Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]

22:42We make no money. But now, let's imagine instead that I had to bring a tray with a fixed number of cookies and I can't make more. Well, what happens is that morning, I'm trying to figure out how many cookies I'm going to make. And I ask myself the question, should I make one more cookie? And if I make one more cookie, it'll have two effects. One is I'll get to send an extra cookie and I'll make whatever the profit on the cookies are times that cookie. But the other is it will increase the number of cookies in the market, which will be the drive down the price of cookies. And this will cause me to sell all of my cookies at a slightly lower price.

23:17And so as I'm making this decision, you can see how there would be a natural maximization point where I maximize profits. Now, in this case, there's two competitors. So when I add an extra cookie to the market, I lower the price for me. I also lower the price for my competitor. I don't internalize the effect on my competitor. So I end up behaving like a monopolist, but a monopolist who only absorbs half of their price impact in the marketplace. In other words, one who faces more elastic demand. But I still behave like a monopolist, just with one facing more elastic demand. So there's still monopoly profits to be had.

23:49So the equilibrium gets work. We will solve our differential questions at the same time. We get to an equilibrium and lo and behold, we end up, we both end up making profits. Okay, this is all very theoretical. So you start studying the cruise line industry. Okay, just to pick an example of an industry. I'm not that. I'm not. I've never owned a cruise line business, but I've been around it. It turns out that if they want more cruise ships, they can't just snap their fingers and have more cruise ships. The number of cruise ships for a good long while is essentially fixed. And so what they do is – this is a perfect example of a corno-oligopoly.

24:22The number of cruise ships is fixed in the short to medium term. So they maximize yield, which basically means they're adjusting price. that leads you down a path of, okay, this is a business where just from that perspective, there's lots of other things to think about. There's brand, there's distribution, there's a lot of things. But from that perspective, now you have a sense as to how this is a business where there should be some monopoly profits. But what will mediate how much economic profits there are is how many competitors there are, right? And also how much elasticity of demand there is.

24:53And then, of course, other factors. And then, of course, there's also the question of, are you in equilibrium or did people accidentally bring too few? Let's say you show up at the fair and you brought a tray of cookies and it rains. Well, now the price of cookies plunges and you lose money, right? Or let's say you show up and for whatever reason a famous singer shows up and there's a gazillion people and now you sell the cookies at premium. So, you know, are you at equilibrium is another good question. But it turns out that like a lot of travel businesses are, you know, corno oligopolies, you know, rental cars, air travel cruises.

25:26So this is an example of using a mental model that allows you to understand like certain types of businesses in a somewhat systematic way. One of the investments I sort of cut my teeth the most on where I first had a lot of success was in the construction equipment rental business. And that is also – it is a Cornell oligopoly. You know, in any market, there's a sort of fixed number of rental companies and they own a certain amount of equipment and their ability to change that in the short term is constrained. It's constrained and therefore, you know, it's a corner of a gobbly. And it's also a good one because elasticity of demand is very inelastic.

26:04Turns out nobody said like, you know, I see the price of man lifts is down 100 bucks this week. I'm going to rent one. And at the same time, nobody ever said like, I'm not going to build my building because the price of man lifts is up 100 bucks this month. I hope that got to your question. But basically, you can think about there being many of these things, like these concepts that you can then kind of follow to their conclusions. And of course, life is complicated and every company has like often a whole confluence of these things. And what you're really looking for is a business where you have a sort of a bunch of these things that are working together.

26:31With the cruise ship industry, like the idea that it takes a long time to build a cruise ship and you can't just snap your fingers and have another cruise ship is fairly invariant to technological change in society. I guess maybe there's some future state where we can like, you know. Print them out. Print them out. But like for now and for the foreseeable future, this is going to be fixed. And so you're looking for, you know, relatively sort of technological change in variant advantages and layered and interwoven that kind of give you the business. And then from there, you know, I have a friend who jokes that a good value investor's, you know, memo is like 20 pages about the business and one page on the valuation.

27:11So like from then from there, it's like, I don't know, like, is it cheap? Does it make a lot of money relative to the price? Is it going to grow a lot relative to the price? You know, these are pretty trivial calculations. If I was thinking about how you would spend your time, it would seem to be incredibly valuable to collect models like this over time. Do you find your way to most of them through a specific business? Which comes first, the business or the mental model? Oh, so you're asking how do you find the gold on the ground? The answer is yes. It's hard. There's nothing – I keep coming back to that, but there's nothing about investing that's not hard.

27:41Um, we, we look for, you know, I, I've, I hired a Stanford professor to assemble all of the economics, um, models in all of the courses in Stanford and then just like walk me through all of them to make sure I hadn't missed any. And I picked up a few that I'd like, you know, missed or forgotten about. I would try to read broadly, like, you know, um, then of course you study companies and one after the other. And for in various companies, it'll sort of like click for you. That's something, you know, that's something is happening. To drive home the point, can you do one more like the Cornell Oligopoly just to give us like a flavored sense of like another thing that you've used in the past?

28:16Secondary reinforcers. So this is just a different place. This is out of psychology. It turns out that there's like a meaningful psychology literature that's been built up in animal studies and people and all the rest. which basically says this idea that when you give, you know, mammals something that stimulates their reward systems, your brain, for lack of a better term, sort of captures the context in which it was received. And then, you know, if it likes it, tries to replicate that context. And you can, the sort of evolutionary reason why this makes sense is self-evident.

28:57And what makes that interesting is that it turns out that the strength of these secondary reinforcers is proportionate to the power of the stimulus as well as it's inversely proportionate to the time lag between when the stimulus comes and when the pleasure sensors get stimulated. So, you know, if something makes you feel good three hours after you got it, your brain kind of doesn't know where it came from. If something makes you feel good, you know, within a moment of when you got it, then your brain knows exactly. And what's interesting about that is this is called secondary reinforcers because you can create these associations between the stimulus and other things that are in the context that it was received.

29:46So you can make rats prefer cocaine that's given to them with a certain color light. They'll continue to seek out that light even when you deprive them of the cocaine. Okay, cool. That's a neat thing to know about the human brain. Where do I see that applied? Well, if I were to rank by margins the consumer packaged goods industries, I think the ranking might look something like this. You'd have the nicotine cigarettes at the top. and then you'd have like dip and then you'd probably have you know coca-cola and then you'd probably have coffee and then you'd probably somewhere have like candy and then you'd have like sugary sweets like um uh you know cookies and stuff like that and then you'd have like tomato sauce and bread and then you'd have i don't know water right something like that it's probably a rough like ranking well it turns out that if you go down that same list and you ask what is stimulating the pleasure people's like you know pleasure systems well in the case of nicotine you know inhaled through a cigarette or a vaping product um nicotine is incredibly powerful and the the respiratory system is a very fast delivery mechanism so you get this very rapid stimulation of people's pleasure sensors and lo and behold it creates these very strong secondary reinforcers, which make people very brand low.

31:15Not only, I mean, if you ever watch smokers, they're not only smoking the same brand, they're smoking at the same time in the same place, like every day. It also helps that nicotine is addictive, which creates a trigger for a habit, which is a whole other brain function piece where you're kind of making and following habits. You know, if you go down the list, caffeine is a good stimulator, but, you know, it's not as potent necessarily as nicotine more importantly you're taking it through your stomach and by the way dip goes through your lips so it's pretty fast but not as fast as cigarettes caffeine you know soda has sugar and caffeine it goes through your stomach so it's slower but it still creates a fair bit of um uh you know the association isn't that far isn't that far apart as you work you know then you get to things like cookies there the cookies mixed with fat and stuff so it slows it down the sugar is mixed with fat and stuff so it slows it down even more but it's still pretty potent.

32:08It's obviously sweet. You work your way farther down. You get to your savories or whatever. Here, yes, these are things people really like, but the stimulation is much weaker. It's more time lagged. And as a consequence, people have a preferred tomato sauce, but in the end, there's much less brand loyalty than, say, a cigarette. Obviously, water, other than if you think about brands that are more status-focused, but if you think about just sort of like a bottle of water. I don't think in the end, anyone's that picky. And I guess the valuable thing in markets would then be that markets don't properly value that insight.

32:43Like if you look at Philip Morris, at one point it was the best performing stock in US history or something like that for like decades and decades. So it would like corroborate this idea that it's probably like a valuable insight, but at some point it gets priced, like insights all get priced. And so maybe that's what you were talking about earlier, which is you need a confluence of these things in an area that's been neglected to find an interesting opportunity, something like that? Yeah, you need something that scares people away. You know, I think the, you know, the example I gave, like, I don't think it's a mystery to most people that like Coca-Cola is a good business, right?

33:18I'm not totally convinced that like, what I just laid out is like, gonna make you a lot of money in the public markets anymore, because I think it's priced in. I'm not totally convinced that the people who own these things understand it. They just have observed that in practice, these are very brand loyal businesses. However, you know, sometimes things come up and, you know, there were, I was involved in a nicotine vaping company, which was reasonably successful and ultimately acquired by a large tobacco company. In the early days, it was not, you didn't have necessarily all this evidence that these were going to be really great businesses.

34:04But the theoretical construct that I just laid out to you was an important sort of guiding factor in giving me confidence that this was a business. There's a lot of other factors, but this is a business that, you know, would ultimately be successful. Or, you know, I have friends who I didn't do it because I thought they were right, but I thought I had other things that were better. And there's opportunity cost to consider. But I have friends who were successful investors in Philip Morris International. They were observing Zinn. And, you know, a lot of this, like, intellectual construct gave them a sense that, like, that Zinn was going to have a lot of brand loyalty.

34:45You know, where at that time, you know, it was sort of unproven. And Zinn, of course, is quite a big one. It has proliferated and there's a lot of brand loyalty. But that wasn't obvious. At least it wasn't in the historical data until – so these were – all of these tricks, they're not useful until they are, I guess would be kind of the way to think about it. If you think about the classical ways of finding edge in markets, it would be informational, which seems kind of gone, analytical, which is a lot of what we're talking about. And then I'll call the last bucket like structural or behavioral or something like that.

