Finding Value Investments with Patient Capital's Samantha McLemore

25:16But over time, again, it's so sensitive to time horizon. If you have a long time horizon and you can put your money away for a long time, there's almost nothing safer. If you have a 20 or 25 year time horizon, you know, equities have never been down over that time. Yeah. U.S. equities. Yes. And so I meditate regularly and, And I keep a journal. And I remember during the COVID pandemic, we were all locked away. But I was emailing with Bill. And he was reading stoicism. And that kind of got me interested. And he was sharing quotes. And so I think it can really help you in the moment to make better decisions if you have these tools.

25:56Recognizing what is and is not within your control and a sense of calm, it turns out to be useful in markets. Yeah. Imagine that. Whoever would have guessed that. And yet most people don't reach that conclusion. They go the other direction. So let's talk a little bit about where we are in the state of the market today. I'm watching real-time transcription, which five years ago would have been magic. There's been dictation software for decades. It's always been pretty terrible. It's amazing how good this is in real time. So let's talk a little bit about artificial intelligence. What are your thoughts?

26:37How does this affect how you're looking at overall markets and how you're looking at individual companies? Yeah, well, I think it's, you know, anyone who knows anything about technology, I have not heard anyone who's knowledgeable about this space not say that it's completely transformational. And, you know, more important, you know, I think, you know, the Capital One CEO, you know, he claims to have the first fintech at Capital One because they were very into data. But he said it's bigger than the agricultural revolution, the invention of fire, the industrial revolution, the digital revolution.

27:12And I haven't really heard anyone dispute that. So there's lots of questions about how long does it take? What exactly does it do? Are companies overvalued now? But I think anyone who knows anything believes that the impact of this is just going to be huge. And so when you're in that sort of situation in the markets, you obviously need to be aware and try to learn everything you can. I think we bought NVIDIA in January of 2024. The interesting thing about this is I love markets because they're so interesting. And they're complex adaptive systems, which make them very, very difficult to outperform.

27:50They're extremely difficult, but they adapt. And so what's interesting to me is that we have this AI bubble, you know, hysteria, basically, where everyone it's all you read all the time. And that makes sense, given that we've had, you know, the tech bubble, we had the housing bubble, we've had some of these bubbles. But I think and it's possible that, you know, there will be something negative here. But you're not seeing valuations at all in line with what we saw in the tech bubble. And the companies that are spending these enormous amounts of money, which they are very large sums of money, they're basically the best companies that ever existed in the history of the world.

28:31If you look at their returns on capital, their free cash flow margin, their revenue growth rates. And so I like that there's all this AI bubble talk because it keeps a lid on the valuations. I think it actually makes it more sustainable. Not that they're, you know, I would have concern in some of the companies like OpenAI, which, you know, had under$4 billion in revenues last year and has committed to$1.4 trillion in spend. So we're watching that very closely. And I think for me, I have children and I'm thinking, what does this mean for the future of employment? And is, you know, what can I advise them to go into, which I think that's a much tougher question now than.

29:09So I'm glad you went over there because I wanted to ask. You've talked about the value of mentorship, about training young people, whether analysts or fund managers, what have you. If you look at the unemployment rate today at 4344, and then you look at the college graduate under 30 unemployment, it's more than double that. It's in the nines. What does AI do for that demographic, being mentored, learning a trade, being able to get a job at an entry level when their competition seems to be software? Yeah. I mean, it's a great question. I'm not sure I have the answer to that. I mean, what we know is you can look at industries adopting AI and those that haven't, and there's clearly an impact on junior hires.

29:58So it is having an impact. And And, you know, Dario Amadei, the CEO of Anthropic, has said he believes that the white collar unemployment rate will be, you know, five to 25 percent in one to five years. So huge impact. And so I think, you know, that's why I'm thinking, like, what do you advise young people to do? I think I ask people at my college that I went to where I'm on the board. The professor's there. They're trying, you know, they've worked hard to set up an AI program and help students be literate and, you know, well versed in this. I think if you can use it as a tool to your advantage, you still need humans to do this work.

