doing equity research. And ultimately, it's why we took the risk to start Saguaro, even knowing, like you said, a lot of great investment firms don't make it. And we don't want to be, as Jeff Bezos says, 80 years old, looking in our bed, reflecting on what we wish we'd done. So great advice and have tried to live that out. All right, Jim, last one. What life lesson have you learned that you wish you knew a lot earlier in life. I hope this one's appropriate, but my wife and I, we have four kids and we've changed tons of diapers over the last 10 years and we've developed something we call the poop principle.

1:02:20It's real simple. If it smells like poop, it is. And number two, if you don't do anything about it, it's only going to get worse. So listen, you know, if you're dealing with some crap in your life, just deal with it, get it done because it's only going to get worse. It's not going to go away and it's going to continue making things unpleasant for you. Well, Jim, thanks so much for taking the time and sharing the story and just wishing you the best of luck on this new venture. Ted, I really appreciate it. Thanks for listening to this Sponsored Insight. Sponsored episodes are paid opportunities for another 12 managers a year to appear on the podcast.

1:02:56If you're interested in telling your story in front of the largest audience of investors in the industry, please email us at team at capital allocators.com to apply for one of the slots.