35:23What do you think about ESG? It comes to mind because of the nicotine examples where there's just a class of investor that's not allowed to own it, which creates like a weird impact on markets, especially if those asset owners are very large. What do you think about ESG? I think that if you manage money for other people, you're deeply arrogant if you are going to apply your ethical framework onto the way that you invest. Society in aggregate comes to a collective view of what's allowed and what's not allowed. And we call that the law. And if a business is violating the law, you know, that's often a bad investment because, you know, obvious.

36:05If society is evolving and the law is likely to change, that is a risk that one needs to factor into an investment. And you'd be sort of silly not to think about that. But if something is just disliked by a group of people, but they haven't built up the critical mass necessary to change the law in this country, and you don't think the risk of that happening is particularly high, but you decide that you're going to apply some moral framework and not make them money to do it, not make money for your partners to do it, that's a really fraught thing. Because what gives you this deep wisdom about what's right and what's wrong that is a better than like the collective will and unjudgment of society.

36:45And by the way, maybe you'd say, okay, fine, I'm not going to use my judgment. I'm going to use my investor's judgment. But then the question becomes, okay, well, but which investor? And how do you weight them? Like, equally? Is it by AUM? What if it's an institution? Do you poll the underlying people at the institution? Like, this is a wild thing. I think a much better approach is to just say that the goal is to maximize returns. And obviously, in doing that, you have to, companies have to comply by the law, you have to comply by the law, and you have to take the change in norms into account.

37:22But laying any sort of further ethics onto that, and then, of course, you maximize returns, people can, of course, take that money and give it to whatever charity, you know, they feel that they want to. And, and I think that that's, that's sort of the only solution. It's like the only solution that I think kind of resolves this problem that isn't fraught. I've noticed in my career that, you know, people in investing circles, they talk a lot about like panics, right? This idea that you want to buy when things are bad. I have noticed that there are certainly economic panics that have happened in my career.

37:50I've also noticed there's sort of moral panics that have happened. And, you know, you can buy into moral panics much the way you can buy into economic panics and you can do well. Now, economic panics bring with them the risk that things could get worse and the business might not survive the challenges that lay ahead. Moral panics bring with them the risk that, you know, you could bring about legislative or regulatory or rulemaking change that can hurt the company. And so you need to take these things into account. But I think that it's reasonable as an investor to look to areas that are viewed as sort of bad but are not illegal.

38:35And for what it's worth, when I've dug into most things like this, I've always discovered that these things are far more complicated than the sort of naive, you know, coal is bad. Okay, well, sure, but, you know, electricity is pretty good.

38:51You know, so it's complicated. I'll add one other thing, which is this idea that I think you mentioned, which is funds that can't invest or whatever. There's an implicit point that you're sort of saying, which is an elasticity of price concept. And I'm not that – I think the literature on this kind of agrees with me. But I don't think that groups of investors deciding to forego certain asset classes like oil companies necessarily cause them to be super cheap. I do think that there can be sort of more broad-based things where people kind of don't want to own something for some reason. And if it's really broad, it can have some effect.

39:24But I think mostly what happens is people just kind of get scared. It's more of a panic. People get scared. Like, oh, no, this company is going to get shut down because this group of people view it as terrible and they're going to try to kill it. I think now's a great time to devote a long block of time to your investment in Carvana. I think people that know you and your firm's history will certainly associate you with the position. It's been an enormous position for you over time. you're one of the biggest investors in the business. And for me, one of the reasons I've asked you so many times to do this is that let's say dating back five or six years now, I've had the chance to talk to you about this company through its many ups and downs.

40:05And it's been one of the most interesting educations that I've received from another investor on investing, just talking to you every so often about this company and what you're thinking about it. And so I've been lucky to enjoy that, you know, the audience of one. And I thought it would be an amazing opportunity to hear you tell the story, which is very complicated. It's a complicated business story. It's a complicated investment story. Your own story about how you were going through it all is interesting and complicated. There's all sorts of dimensionality to it. You were joking that it's like five rivers coming together.

40:37You kind of have to explain each river, but we have the luxury of time here. So I don't know how best to start with which river maybe you can pick, but I want to devote like a lot of time and I'll have lots of follow-up questions because I just think like you can go look at the Carvana price chart. You can listen to my two conversations with Ernie. Like there's lots of, there's lots of stuff out there about Carvana, but the thing that I find interesting is the investor's perspective as the person that probably had the biggest position held onto it, bought more, has been with it the longest. You sort of had the most holistic perspective on it.

41:10And I want everyone to benefit from what it's like to own and live through one of those episodes. Sure. And part of the reason I actually, that almost all the reason I said, yes, more than all the reason I said, yes, to coming on is that it is it has been such a wild episode in business history. And I sort of worried that if I didn't try to memorialize it to some extent, that it would get forgotten. And it is such a great it is such an interesting story. I think it deserves to be memorialized. I also think it's sort of wildly misunderstood in terms of what happened to Carvana in 2022 and 2023 and beyond.

41:49So, yeah, I guess maybe a place to start just to level set for people who don't know it so well. Carvana is an online retailer of used cars. It was founded in 2013 by Ernie Garcia, who you've had on. And if you were to broadly describe the company's history from 2013 to 2021, it was up and to the right. The business grew every year. Its margins improved every year. And it grew really fast. It was doubling often every year. Slid a little bit, but that was kind of roughly the pace. You know, if you'd spoken to me in 2021, I roughly would have expected a continuation of that trend. And, of course, what happened was the business slowed.

42:35It lost tons of money. The stock went down 99%, which is more than – Pretty bad. It's pretty bad. And then, you know, to ruin the story, which I think most people – you know, it turns out that was all a mistake. Like, the company's fine. It's right back. It's a little behind where I sort of thought it would be, but it's actually more profitable and it's back on track and the stock's mostly recovered and all the rest. So that's kind of the broad arc. Especially now that we've laid the groundwork for how you sort of apply ways of thinking to understanding a new company. Sure. And so maybe even make it specific to you.

43:08Like, how did you encounter it? What were some of the models that, you know, felt relevant to you as you tried to learn about the business and use that as a way to introduce, like, how the business works? I first encountered Carvana in 2018. and they used to have a video up on their site, they might still, that kind of describes the business. It was a pre-IPO video, one of these things you put up or whatever. And I remember sort of watching that video, basically realizing this is an amazing business that's going to do great. And it's incredibly underpriced. And I'm going to own a lot of this, provided like everything they just said is true.

43:43But obviously that's not how reality works in the sense that the reason why I felt like that was years and years and years of context. And so to go further back over the prior years for, you know, like when you're in my business, you're waiting for your stocks to go up. In the meantime, you're sort of looking at other things. And so I had spent time studying CarMax and I had spent time studying car dealerships. So I was sort of reasonably fluent in kind of how the auto retailing business works. I'd also been involved in the auto lending business. I'd been involved in credit acceptance, which is a one on auto lender.

44:18I'd also, you know, looked obviously who hasn't like studied Amazon and like read the everything store. I'd also studied logistics companies. And I'd also looked at, you know, manufacturing companies and all the rest and software companies. And so it turns out that Carvana is like all of these things. As they were explaining the business, it was clear to me that the economic advantages that allow someone to build a successful distribution company or a successful retailer or a successful lender, all of them have economies of scale, skill, and trust. And what Carvana was building was going to involve all of the advantages from all of these different businesses that they're effectively in at the same time.

45:05And this is called economies of scope. And by being great at all of these things, it could produce this very big moat. what I didn't believe necessarily until I saw that video was that anyone would buy a car on the internet because that was just common wisdom. And at the time, this is, you know, this was a while ago. This is before it was obvious, but they just had some cohort curves. And I was like, well, people clearly love this. And so at that point, like it was kind of like love at first sight. Maybe to sort of explain a bit about the business and why I think it's so, So the things I identified turned into the tremendous advantages it has today and are kind of the most.

45:48So let me just spend a few minutes. So at the core, the way the Carvana system works, it will follow a car. Carvana buy cars mostly from the public. You take a picture of your license plate and you enter a few things and it's like four questions and they'll give you a price. You can exercise it or not. You have seven days. Once you do that, you can arrange to have someone pick up the car for a small fee or Or you can drop it off at one of their hubs and, you know, get your money. And the transaction takes no time. Everyone gives them five stars. Doing that's hard, right? Like what I just said, it sounds so simple.

46:19But actually being able to take a license plate to map it to a VIN, to map all the features of the car's VIN, to then be able to figure out, like, what you think you're going to be able to sell that car for, how much it's going to cost to ship it, how much it's going to cost to recondition it, and be able to work out from all that. Therefore, what you think you're going to be able to make on the car and then to figure out what you want to offer in order to maximize the profits from this lead and to do it all for every car on the road all the time across the country. It's wild. Then Carvana owns a real estate footprint.

46:56That real estate footprint consists of larger inspection reconditioning centers. These are, I think, very big facilities that can recondition up to 40 ,000 cars a year with 6 ,000, 7 ,000, 8 ,000 cars in the parking lot, which is a lot of cars. Then there's local points of presence that they call hubs. And those hubs would be, you know, there's one in Fairfield, Connecticut. Small facilities that originally were sort of purely non-consumer facing. Now they've modified them to be somewhat consumer facing, but they're, you know, they're not very big. And so the car's at the hub. The hub is connected to the IRC.

47:34Let's say you have the car picked up. One of their nifty little single haulers will come out. They'll pick the car up. They'll bring it back to the hub. From there, that hub is connected to the IRC via logistics on a nine-car hauler. Those IRCs are then connected to each other via logistics on nine-car haulers. And what that does is it's built a hub and spoke logistic system. It's like FedEx or something. The sort of insight there, which Ernie had, was if you wanted – historically, if you wanted to ship cars, it was very slow and expensive. And the reason is that sort of the amount of car shipping happening between Fairfield, Connecticut and, you know, Alabama and someplace in Alabama.