30:38And so, you know, being capable in that is really important. You know, I was at a Santa Fe Institute meeting a couple weeks ago, you know, that was on AI. And they talked about how what the models aren't good at, which I thought was really interesting, is complex problem solving and creativity. So those seem more unique human endeavors. So leaning into areas where, you know, those are critical skills, I think, are important. But areas like law or, you know, obviously customer service coding, some of these areas are getting quite disrupted. And you're saying complex problem solving and creativity, AI is not great at.

31:20These models cannot do it. Now, will they get there? I don't know. But I think what's useful is to have a human who is well versed and can think critically about because these models hallucinate. They'll make up lies. They'll tell you incorrect information. They're getting better at that. But having someone who knows how to check facts, use different models in different situations, you know, that's going to be very valuable. I think who can figure stuff out that you haven't been taught, go and solve real problems in the real world, I think is also valuable. So every time we see a backtest that's based on historical data, it always looks great.

31:57And built into the backtest of the assumption, the future is going to look like the past. How much of what we're seeing in artificial intelligence is sort of paralleling that, hey, we're working off the corpus of all these documents that have been previously written. If you want to do something that's not going to get replaced by AI, you have to go in a different direction. Yeah, no, I think that's a great point. I mean, what the models do is they look at all of the information that's out there and they can, you know, do things with it instantaneously. And so I think there's a belief in the technology community that they will eventually have a breakthrough where they can have novel ideas.

32:37You know, that's unclear if and when that'll happen. You know, it hasn't happened yet. And so, you know, if you can do that, if you can use ideas in an innovative way, if you can certainly I think in the investment business for long term investors, what you've seen is machine learning and large language models have already been used to optimize short term trading models. And again, we don't compete there because I think it's extremely difficult to compete. But I think long term, those models have not been used to think about long term investments. We talk about time arbitrage and patience and what do we think the world's going to look like in 5, 10, 15 years.

33:23The future is uncertain. No one knows. So I don't see how the models are going to get an edge there. I mean, if they become smarter than all humans at some point, maybe. But it'll be one of the last things, hopefully. So are you using AI in your firm? And if so, how? We are. And we talk about AI all the time. And so I tell the employees all the time, like, you have to be all over this and learn how to use these models because they're going to displace you if, not you specifically, but all of us if we don't. And so it's still so early. So I think a lot of what's going on now is more experimentation, both at big companies and small companies.

34:06There was an article in the Journal yesterday about how small businesses have had, you know, have been transformed by this because they can do so many things. Like I used one to create a profit sharing plan and I just went back and forth with ChatGPT like, no, I don't want this. No, I want that. Like, what is this model? And it like created it for me, you know, with the back and forth. And I sent it to the lawyers and it was good to go. I mean, it was good. it needed no changes. And so I'd been, you know, I've been wanting to do that for a long time and the team was busy with all sorts of stuff.

34:35So I finally just did it and it probably took me like an hour to do that. But we try it. We try tools on the investment side, you know, that are both specialized and more generalized. I use ChatGPT all the time for, you know, everything in terms of doing research. And, you know, it's really, you know, quite amazing. And we have, you know, We have a new tech person that we hired who has played around with automating and using agents to do certain tasks that people did. So I do think it is going to replace some work. Now, I don't think we'll have less jobs. People will just be able to do more higher level work.

35:11Makes sense. You earlier compared this to the dot coms. What are the parallels that are a fair comparison to the late 90s tech and telecom bubble? And what do you think is really separating this era from the late 1990s? Well, I think the clearest parallel is the market valuation overall is at high levels that we haven't seen since then. So I think the market's at 22 times the next 12 months earnings, and it peaked at like 25 times then. So we're, you know, after the financial crisis, we were at very low levels and we've spent, you know, the past 16 years, you know, having great markets, some of the best markets we've ever had and the valuations have risen.