48:18Mobile. Mobile, Alabama. It's just no volume. And so the car, your point-to-point system doesn't work. So what they've done in their hub-and-spoke system is they've collapsed down all this volume onto relatively narrow routes. Most of the shipping is happening between IRCs. There's a relatively small number of them, and they're sort of sparsely connected. And what that allows them to do is to move trucks continuously back and forth, loaded with cars between these IRCs. And you can think about them as almost train tracks where the vehicles can move continuously between these spots. And what that does is, you know, if a truck travels, you know, 40 miles an hour on average and, you know, costs like, you know,$3 a mile to travel, then you can work out what the cost on a nine car hauler, how fast cars can travel and what the cost is.

49:02And it's actually not that high. And so, but running a hub and spoke logistic network like this, one, it's hard, right? Like logistic, like building a logistic system requires a lot of density, requires a lot of scale. There's also a lot of technology to it, recruiting drivers, you know, there's a lot. Um, but that's the next piece of the system with that, the car will come to an IRC and at that IRC, it'll get reconditioned and reconditioning a car in an IRC is a challenging thing. Which dents do you repair? How do you repair it? Um, and you can think about a reconditioning center as a bunch of different stations that do a bunch of different work.

49:40That's relatively homogenous. So changing tires, changing oil, inspecting, um, paintless dent repair, painting, whatever the thing may be. A car starts out with a mix of work that has to be done to it. That has to be ascertained in an inspection. And then the car is going to be routed through the IRC to different stations and then come out and be imaged and put on the website. Some time later, it sells. They take the car, nine-car hauler to the hub. Now, you'll see this is beautifully balanced. The cars are coming back from the hub. They're also going out to the hub. Sure. Right? So the car will go from the IRC it's at to the IRC closest to the customer along basically the rails.

50:17and then it will go from the IRC to the hub. And then from the hub, it'll be delivered on the single car hauler or picked up by the consumer. That's the physical system. There's also finance. If you go on their site and you enter information, instead of searching by price, you can search every car by payment. So you can adjust the number of the months, your down payment, and you can see each payment for each car to the penny based on your individual credit score. And this isn't an estimate. this is exactly what it is. In order to do this, Carvana has a fully vertically integrated financing stack.

50:54So they're essentially underwriting you for every loan combination for every car in real time. And then they're taking that and they're making it available to you through this cool widget. To this day, as far as I'm aware, no one's replicated this capability. In order to do it, you need to be vertically integrated into prime lending, subprime lending, it just turns out that like no one else is. And it's also very hard to get into, you know, to do these businesses as well. There's title and registration. Obviously, you've got customer service. The thing about this business, you have to remember that like, this is all great, but things go wrong.

51:28Then you have to deal with like all the many, many corner cases that can come up. If you want to entertain yourself, like go read the one-star reviews at Carvana. It's like, well, I was moving and I ordered the car when I lived in Florida, but I needed it delivered to North Carolina. And, you know, then like there was a hurricane. and as a consequence it was late but then like there was a problem with a title and you're like and it's like oh my god that's kind of the how the system works now in in that whole system like let's identify some economies of like scale inventory turns out selection matters matters a lot and there's if you think about all the makes models trims years of cars uh as well as mileage like the selection space is massive and carvana's coverage even at its size is is still relatively small.

52:12And so as a consequence, conversions go up as selection goes up. And so selection is like big economy scale. Everything's dark. Yeah. Logistics. The cost of running a logistics system, you know, you can think about moving these trucks like a fixed cost. And if you want to provide complete connectivity and move cars quickly, it turns out conversion speeds matter a lot. And by the way, when you think about the inventory space, inventory near to customers increases conversion because you can get to them faster. Then you can think about these IRCs. These These are very large facilities. It turns out that run well, you can recondition cars for a lot less money and time because cars are depreciating assets if you have like a big facility.

52:52So like if I have a traditional dealership, the car comes in and like one guy does all the one guy or gal does all the repairs. But the problem is that person isn't necessarily the right level of like they're overqualified for a lot of the things they're going to do on the car. And they have to change tasks. And that slows you down. If you're at Carvana, you can have people who are very entry level to do the cleaning and the oil changes and the tire changes. And you can have advanced mechanics do just like a very narrow subset of stuff. And you can have people at like specialized stations where like this is what they're doing.

53:26And so they can be more efficient. Now, to do that, you have to efficiently route the cars through the system and all the rest. Also, the dealership is in like an expensive place. And so you have less overhead. So like these are just examples of places. But there's economies of scale to doing that as well as enormous like process power, like economies of skill. Underwriting loans is, you know, obviously a, you know, an endeavor where you learn the way to do this over time. You connect all these data sources. You learn how to predict defaults. You then get data over years that cycles back into it.

53:56Title registration, like there's software that's built to run all this. So this is like there's enormous economies of scale and skill in terms of like being able to do all these things. And then I would be really remiss if I didn't mention trust. Consumers, when they buy a car, it's an active – a sight unseen in the air, it's an active trust. We can talk about how Carvana grows, and it was one of the things that kind of went wrong in 2022. But, like, getting – Carvana is able to get people to buy cars because there's been an enormous amount of word of mouth built up over many years of delivering great experiences.

54:31And, you know, you can't buy that. You have to build it up over time. And that's trust on the buying side. There's also trust on the selling side, although less. There's also trust in the financing business, right? You make these loans, then you sell them. And the people who buy these loans have to trust that you're making these loans to spec and that the loans are going to perform kind of as advertised. You're a great originator, yeah. Subject to economic conditions. The other thing about this business is if you think about a car transaction, it's a whole series of things that have to go right.

54:57And if you get any one of them wrong, you're going to lose money on the transaction and your customers are going to be miserable. And this is economies of scope, right? So this is the idea that you have to put this whole portfolio of things together, and you have to get them all right. And you have to get them all right every time. And, you know, this is – it's this combination of things. And if anything I've said sounds easy, it's because I haven't described it right. Like, it's so hard. And so that's why everyone who's tried to build this business besides Carvana has failed. And that's why it's taken Carvana, you know, over 10 years and$10 billion to get, you know, where it is.

55:30And, you know, outside the U, outside the U S there were other people trying to copy Carvana in other markets and, you know, some of them are doing okay. A lot of them have failed, but none of them are doing really great. And just the bottom line is that it is so hard. Just to pause on the, on just like the concept of combining skill, scope, trust, you know, traditional economies of scale of different types. Is there another business that comes to mind? maybe it's Amazon, that you think captures all these same things that has interested you through time, just to like draw a comparative point for people.

56:04I actually love the comparison Amazon, but you know, there's a famous, there's a video I saw once I'm famous, but I love it where Jeff Bezos is describing why books is the first best placed for an internet business. And he talks about how the selection matters so much. And then he talks about how you can get the books and you can ship the books and, and, um, you know, um, and you can pay for the books. Well, imagine if, I actually think that from a consumer's perspective, used cars is just as great as books. The selection space is infinite. Selection matters an enormous amount. Also, what I described with Carvana's system is a lower cost operate system than the traditional dealership system.

56:39It's a better experience. But the thing about books is it's really easy to do. Imagine if you had to start Amazon, but you couldn't just call the manufacturer and get books, you had to manufacture them. And imagine if, you know, you couldn't just call FedEx and have them ship the books. You had to build basically FedEx. And imagine if you couldn't just like accept MasterCard, right? You had to build a financing platform. And Lord knows you can't just sell the person the book. You have to do title and registration, right? And all that. And, you know, with books, the stakes really just aren't that high.

57:19And so people are willing to try it. And if it doesn't go so well, you know, they're disappointed, but it's okay. Car is second largest purchase of your life. And so you can imagine how like that is also really challenging. And so in the sort of fulfillment sense of it, I think, you know, used vehicles are probably the hardest thing to build in. But the analogy to Amazon, actually, I think is apt. I've interviewed Ernie a few times. My bias is that I think very highly of Ernie and he's a much maligned figure because of everything that's going on with Carvana. And it's so fascinating to me to hear all the different Rashomon style parts of the story.

58:02So I'll put out there that I think very highly of Ernie based on what I've known. I haven't studied the business like you at all. I don't own Carvana. I don't have a dog in this hunt financially, but I think it's important to say a little bit about management. And maybe it's also an excuse since I haven't asked you yet to talk about how you think about management as it relates to certain businesses and where you fall on the spectrum of like leadership is everything to like the Buffett ham sandwich, you know, concept of a business that's so good that a ham sandwich could run it because someday someone will or one will.

58:32So talk about Ernie, the management team behind the team behind Carvana and kind of your philosophy on management and investing. If you'd asked me five years ago, I would have put myself firmly in the let's focus on the business, I don't think I bring much advantage to understanding management. It's been an exciting five years. And in that time, one of the things that's come out is the businesses where if you'd ask me, okay, Cliff, I get it, you don't care, but like rank them anyway. And I'd ranked them, the teams that I was involved with, I would like my that ranking would have perfectly predicted how, how like things did relative to my expectations at the time.

59:09So what I learned there was two things. One matters. I knew it mattered. But more importantly, I think I can judge it. And so now I fall into the, obviously I care predominantly about the business and the price. Like that is in the end, the right thing. A great team with a terrible business is going to be a channel. It's going to be a slog. There's just no two ways about it. By the way, just go back to your contained versus uncontained point. Like that's another idea is like there are businesses where there's a new problem to solve every six to 12 months and it throws up a never ending series of hard problems.

59:40You know, so you want businesses, so a contained one would be one where like once it's, set it and forget it's the wrong term, but there's like an obvious, like, would you like to sell more cars? Yes. Yes, I'd like to. Okay. So now going back to management. So I don't necessarily think I'm going to ever get to a point where I'm like, this team is great. I don't care that this is a business that will throw up, perpetually throw up hard problems. I'll buy it anyway. But I do think that I've now come to understand that like, that I can judge it and that management matters a lot. So it gets weighted into my thinking in a way it wasn't before.

1:00:13And for what it's worth, I'll add to you how I judge it. Meeting with a management team is great. It turns out all the people who become CEOs figured out how to sound great. You know, I learn a little bit, but I certainly listen to them talk in public. And you can definitely pick up over time who kind of is making what seem like sound business judgments and giving good reasons for them and people who, you know, aren't. That being said, the really good way to do it, I find, is I talk to former employees. And I'm certainly interested. I'm using that to learn about the company, learn about how it works, how do you buy things, how do you sell things, blah, blah, blah.

1:00:46But I'm also just assessing them. And, you know, a company which spits off people who worked there for 10 years, left on good terms, who you're just like, I don't get it. Like, this guy's an idiot. That says something about, you know, the caliber of people in the organization. And the human capital exhaust is kind of indicative of what's inside. and conversely when you find yourself go talk to 10 former employees who spent at least 5 years at Capital One they'll blow your mind that tells you something about what's going on in Capital One and so I find that that's really the best approach as to earning I think you know at the risk of inflating his ego I think that someday people will compare Jeff Bezos to Ernie Garcia, not the other way around.

1:01:41He's extraordinary, right? This business is incredibly difficult, as I've tried to emphasize so many times. There's a reason why they've succeeded where, you know, nobody else in the world has been able to, you know, succeed. And I'll also add that, like, I'm aware, obviously, of his dad's history, you know, with the savings and loan crisis. And, you know, this is, you know, I think it was either a$20 or$50 fine that he paid as like a late 20 something. And this is, by the way, his dad, not him. And, you know, this is 50 years ago or 40 years ago. It's just, you know, it is wild to me that people then take...

1:02:26What is that? Yeah, people take that fact. They're like, therefore, this company, you know, is a fraud. And it's like, oh, my God, like this is the, you know, the guy was a billionaire. What was his plan to like make a few billion more but send everyone he loves to prison? Like this makes no sense to me. If you just spend any time dealing with talking to people who've dealt with the Garcias over the 35 years that, you know, since the, you know, guy, you know, made a mistake, which, you know, if you actually go through the details of it, it's not obvious he did anything super wrong. But like whatever, he got caught up in stuff.

1:02:59Everyone speaks incredibly highly of them. They've done nothing but behave totally ethically. If you go through the experience that the company had in 2022 or whatever, there were plenty of opportunities for them to hurt us as third-party shareholders, and they haven't. So, I mean, Ernie does a great job of just tuning all that nonsense out. As to what he does well, he's incredibly smart. He's assembled a team around him that are incredibly smart. And he does a great job of thinking about things. in a variety of perspectives that are very wise. So on the one hand, he'll analytically explain to you how, as an outside investor, you could look at CarMax and try to make a sensible guess at what Carvana sees as its price elasticity demand, which is a fairly analytical thing.

1:03:44And then, you know, if we were to ask him a question about, you know, once upon a time, I sort of said, why don't you adjust your pricing to kind of like compete more aggressively with Vroom? and he basically sort of described how if he made competing with Vroom something that mattered, then suddenly instead of focusing on the customer, everyone in the organization would be sort of, when Vroom wins, we lose. When Vroom loses, we win. We're not focused on the customer anymore. And he was thinking about the second and third order, like social effects on his culture. And he's very deliberate about things like that.

1:04:13All right. Now we get to talk about the tough part of the whole story and experience. What went wrong with the business? Just tell us the whole story. Like what it was like to be one of the larger investors in the business as this was going wrong? What did you do? How did you second guess yourself? What was the psychology like? I'm interested in all aspects of it. It's worth pointing out where the company is today because through most of the company's history, it was obvious that Carvana could grow. Margins, however, were improving, but there was always debate around the economics of the business.

1:04:44And I said earlier that this is a more efficient system. And for a long time, that was a matter of conjecture. I could sort of work out unit economics and how much does it cost to ship a car a mile and blah, blah, blah. But like it didn't, you know, we couldn't see it like on the press release. As of now, the company's margins, EBITDA margins, and they have very little stock-based comp and relatively little capex, are 10.5%, you know, percentage and rising. And they'll probably get to the 13, 14-ish percent range based on what they've said. And there's no reason to doubt it.

1:05:24And the average car dealership is about four and a half. So they make of the order of two and a half, three acts, the margins of their competitors. And we track every car that they sell and we compare it to similar cars sold by CarMax. We also compare it to other market indices. And we believe that they sell cars of the order of sort of$500,$600 cheaper doing that. Now, in fairness, they charge a bit more on financing, but it's still cheaper overall. And they offer, obviously, a far superior experience, far superior selection. And they're growing. There's high-frequency data that's published. And so recently, they've been sort of growing 45 % to 50 % year over year.

1:06:10And so the idea that they're putting all of these things together, at this point, you no longer need to speculate about the power of the model. It's also a model that gets better as it gets bigger, right? So as time goes on, the selection gets better. And so I should make a note here. A traditional car dealership is a monolithic unit, a certain number of cars. Even if you think about like CarGurus, it's a certain number of dealerships in your area that collectively have some number of cars. Carvana's pooled national inventory is like there are more cars available on Carvana's website right now than there are for us right now sitting here in the entire state of Connecticut from all the other dealerships.

1:06:45Right. Right. And that's only going to improve brand. Also, process efficiency. They still have a long ways to go in terms of fixed cost leverage is a long ways to go. So this is a business that gets better as it gets bigger. And it's already so much better than its rivals. And its rivals, of course, it's very challenging. to meaningfully update the processes in a car dealership. It's just not a very skilled organization. How much technology can they really bring to pair? All the rest. I thought I'd just finish that story. The company grows. The company had enormous amounts of demand in 2021. Just put a car on the site, car disappeared.

1:07:22And they were trying to overcome the challenges of the pandemic, to build supply, to grow tremendously into 2022. They sold something on the order of 425 ,000 cars in 2021. they had ambitions of doubling or more in 2022. To do that over the course of all 21, they were hiring and hiring. As it would work out, demand collapsed. And they discovered all manner of operational problems that they were having. And it made 2022 really challenging. When you tell a story like this, you have the benefit of everything you learned during the whole period and everything you learned after and all the time to synthesize it and sit calmly later on and figure it all out.

1:08:04All of this happened in a cloud of dust with incomplete data. So it's all going to sound so neat and put together and understood. And there were definitely pieces of this that I had nailed, and there were pieces of it that I learned later. But I just want to, you know, this was real life. What happened was, at least my understanding of it now, was a few things. One is they had a bunch of latent operational issues we can walk through. Another was that there was just a very unusual used vehicle market, which led to the used vehicle market being significantly smaller than normal. in 22, and it still hasn't fully recovered.

1:08:35It's only partially recovered. In particular, it was bad for independence. And we'll talk about that. Another was the vehicle financing market did totally strange things, which made life absolutely miserable for them. And then, of course, because things had to be the way they were, they bought Odessa, they added a bunch of debt, the capital markets were close to them, all the rest, which is another set of external facts. So let's just in terms of, let's just do internal operational stuff. It's interesting. The company had been growing year after year, circa 100%. And when you're doing something as complicated as what Carvana is doing and growing as fast as Carvana is growing, things were always going wrong.

1:09:13And I would always hear kind of some horror story or another out of some part of the organization. But, you know, you looked at the overall star ratings. They had great reviews. It was like, well, you know, it's a big organization. They're growing really fast. Think about it. Like if you're doubling every year, less than half of your employees on average have been with you for like less than a year. Right? This is wild. They also had deliberately prioritized speed and growth over necessarily slowing down and like really hardening their processes. And the reason for this was that they viewed, you know, this is a scale business.

1:09:42And there was risk that if they weren't first to scale, that they would be disadvantaged over time. And at the time, their competitors hadn't failed yet. They grew a lot of their operations were more mediated by like I'd call it tribal knowledge and culture. And so silly example, but a real one. There's a role at the IRC, Inspection and Reconditioning Center, for receiving trucks, taking the cars off the trucks, putting different cars on the trucks, and sending the trucks on their merry way. This sounds simple enough, but it's a lot of trucks. It's a lot of cars. And there's this question of where do you put the cars and what order do you put them on the trucks in?

1:10:20And by the way, if one of them doesn't start, what do you do? And how do you staff this operation? because it turns out fetching a car in a 6 ,000-car parking lot is like – it's not like walking down the street and getting a car, right? And all of these things. And if someone's done it well and sort of smart, they can kind of figure it out and they can do a pretty decent job. But as you scale, you're putting people into roles who may not be as good at this. And in 2021, in retrospect, for the first time, the business kind of, in part because of COVID, in part because of the growth, the businesses kind of reach, outstripped its grasp from a process maturity perspective.

1:11:02Now, in 2022, there's a software system. And the software system tells you, like, this is how many people you need at these times of the day. And this is where you're going to put the cars. And here's your protocols. You're going to have a starter, like a jumper. You're going to keep it here, right? And this is how you do this. And it turns out that this set of protocols locally and globally optimizes better than even the best people. But also makes sure that everybody, so it takes the best people, makes them better, and then takes everyone else and makes them almost as good as the best. That software had never been written.

1:11:34Because this was just not a function that someone had ever bought. Because think about how, in and of itself, what I just described is a fairly meaningful project. Before 2018, before 2019, I should say, the company bought almost all of its cars at auction. So the flow of cars was auction to IRC to customers. Starting in 2019, the company began buying cars in the public. And this has been a wildly successful thing. They make a lot more money doing this. But it turns out that when you do that, you create the potential that if you buy more cars than your – if you have a node in your system, an IRC, it's possible, unless you've thought about this, for cars to accumulate at a node.

1:12:09You can be buying more cars than are leaving that system or more cars can be transiting in than are leaving. And if you have finite amounts of parking, this can create congestion. And what had happened, what interestingly would happen for the first time in 2021 or so was the buying cars process became really successful. And they were buying more cars for the first time. And so now suddenly they had this shift in the logistic system, sort of flip the direction of net flow. This is fine. You just need to build a bunch of things to change it. But this is an example of the sort of thing that was happening all at the same time.