35:56So I, you know, again, as value managers, that makes us, you know, on alert for signs that things might be going awry. But there's many more, I think, more significant differences. So during that, there was, you know, I think technology hit 50 times earnings as a sector. And a lot of the technology companies were losing a ton of money. And there was a lot of, you know, debt financing. So there's a lot of unsustainable things. The build out of, you know, the fiber networks, they were building for future demand that wasn't yet there. So that's very different than today. We have this, you know, big infrastructure build out.

36:36But, you know, there's still shortages of demand. They can't meet the demand that already exists. That's a very different situation. And the companies that are building them, you know, building this infrastructure out, for the most part, are, you know, extremely, the hyperscalers are extremely well capitalized with great balance sheets, high free cash flow margins. So, you know, the risk, that sort of risk doesn't exist. And also at the end of the tech bubble, everyone was piled into, you know, Bill recognized the peak and actually got out of those names. And what made him recognize it was that, you know, I think in the first quarter of 2000, you know, a very high percent, like 75 percent of money managers outperformed and only two sectors outperformed tech and telecom.

37:20And so everyone was piled into a very narrow area of the market. That is not at all, you know, what you're seeing now. And so I just now, you know, I think the bear case would be that for some reason, you know, the demand doesn't exist and, you know, the spend rolls over. Again, I still think it would be a much more modest, you know, pullback just because of those underlying, you know, fundamental business factors. There are other areas of the market like quantum computing and nuclear fission that are much more speculative that have already pulled back 50 percent actually just in this decline.

37:56So that also is a good thing. I think it keeps the market healthier, longer. So you don't explicitly talk about economic cycles, but every now and then I hear you drifting over to unemployment and growth and infrastructure and economist type speaks. How often do you use what's going on in the broader economy as part of your process? Do you think about that? Are economic cycles significant to your process? Or is the economy going to do what it's going to do and it doesn't interfere with your approach? Well, we definitely try to understand what's going on in the economy because it can have big impacts on investments.

38:40There's a lot of, no one can forecast the economy. There's a lot of good evidence that no one does that. Economists don't do it. Investors don't do it. So it's a futile effort. A lot of people claim that they have some view about the future of the world. What do we see in a recession forecast every year for the past three or four years? They'll get it right eventually. Right. And so, you know, the best strategy is just, you know, if you have a long time horizon to stay invested, but we want to be aware of risks and the impact. I mean, our whole process is analyzing the fundamentals of businesses and looking at what the intrinsic value looks like.

39:16And that's a distribution of outcomes because the future is uncertain. So we're doing different scenarios and then we compare it to market expectations. And so we like a clear gap in those two things. And we like, you know, better risk rewards. But we there's a lot that goes into both both of those things. You know, sentiment goes into the market expectations, you know, where people are positioned. And, you know, obviously the economic cycle for certain businesses has a big impact. It's very sensitive to your time horizon, And, you know, just how much it matters. And the longer your time horizon, the less it matters.

39:51Coming up, we continue our conversation with Samantha McLemore, chief investment officer and founder of Patience Capital, talking about the state of the economy today. I'm Barry Gritholtz. You're listening to Masters in Business on Bloomberg Radio.

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41:22I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. Let's return to my previously recorded conversation live at the Phillips Collection in Washington, D.C. with Patient Capital's Samantha McLemore. So you mentioned sentiment. I'm trying to remember a moment in history where collectively the investor class, the pundit class, the media, all in real time identified a major market bubble at once. Is it is it just too glib to say, hey, everybody's forecasting a bubble, therefore it can't be a bubble? Well, I'm a contrarian. So, you know, like that that kind of, you know, thinking appeals to me.

42:07I think it is true that usually what, you know, Howard Marks wrote a great memo on the whole tech space in January. And, you know, I thought the most important line in that was, you know, a bubble is characterized by psychological extremeness. extremeness. And so it is that psychological state. So we're not, when everyone's bemoaning a bubble and fearing a bubble and claiming a bubble, that makes a bubble much less likely because people are then not positioned in it. And usually where the biggest risks are, are not where you're focused on. If you know there's a risk in a certain area, you treat it much differently.