1:12:43A lot of this was covered up in 21 because they were hiring to beat the band. And so when you have excess staffing, it kind of covers up a lot of blemishes. As you get into the end of 21, the first indication that something was wrong was, you know, slightly weak November. And then Omicron happened. Their whole system became a disaster. And the reason is that if you think about a car as like a series of events that have to happen one after the other. Let's say you have a truck and the truck goes out to 250 miles, switches with the driver and comes back. Well, if that driver calls in sick, like how does that truck route continue?

1:13:16Okay, so now you have nine cars that just got stranded somewhere, right? How do you get those cars moving again? And now this happens all the time. But like if this happens a lot, you overwhelm your ability to clear these things. And now you have cars piling up in basically giant traffic jams throughout their whole system. And then your delivery times that you're promising on your website have to get way extended because you just can't. So your sales come way down. which if you haven't had a system before where you could accidentally buy more cars and you're selling because that's never come up now suddenly you have a problem where like you're buying cars you're accumulating the system you know and you don't have your flows through your logistic system haven't been optimized for this so the cars are piling up everywhere you're sort of shuttle you're shuttling cars this is what the system looked like in you know january of 2022 it was total wreck.

1:14:05And they were trying to fix it. And, you know, it took them a few months to do it. It took them three, six months or whatever to fix this. But the important fact is that it obscured demand, which was falling off a cliff. Underlying demand was falling off a cliff. And it meant that they were still behaving in February like demand was as it had been in September, even though by that point in retrospect, demand had materially declined. They bought Odessa using tech. Odessa was, just describe what Odessa was. Sure. So Odessa is a traditional auction business. So think a large lot, people bring car dealerships, fleets, they bring cars, and they hold in-person auctions.

1:14:56You drive them down a lane, people bid. The in-person auction business will have a long tail to it, but it's eventually a decaying business over time. But what they got with Edessa is 54, I believe, very large, centrally located properties on which they can build IRCs and store facilities. One of the challenges in their business had been that it turns out they worked out that it is better for them to have large IRCs located relatively close to the customer because fast delivery speeds are good. Access to labor pools is good. And those are more important than kind of the benefits of being far away.

1:15:31But it turns out that building, getting 200 acres, you know, like zoned for, you know, auto industrial in like, you know, within 10 miles of downtown Boston is difficult to say the least. It turns out this is the sort of property that Odessa had. And so they basically was, they bought it for the commercial real estate. It came with the auction business, which has a lot of benefits to them as well.

1:15:56and makes all the sense in the world. In retrospect, it's been a huge home run. But they bought it with all debt. They bought it in February of 22. After, if you read the proxy or whatever, they've been talking for years. It just happened. The timing was bad. So what happens is you get to March and they sort of realize that they have a demand problem. And I haven't really addressed what was going on that caused the demand problem. So there were, as far as I, My best understanding is there were three things. Although at the time, I pretty much only sort of knew about two of them. And it's worth pointing out that all of these things, they kind of got worse and worse and worse and worse and worse over time.

1:16:33So you thought you'd identified it. And then like six months later, it was like worse. So the first, there were chip shortages during 2020 and 21, which caused manufacturing shortages and caused used car prices to rise. You think about the used car business as facilitating people swapping cars. But what happens oftentimes when people are swapping cars is their upgrade. And so if prices are higher, the cost of upgrading is greater. And that tends to reduce people's propensity to swap cars. As a consequence of that, the used car industry, which is typically about 40 to 42 million cars a year, it was about 39 and change in 2021, fell to about 36 million cars or 34 million cars.

1:17:13I think it got as low as 34 annualized and did 36 for the year or something like that. I met in my stats totally off. But it fell. And this doesn't seem like a huge negative effect, but it was bigger than you might realize because what happened was franchise dealerships, I think you're Ford or Toyota dealership, when a lease vehicle is returned, unless the customer exercises their buyout, the landing dealership, the one you return it to, gets the car at a price that's been set at the time the lease was created. And so when car prices rise, if the lease returning person, of course, dealership has no incentive to tell them that they have the right to buy the car, doesn't know this, which many people haven't read the footprint of their leases, and they return the car, the dealership gets basically a really cheap car.

1:17:58What this turns into is a big subsidy for franchise dealerships. And those dealerships would then turn around and sell this car. It would look to them like a big profit, but it was actually really cheap relative to wholesale prices. But what that's doing is putting enormous pressure on non-franchise dealerships who don't have access to the super cheap inventory. Oh, by the way, that's us. We're a non-franchise dealership. And so the best example to understand the magnitude of this is CarMax. So if CarMax in the Great Recession, CarMax briefly saw nearly a 20 % decline in comp store sales for like a few months.

1:18:33And then it was sort of down like back up to like low double digits. CarMax's comp store sales were down 20 % for the whole year in 2022. And they, by the way, like still haven't recovered. I think they've sort of clawed half that back. The reason was in part because cars are more expensive and interest rates also made cars more expensive. And the other thing was this weird effect where franchise dealerships were being unusually competitive because they had access to this unusual source of cheap supply. So as a starting point, you had the biggest decline since the Great Recession, including the Great Recession, bigger than the Great Recession, in the number of used transactions at an independent dealership, which is a rough place to start.

1:19:13To make matters worse, so that was the used vehicle market. Carvana was facing that. The second thing that happened, when interest rates rose, the sort of naive thing you would think, which is certainly what I thought, was it wouldn't matter all that much to Carvana. Right? Okay, so interest rates will rise. That could affect the overall market a little bit. It will probably affect car prices a bit, sort of the depreciation curve of a car. But in the end, people's propensity to sort of swap cars shouldn't change that much. And yes, DeCarvana's financing business, you know, they just finance spread off of rates.

1:19:43So whether rates are, you know, one or four sort of shouldn't really matter that much. And that's totally correct. And that's exactly where we got to. But there was a hitch.

1:19:55You see what I didn't know?

1:19:59This is where the 99 % part comes from. You see what I didn't know? was that when rates would go up, so the auto finance markets made up of a bunch of credit unions and small banks and then a bunch of larger banks who compete and then independents like Carvana who compete. The credit unions price their loans, I mean, it depends on the credit union, but like off of deposit rates or off of Fed funds or off of a napkin. The two-year went up and Fed funds were low and deposit rates were low. And the credit unions, and when I say the two-year, it's worth pointing out, the average duration of a pool of auto loans, including prepayments and defaults, is about two years.

1:20:39So the two years are reasonable proxy for the appropriate kind of risk-free benchmark. So in late 21, as the two-year goes racing up, as people expect Fed funds to rise, all these competitors just didn't raise rates because they didn't. There's no academic reason why they shouldn't have. They just sort of didn't. And then even as Fed funds began to rise, they were super slow. And, you know, I remember there was a long period of time where like Navy Federal was offering car loans at a discount to the Treasury of the comparable duration. And this is a big problem for us. This is funny, except for the fact that we have to compete with this every day.

1:21:20Industry-wide, auto loan spreads by late 2022 were at the lowest levels in the whole time series I have, going back to before the crisis, before the financial crisis in 2008. And it was a wild time for that to be the case because every other consumer credit spread was wide for a whole bunch of really good reasons. And the underlying auto collateral was the most kind of overpriced it would ever be. So auto loans should have been really expensive on a spread basis, but instead they were at their all-time tights. And the reason was that there was just all these dumb competitors. And then you'd call these, we did research into what was going on, And, you know, be like, well, our asset liability management committee meets like once a quarter.

1:22:03And then we try not to raise rates more than like 25 bips at a time. And you just like all. And then it takes us 60 days to implement the rate changes because our systems, blah, blah, blah. And you're just like, but guys, like. It's kind of like when oil goes negative. Like this is not supposed to happen. Right. This is definitely not in the textbook. But so the problem. So CarMax, they just ate it. They just originated at low spreads. and then the next year, and even to somewhat, it's getting better now. But if you look at their financials, you can see they paid for it a year or two later, but they ate it at the time.

1:22:34They sacrificed it to the future for the present. Carvana was not in that position, right? Like we, you know, the company needed the money. So Carvana had to price to reality. And that meant that Carvana was in the market with loans that were like meaningfully more expensive than competitors, which did not help. And to just put this in context, Capital One also priced to reality because they're smart, they saw their auto originations fall 50, 5-0 percent. So Carvana is dealing with both of those things. The other thing, which I think is more subtle, but I also think is true, has to do with early adopters.

1:23:09And to explain this, I need to go back and explain a little about how Carvana grows. And this is one of these, this is the part that I was least aware of at the time, but I've done more work on and I've come to understand a lot better. Carvana, you know, if you think about a market like Connecticut, Carvana has, I don't know exactly how big Connecticut's, you know, fleet total used vehicle inventory is. But let's say that Carvana has something like three quarters of all the inventory, including Carvana's inventory in the state of Connecticut, just to make up a number. One might ask why we don't have like three quarters of the sales.

1:23:41Because they probably have, I don't know, Connecticut sales have in my head with like 100%, something like that. And so, you know, the first thing you might do is throw out, okay, well, there's some cars they have there in California. There's shipping fees. There's delays. Like, let's only look at cars that are nearby. And so you cut that inventory down. And then you might say, well, let's throw out people who haven't heard of Carvana. It turns out they have like 80 % awareness, but we'll throw out some people. Okay, let's reduce. Half of people say they don't want to buy a car online right now, although the number is gradually falling.

1:24:06But like, let's throw out, you know, that half. You're still left with a number that's way higher than where they are. So like, where are the sales? And also weird is, okay, you go into a market, you have all this huge inventory, this great product. Why does it take all, you know, why do sales kind of ramp like this as opposed to just like step function? Like what is delaying people adopting this? I didn't have a great answer for that for a long time, but I kind of thought it was word of mouth. I was kind of like, you know, I think it just takes time, word of mouth. And my evidence for that was that if you surveyed people who bought from Carvon Mass and if they recommended it to people, I think it's something like four, they would recommend it to four people on average, which is an enormous number.

1:24:44Yeah, a viral thing. Yeah. And so that's where I'd left it. But as, you know, in the sort of wreckage of trying to figure all this stuff out, you know, I started thinking harder about this. And it occurred to me that I'd never done two things which seem obvious in retrospect. One was I'd never asked people how important this word of mouth was to their decision to buy from Carvana. So we added to the survey something to the effect of, you know, like, did you get a recommendation from a friend or family member? How important was it? And we found that 70 % of people said that it was either somewhat or very important in their choice to buy from Carvana.

1:25:19Therefore, only a third of people were buying from Carvana without the recommendation of a friend or family member. And, you know, once I saw that, that got me thinking, like, I wonder what's going on with this third of people, you know, who are buying without the recommendation. So that convinced me there's a virality, right? Like, you know, but what's going on with these people who are buying without the recommendation of a friend or family member? And my theory was, well, they're early adopters. So we survey people who bought from Carvana. We ask them questions like, do you have a Robinhood account?

1:25:46Have you ever owned like Bitcoin? You know, do you do online grocery shopping? And the answer is like, of course I do all these things. Like, you know, oh, yes, yes, yes. Way higher than non-Carvana buyers. So now I can say, look, many people won't do it unless someone says, okay, some people will just give it a plunge, right? And in general, the more early adopter-ish you are, the less nudging you need from relations to do it. And that's what drives the growth curve. It also gets us back to 2022. You see, back in 21, let's say that you were the sort of person who had a Robinhood account. And you might have speculated in some SPACs and some cryptocurrencies.

1:26:21You might have had a windfall. And you might have thought, you know, look, this isn't like billions of dollars. This is thousands of dollars, tens of thousands of dollars maybe. You might have thought that given your windfall, you were going to go buy a car. And you might have thought to yourself, since you're the sort of person who owns like SPACs and cryptocurrencies and shops online, obviously the place you were going to buy a car was Carvana. Now, you may or may not have actually bought that car at Carvana because Carvana was sold out and they might not have got what you wanted. You might have gone somewhere else.

1:26:49But here's the deal. You pulled your demand forward. So from Carvana's perspective, even if this is like Carvana in 2021 had like 1 % share. So even at this 0.3 % of the market, this does not have to be a lot of the market for Carvana to feel this enormous demand pull, which they definitely saw. And it also means that you roll forward a year and all these people are in the exact opposite position. They've just had the opposite of a windfall, whatever you call that, sort of unexpected loss. Decimation. Yes. And the year before, they all just bought a car. So it turns out, from Carvana's perspective, although none of us sort of realized it at the time, this isn't great.

1:27:26So I think that was the third contributor that was unique to Carvana. So you have these three. You've got the overall market is down more than the Great Recession. You've got the tightest auto credit spreads ever. And you can't match. And you have this unique thing where you kind of all of your sort of bleeding edge customers bought last year. And you just bought this big asset with a bunch of debt. And you just bought this big asset with a bunch of debt. And it turns out that you're learning that like a bunch of your processes. Like eventually, I always sort of thought that Carvana would have bumps in the road operationally.

1:27:56But it turns out they're all now. And none of that was totally obvious at the time. There were bits and pieces. You're kind of learning as you go. The rate stuff was pretty clear. The market stuff was pretty clear. The stuff I described, but all this data comes at a lag. It was all in a cloud of uncertainty. And then you do what Carvana has to do, which is you start cutting. and this is a bit one of the things that's glorious about this business is that as it gets bigger it gets better and size begets size it's just a virtuous cycle but here's the thing when you cut that a lot because of all this like stuff um that all runs against you so you slash advertising you slash inventory and then out over external demand gets even worse and you've reduced things that drive down demand further.

1:28:52And they were like chasing a ball down a hill all year long. And, you know, Ernie told you the story on your podcast about kind of how they got better organizationally at being, at focusing on efficiency and how they kind of learned their way into it. And, you know, look, the reality is, is like the sort of 10 ,000 foot telling of the story was they were okay getting more efficient between March and November of 2022. And they got really amazing at it after November of 22. Took him six months to figure it out. That's fine. So I lived for those six months. It did not feel like I just described it.

1:29:30It felt like a very long time. And for context, it's by far your biggest position. Absolutely. By far, it's my biggest position. And it didn't help that nothing else I didn't seem to be doing well at the time either. And by the time you get to the fall of 22, demand just keeps going away. And they hadn't by that point caught up on costs to fix it. So everyone at this point, not everyone, but there was a narrative out there. Look, the problem is it doesn't work. The problem is they're trying to get the profitability, but they can't do it. If they keep cutting costs, they said, okay, in May, this operational plan is like, okay, so I'm going to re-underwrite everything.

1:30:08And it's like, I think they can do this. This makes sense to me. and they have a lot of liquidity to make this work. Fast forward six months, they've burned a lot of liquidity. They're way behind, right? And now at that point, you're like, well, if next year looks like this year, we're going to run out of money kind of in 13, 14 months. You'd ask, well, is that going to happen? You'd say, well, no, I don't think so. You know, like, I don't think so. I think they're going to fix it. I think the unit economics work. And by the way, this crazy thing with the credit markets is going to end at some point.

1:30:39And like, I'm sure Navy Federal isn't going to give away free money forever. And but then you say, yeah, but of course, I never thought Navy Federal would be giving away free money for like, you know, nine months. Like, I thought it was going to be like a few weeks, right, before they noticed that interest rates had changed. I never thought it'd taken this long, you know, that they'd have so much trouble chasing demand this far down. And so at that point, that was when it was the most challenging part of the of the investment, because at that point, like you did have to put on the table, like Ernie would say, look, we're we're cutting costs and we're burning cash.

1:31:10Um, and there's, you know, as our costs go down, like eventually we'll be profitable. But like, as to the pace of that versus the cash burn, like reasonable people could disagree as to whether like, we'll get there in time. Um, which is like, you know, super reassuring. Um, and then what happened was they got much faster at cutting costs. The banking system kind of discovered that interest rates had gone up. and that really helped and sometime instead of January, February of 23 instead of chasing demand it looked like they were restraining it and you can sort of see that because if you think about delivery lead times on the website as like a line you can sort of see how long the line is to get a car and you could see that the units were steady but the lines were longer if that makes any sense Yeah.

1:32:05And and and so and then rates, you know, fix themselves. And the industry is seen, you know, as car prices, manufacturing, car prices ground lower. And over time, you know, unit volumes have improved, you know, industry right a bit, although it's still pretty low. And they succeeded in cutting a lot of costs and, you know, and got to the place they are today, which is, you know, that everything worked. Oh, I forgot to mention, because everyone thinks the whole story is they got this deal with Apollo. Yeah. So basically, along the way, one of the levers they had to pull was putting their lenders in a prisoner's dilemma.

1:32:41So you have bondholders and you basically say, look, we might not pay any of you. But like the first person who accepts less gets paid first. And if your documents are written, you can do that the right way. written the right way you can do that. And they were. And so they ended up negotiating this new secured loan structure and people converted their debt into new debt, which is safer, higher priority at a discount. And that whole exchange happened in the summer of 23. And a lot of sort of the retelling of the stories. And by virtue of that exchange, they like saved the business. By that point, the data I was looking at said that everything was great.

1:33:19That was just kind of like, you know, the cherry on top because that saved them a ton of money in terms of interest, expense and debt. But it was not by any stretch the thing that turned the business. Can you talk about your investing decisions? Because during that period, like every day is kind of a decision, like not selling is a big decision as the information comes online. What did you do? Like, did you buy more? Were there constraints on how much you could buy? Would you have done anything differently in hindsight? like what were the frictions that obviously wouldn't bubble more than I stupid question there are stupid questions I would have sold all of it at the peak and bought all of it very stupid question I think you know what I mean like what were what were like the real walk us through like the psychology the barriers the like yeah you know so the real hard stuff I knew the issues they were having logistically in q1 like I could I could see it and when I say I could see it, like we look at a lot of data on the website.

1:34:17So I knew that Omicron was an issue. And so the disappointing surprise was that as Omicron kind of cleared up, you know, it was like I was waiting for like some units to come out of the system. I was like, why are they not selling any units? It was kind of clear there was a problem, but then the stock had thirded. And it went down the first sort of most of that thirding was because things were really bad during Omicron. But until you realize that there was a deep demand problem, that seemed like the sort of thing that happens in markets when you have a short-term operational hiccup. And it was only once demand didn't kind of recover that you're like, uh-oh, something's wrong.

1:34:52But by then, prices go down so much, you're kind of like, well. I didn't actually buy any the whole way down to there. And the reason was just, it was a big position, and I generally don't buy more of things that are over a certain amount of the fund. And I was sort of waiting. You know, it was kind of like, well, if it gets below that, I'll buy more. If it doesn't, it's fine. um and then i bought a bit more um after that but then i was something was off so i kind of didn't buy a lot and then they came out uh with this like operational plan and it did this issuance at 80 um and i thought okay like this this is this is they'll fix this this is it so i bought a bunch more and then the stock went all the way down to uh then the 20 uh and in that intervening period, I'd gone out to visit them again.

1:35:42And I'd gone through the whole operational plan with them and like tried to read, basically do a blank sheet of paper, like underwriting. And I convinced myself that this would work. No, Clifford, you weren't a moron. Yes, the stock was down 95%. But like, but like this was this was, you know, okay, and they'll be fine. And it's just, It's just, you know, they're going to sort it out. And so, but I realized at that point that there were more kind of deep operational fixes in the business than I'd realized. And so, my thinking at the time was like, they should be fine. I'll buy half now. And I'll buy half when I can see it turn.

1:36:25And in order to see it turn, what I'm going to do is we work with a third-party consulting firm that basically does analytics, like web scraping and database, go get credit card data and match it and blah, blah, blah. And so we're like, okay, we're going to just go. We're going to instrument the heck out of this in a way. We already were instrumenting it somewhat, but we're really going to turn our attention to focusing on instrumenting this. And we're going to focus on the things we think we're going to see first when we see the turn. And when we see the turn, you know, we're going to know and maybe we'll pay a little more, but we're going to get that's when we buy the second half of the stock.

1:37:00And that was May. So I bought the first half. And I think it's sort of in the mid 20s is where I ended up getting kind of most of it. And so I bought some at 80s, some in the mid 20s. And this is like 180 in the mid 20s. And then and then we start instrumenting and we start waiting. And like things just get worse and worse and worse. It's like every marginal data point was like worse. um i remember i uh you know things the week after thanksgiving sales always fall off on thanksgiving and then they always come back the week after it's always a little lower because of seasonality and it was like sales fell off during thanksgiving and then they like just didn't and it was just like what the heck

1:37:43um and like you know you're living this in real time right you're just like what the heck um and so i was really glad i hadn't bought the second half um but i was at this point we had things pretty well instrumented. And, you know, we had all this rate data, which I hadn't had in the beginning of this process. We had just a lot, like a lot of ways to capture how cars move. There's just a lot. So then, you know, the year ends, they put out this poison pill. And the poison pill basically said that anyone who owns over 5%, which was like me and like two other people, can't buy more stock. And they had very good reason to do this.

1:38:18The reason is they They had big NOLs. And there's IRS rules having to do a turnover. And if there'd be too much turnover amongst the 5 % holders, then they would have destroyed the value of those NOLs. Because the way they repriced it, if a certain amount of turnover happens, they repriced the NOLs based on your market cap. So the market cap was super low. And the NOLs could turn over. And there'd been a bunch of turnovers. So there was a risk they were going to cross some threshold. And so they put this poison pill in, which made all the sense in the world for them. But it was not particularly helpful for me.

1:38:46but you know to be honest my initial reaction was like well that's annoying but i wasn't planning to buy any right now anyway right um but then as fate would have it you know six weeks eight weeks later i'm looking at all of my data and like it's all green shoots and i'm like darn um that wasn't what i said it was different word um and um so i'm i tried to reach out to see if they could make an exception but of course you know they can't all that stuff so we ended up not being able to buy anymore. Now I should say when I made the decision to buy half now and half later, I promised myself that I wouldn't beat myself up.

1:39:20If I said, listen, Cliff, you will be a happy, successful person if you write about this, whether you buy this other half or not. So it's all good. And so I'm still telling myself that. Uh, so say a little bit about the, the range of psychology and maybe like how close you got to thinking, you know, just really deeply questioning yourself. Like you're one of these investors that typically knows when I've talked to you about companies, you've known more about the company than anyone else I've talked to about that same company. And that's always been the case with Carvana. I think that was true prior to the 99 decline.

1:40:00It's probably true today. But even despite that, even though you knew so much, it's sort of like the Navy Federal Credit Union X Factor thing. Like, how are you wired? Like, how distraught did you get? I'll talk about how it was super miserable. And, like, it's pretty easy to imagine how it was super miserable. But it is worth just making a point. Like, we were not fighting the Japanese in the Pacific. Like, it sucked, you know, but. Right. In the realm of human experience, I've lived a blessed life. I would say one way to think about it is there were two versions of me. There was the me who you spoke to, who I think would sort of cogently say, well, there's this weird thing going on with rates and it can't last forever.

1:40:45And when it gets better, I think this will get better. And there was the me who was laying awake at night at 1 a.m. who was just kind of like, you know, my inner voice was not being kind to me. And I've always thought of myself as a person. I think I am sort of naturally one of these people who has pretty good control over his inner monologue. And it was the first and only time in my life where I, like, lost control of my inner monologue. Like, I, you know, would lay awake at night. I never lose sleep over things. I sleep. And I would lay awake at night. And I would, you know, fret and berate myself.

1:41:23And it's super hard to live like that. But, you know, like, again, it didn't have terminal cancer. I wasn't fighting the Japanese in the Pacific. Like, it was, you know, within the wrong human experience. But, like, it was super difficult. And, you know, you have partners that you've let down, right? And, I mean, I say you've let them down as though you've let them down. Like, have you let them down? Like, your view of the world is that maybe you haven't let them down. It's just like this is, you know, just a very big wave.

1:41:52But, like, then your partners would, you know, you've got different responses. You know, I had some smaller partners who are no longer partners who, you know, were mean. But, like, I had other, you know, partners who would very sensibly and totally appropriately, like, want to grill me about it. But that grilling didn't – it wasn't, like, mean. It was totally reasonable. But, like, it didn't come from a place of confidence, right? You know, we'll eventually get to people I'm grateful for. But there was one partner who drove, you know, a long distance to have lunch with me. And it turns out that was the only reason they drove this long distance.

1:42:26and we get to lunch and this is not going to go great. These meetings haven't been going my way recently. And we sit down and he goes, Cliff, I'm just here to express my and everyone I work with's view that you're awesome. And you're going through a lot and I'm just here to say, you're great, we support you, let us know if we can be helpful, but we're team Cliff. And I didn't cry, but I was like, wow. Like, what a thing. And he's like, yeah, look, we're here for lunch. I drove here just to meet with you. We can talk about investing. Yeah, we can talk about everything. So I don't really care. But like, this is what we're, and I was just like, it was like, wow.

1:43:06And so that would be the other thing. Like, I still, to that day, and I think it makes me a better person. Because I remember how that affected me. Like, the other day, there's a CEO in a company I'm involved in. And he's wrongly getting a lot of crap from really dumb investors. So I wrote him, like, I sent him, like, a hug. Like I sent him like a nice, like a really nice email, I think. As nice as I could write it. But I think it makes me a better person to be on that side and to hear it and remember. So in terms of other things I'm grateful for, that would be another one. But you've let people down and you internalize that.

1:43:38And there's also this weird thing that happens where like, when you own a stock that's down 30%, you know, okay, here's what's wrong. Here's what we're going to fix it, right? Blah, blah, blah. When it's down 99%, like so, you know, someone meets this and is like, what's up with Carvana? And you're like, well, I'm aware that last year I thought they were going to sell 800 ,000 cars. And they're on track to sell 300. And I'm also aware that last year I thought they'd made positive EBITDA this year. And they're on track to lose$2 billion. And I'm also aware that the stock is down 99%. But what I'm about to say is I think things are going to be okay.

1:44:15And you can see how that makes you seem like you've lost the plot. Yeah. And there isn't a good way to like say that that doesn't make you seem totally nuts. Because basically, you say all that and they're like, oh, you denial bull market baby. And so, that was another real tricky thing. There was no good way. And there was at some level deep uncertainty because things had gotten bad enough where I couldn't be like, look, I'm 100. I couldn't be like, yes, yes, we're fine. It was like, look, things are way off course, right? And for reasons I never would have predicted. And so how do you have that meeting, right?

1:44:59And then how do you have the 30th version of that meeting, right? Because you do these over and over, right? And then, of course, you leave that meeting and you've sort of done it. And then you drive and the stock's down another 8%, right? And, you know, you're like going to the gym and you're like, you know, particularly, you know, whatever. Like you sort of try to manage yourself and then you can't sleep. But it's really it was really hard. I'd rather not go through it again. It's it's such an I'm so glad we did the like the long version of the story because whether or not people care about this specific stock.

1:45:33I just think like as an investing and business story, it is very singular. I said this on the Ernie episode. we looked because he gave me that stat about going down 90 % is like going down 20 % 20 times or something like that. And each one's painful. There really is not another example of a company that was that big by market cap or something that went down 99 % that survived and like wasn't a fraud. Like it, it, it, like it doesn't, that's an end of one. It doesn't exist in the record. And so it's so cool to hear its major investor talk through the entire thing from soup to nuts. And I guess in conclusion, I'm curious how you think you will most approach future investment opportunities differently as a result of having had this specific experience personally.

1:46:20One thing I mentioned earlier was the importance of management teams. Like if I rank things instead of how they ultimately turned out over the full span, the management teams were wildly predictive of outcomes versus my expectations. So that's like a practical learning. Another is that in general, I have a new and deeper appreciation for how much harder it is in reality to go from unprofitable to profitable than it is on paper. And everyone, I feel like that's kind of trite. But the thing is, you do this analysis, you're like, okay, this is the incremental margins and blah, blah, blah. And it all makes sense.

1:47:00But now I've seen this play out up close. And it's hard. Like it's so hard. It's so much harder than it looks. And so I think my, it's not that I won't invest in unlocks making companies, but like my willingness to underwrite to that is just adjusted. There's like a base rate adjustment that I'm, that's more salient for me than it was before. I have like less of an interest, I should say, in investing in businesses that have narrower advantages. Because like life will throw massive curveballs at you. And like, you know, there's sort of an interesting point, which is like, if you'd asked me why I owned so much Carvana back when it traded for like 300 back in 2021, I would have said, this is an incredibly stout business.

1:47:43People do not appreciate how stout this business is. And in retrospect, I was right. Right. Like the world threw like three, like once in a generation curveballs at these guys at the same time while they were having all kinds of internal problems that don't happen that often. And they added debt and like, you know, whatever at the same time. And they did it. Like they got through it. So it turns out it really was that stout. But had it not been that stout, had these sort of advantages been, you know, if this business all grown up and super great was a 5 % margin business and not like a 13 % or 14 % margin business, I'm not sure they'd have had the wherewithal to make it.

1:48:23So I have a greater, like my sort of just my reaction to companies where, yeah, like it works, but there's just consumer surplus isn't that much. And the advantage isn't that big, but like pencils, it's just kind of like move on. Has it made you think any differently about your appetite for concentration? Just like I think of that old quote, like the only rational deployment of our ignorance is diversification. Yeah. And that like it's not ignorance so much. It's just like the Navy Federal Credit Union factor. Like that stuff happens in the world. And a simple way to protect against that, you know, the idiosyncratic math of like whatever, at 15 positions, the risk is all gone.

1:49:02And like, why not have 15 positions instead of five? Like, has it made you re-question that stuff? Obviously, your portfolio is the answer to this question. So maybe the answer is no. But curious what you think. It's made me re-question that. Well, I think on the one hand, you know, one of the things that I have said to people who've asked me about this is sort of like the lessons from this period are important, but it's a teaspoon of medicine, not the whole bottle. So on the margin, I'm less interested in loss-making companies, but I'm not excluding them. On the margin, I think there's probably room to be a little more diversified.

1:49:40But, you know, like we've had a lot of success over the whole history of the fund up to, through, and including this period. That success was because of how we did things. And if I were to have thrown out the concentration over the whole life, I think we'd come out in a worse place. albeit maybe with less volatility. And so the lesson is, yeah, like on the margin, there's room to be more diversified probably, especially if you factor in the idea that you might have some companies that are less like stout. But the teaspoon of medicine, not the whole bottle. Well, it's an incredible story. I'd love to take our remaining time and talk about the world and the future and investing kind of writ more large.

1:50:25One of the things, I think we're allowed to talk about IQ again. which is why I'll frame the question this way. If you think about like the world's stock of processing power in human brains, you know, some measure of the number of people with a certain amount of processing power, plus like how efficiently they use that, or if they use it productively, or if they just play video games or something. And then we think about the introduction. There's a question about the introduction of artificial intelligence into the world, which I'm curious for your take on generally, but I'm also more specifically for curious for your take on the introduction of intelligence and processing power into the job of investing, of like ingesting information, looking for stuff that overlaps, training on past pattern recognition and what's worked in businesses historically.

1:51:12And if we fast forward 10 years or something, what it's going to be like for even a very smart human to invest in a world that is full of artificial intelligence. And I'm just curious, I haven't talked to you about this before in such specific terms. I'm just curious for your take on the whole thing, how you've processed watching it unfold in the last couple of years and how you think it'll affect this job. Yeah, you should ask someone really smart about that. And here we are. I'll tell you a few thoughts on artificial intelligence that are super narrow, because some world is big and complicated.

1:51:49And I think maybe one of the lessons of 2022 is that that you don't know a lot, I find this world to be super helpful. I use various AIs every day, you know, in particular for businesses where there's a lot of information on the internet, right? So if you're studying Medicare Advantage or Medicaid managed care companies, you know, let's take Medicaid managed care, there's think tanks and government reports and RFPs, and you could fill a room with the materials that are on the internet, and you can't possibly read all of it and most of it's kind of boring anyway. But, you know, these things can.

1:52:23And so then you can ask it questions like, OK, like who won, you know, the RFPs? Did the incumbent win or did the entrant win for Medicaid RFPs in the last 50 RFPs by state? And like, what were the major qualitative factors identified in the decision that like drove each one? Make me a table, right? And that's a ton of work. And, you know, it takes two seconds with an AI. So I think that in the playing field of life, it advantages someone like me who works fairly independently. I don't have like a giant team in investing. As to whether these, like right now, an enormous amount of information is not in the internet.

1:53:03So if I were to grill an AI about all things like Medicaid, managed care, it knows a lot. If I grill it about Carvana, we pretty quickly run out of stuff. This interview will get in there, but most of what I know about Carvana, I've learned from a lot of thinking, a lot of talking to people who used to work there, a lot of data scraping and other things that just aren't in the internet yet. And so the tools, if you spent a bunch of time trying to learn about Carvana from an AI, I don't think you'd get very far. That being said, over time, maybe they have agents that are able to gather information, put it into the internet.

1:53:45Maybe the internet, this corpus information, the internet gets bigger because more stuff is put in there in other ways. And of course, these tools are only going to get better. You know, when AIs get to the point where they can make investing decisions, there's probably not a lot. That's pretty far down the spectrum, I think, of things that they would require doing. It's kind of like asking about the singularity. It's like, eh, you know, I sometimes am grateful that I've had a chance to sort of do well, you know, before all this happened. because, you know, it might be hard to do well after all this happens.

1:54:19If I reflect on the future sort of big picture, I mean, people used to ask me what my macro opinion was, and they always meant like interest rates and GDP growth. And I always give them some version of something like, look, I'm fully confident that my great-grandchildren will marvel at my poverty. And unless they're all dead, but hopefully they won't be. I think these tools make it all the clearer how we're going to get there, you know, especially if quantum computing happens, right? Because the ability to create synthetic data with real-world simulations using quantum simulators and then to train the AIs on that seems like a wildly interesting tool.

1:54:59Your portfolio is, I don't know if it's entirely, but it's been historically mostly U.S. companies. If I think about the U.S., you've got all these incredible advantages. We're the home of innovation. We've got this incredible geographic isolation and abundance here domestically. Our currency has been the reserve currency of the world. We sort of control our own destiny in those ways. Any observations just about the US as what historically has been the most fertile soil for finding great investment opportunities in kind of the modern era and whether or not that is changing one way or the other?

1:55:31The US is an amazing system. I think there's a lot of reasons for that. I mean, I tend to think about the idea that there was meaningful selection effects in the people who chose to migrate to the U.S. versus the people who chose to stay behind. And that probably led to us having, you know, the U.S. having a gene pool that, you know, an aggregate is selected for people, the sorts of people who will create businesses and be sort of independent minded and, you know, get on a ship and travel to an unknown land across the other side of the sea for a better life. I don't see that, you know, changing in any deep way.

1:56:03But I don't necessarily think I've invested in the U.S. because it's such a great place per se. I think I've mostly invested in the U.S. because, you know, I always use the following example. You talk to some investor and they're telling you about their like British, you know, restaurant investment or something. You say, that's so cool. It sounds like you really know England really well. Why don't you tell me three places you could buy a power drill in the U.K.? And they sort of like realize that they don't know. Right. And there's just an enormous amount that you learn about a place by being there.

1:56:33And so it's not that I could never invest outside the U.S. It's just that I'm keenly aware that overcoming a certain degree of naivete is very, very hard, even for some places seemingly close as the U.K. And so I just think that the U.S. is an enormous market. There's lots of interesting things to do. And someone will pitch me some Chinese stock. And I say, that's fascinating. I'm sure it's going to be great. I'm going to put it on the bottom of my list right after all the American stocks. That served me well. I'm sure I miss all kinds of stuff. But we've got to pick our lines. I think it's so interesting and funny that lots of the big investors out there have gotten to the position they're in owning Microsoft and Amazon and these exciting big, like, no one gets faulted for this.

1:57:15And we're talking about used cars and subprime lending and, you know, things like this. I used to own multi-level marketers, too. Right, of course. And it's just so interesting how many different ways there are to do really well in investing. and maybe the last question I'll ask before my traditional closing one is just how you process the really big, like I'm sure you think Microsoft is a great business, like objectively it's just a great business. How do you process those ones that are so dominant in the market that are such a huge percent of the market's market cap or whatever? How do you think about for your own money, I know you're a huge investor in your own funds, your own fund.

1:57:55Do you want exposure to those things? like, you know, market exposure. What do you think about market exposure for the average person? It seems like a very sensible thing for the average investor. Like, do you ever feel strange that there are these like massive, incredible, what seem like enduring businesses that you have nothing to do with? I have a fairly boring view like everyone else. I think for the average investor, you know, an S &P 500 ETF is a great way to go, maybe an all market ETF or whatever. But I've certainly looked at all these big companies. They are great for a reason. you know, I've certainly thought at times that they represented like good to even superior, you know, returns.

1:58:34It's just never, they've never kind of, I mean, one of the hardest parts about my job is like, I sit around and I study all these things and I find plenty of things where, you know, I said a joke in the hundred billion dollar portfolio, there's definitely room for that. But we don't, you know, we're not managing a hundred billion dollars. And as it is, you know, the opportunity cost of selling A to buy B doesn't work. So the hardest part about this, One of the harder parts about my business, about my day-to-day is like spending a lot of time on something, getting to know it really well, concluding that it's a great investment, but just not quite as great as the other thing.

1:59:03You know, that's frustrating. And there have been times I remember, you know, back in 2010, like Google, my friend of mine put it really well. There's Google sitting there looking all cheap. Right. And, you know, he was right. But thank goodness I didn't buy it because I think the things I owned, you know, did better. But not all of them. So, you know, I wish I could have picked the worst thing I had. But, like, that's not how life works. These are great businesses. If I ever, you know, retire, I imagine I'll stop thinking about stocks and diversify and I'd own them. And if I had someone who wasn't, you know, if my mother wasn't invested in my fund, I'd, you know, tell her to, you know, buy that.

1:59:37But, you know, there's a lot of businesses I don't own. The key isn't to understand everything or to pick the, even to pick the very best one. The key is to pick a bunch of things, a handful of things that you know well and, you know, are going to do well and watch them closely and don't worry too much about all the other stuff. Whenever we talk, time flies by. There's 20 things I could ask you about. Maybe I'll convince you to do this another five years. We could talk about those then. But for now, I have to ask my traditional closing question. What's the kindest thing that anyone's ever done for you?

2:00:03So I had the two that I mentioned earlier. One was the guy who, you know, right when I was starting my fund, invested, you know, in it. And, you know, I didn't quite appreciate at the moment just how rare that was. But it turned out to be a major kind of event that played a big role in me ultimately having some success. and then the other one was you know in 2022 that partner who went out of his way to just come and you know basically buck me up over lunch you know didn't have to do it what a kind thing to do I mean and you think about how I mean I'd lost the guy to fortune right at least on paper right and and it not only did it make me feel better at the time but I think it's made me a better person because I can reflect on that now and try to make sure that, you know, you got a management team, things are not going well, you know, like, what are you going to do?

2:01:04On the one hand, you have an obligation to understand. So you have to ask questions, but on the other hand, like they're trying, right. Even if they're idiots, they're trying. Right. And so, you know, it's important to sort of remember how I felt then and how I was treated by different people and like how I want to treat people. Um, and so maybe a better person. It's great. Beautiful stories. Cliff, thanks for finally doing this with me. Thanks for your time. If you enjoyed this episode, visit joincolossus.com where you'll find every episode of this podcast complete with hand edited transcripts.

2:01:33You can also subscribe to Colossus Review, our quarterly print, digital, and private audio publication featuring in-depth profiles of the founders, investors, and companies that we admire most. Learn more at joincolossus.com slash subscribe.

2:01:54Bye.

2:02:02gets too open