42:41You manage it much differently. If everyone's doing that, you know, NVIDIA, you know, so the risk would be NVIDIA's earnings are unsustainable. And they've had this huge run up and they've captured so far about 90 % of the economic profits in AI. Again, they're going to report tomorrow night. If I were a betting man, which I'm not, I'm an investing woman, but I would say they're going to beat. And then the market might really like that because it's coming into it oversold. But I think the risk is something happens to earnings and they have an earnings cycle. Again, I don't see that in the near term.

43:18But there's no valuation excesses are just not there. These companies, if you look at NVIDIA is growing 40 plus percent this year, trading at 28 times next year's earnings. That is not a bubble. That's not bubble valuations at all. It's not what we saw in the tech bubble. So again, I think it is true that when everyone's worried about a bubble, it's likely not a bubble. So people have been talking about a K-shaped economy that the upper arm is doing great, the lower arm is doing poorly. Can you apply the same thing to valuations with the market? If you take the top 10 or 20 stocks, they seem to be much more richly valued than the rest of the whatever you want to use, Wilshire 5000 or S &P 500.

44:04How do you think about that bifurcation? Yeah, well, I think there are certain areas, you know, in the market, like quality or like return on capital, where those, again, if you have high quality, high return on capital, high free cash flow margins, those companies should be valued at, you know, overall a higher level. But we've seen very wide gaps there. So I think I have a huge respect for the market, though, because we're every day we're doing the work on, OK, let's this company might be attractive. Let's do the work on that and see what the market's pricing in. And we'll say, what is the market telling us this business can do?

44:37And usually the market's pretty good at like, OK, yeah, that's the easiest case to make. And the market will reflect that. So it's more anomalous to find areas where that's wrong, especially, you know, the markets had a huge move up. So the more it moves up, the harder it is. But we're still finding, you know, opportunities. I think we added significantly to health care and small caps, you know, earlier this year. And health care until recently was at a 50-year relative valuation low. And those are good businesses with good returns on capital. And so, you know, the market gets so hyper short-term focused, you know, so many people these days are focused on the next quarter and they want to outperform every month and every quarter.

45:18So again, if you can look out longer, I think you do have opportunities. But the reason people don't is because you sometimes have more downside in the short term if you're buying into weakness. So how do you think overall about valuation and future return expectations when generally the markets had a good run and valuations are, if not bubblicious, a little more rich than average? Yeah. I mean, my view on valuations is they're at the high end of the historical range. So again, that makes me more alert, more cautious. I think if you look at the underlying fundamentals and just the returns on capital of businesses, the free cash flow margins, the balance sheets, higher valuations are justified.

46:01But markets go through these cycles of undervaluation, overvaluation, and then back again. And so that's just part of markets. Again, I don't think we're at levels that I'm extremely concerned. I still think there are attractive opportunities in markets. But where we can add ballast to the portfolio, defensive areas like health care, again, I think that helps position the portfolio for a variety of different sorts of environments. And there's still plenty of cheap, cheap, cheap names in the market. So I have three of my favorite questions I always ask guests. But before I get to that, I want to throw a little bit of a curveball at you.

46:43What do you think investors are not talking about when they're not thinking about AI bubbles? What are they overlooking? What topics or ideas or strategies are they just not thinking about that perhaps they should be? Yeah, well, that's a really hard one because I think, you know, there's so many investors out there thinking about so many things. And now in today's day and age with great podcasts like yours and Twitter and X and all the research online, you can get access to all of the thinking. So, you know, I'm not sure that there's things people aren't thinking about that much. But I would say, you know, one of my biggest lessons from Bill was the big money are made in the big moves.

47:24And so you need to be looking for those and you need to hold those. And actually holding them is even harder than looking for them. And so I think people focus if you if you have a long time horizon and you're interested in growing your wealth, which is what we want to do. That's our number one objective is to make money. You know, I never saw Bill get upset about a stock that went down or losing money on a certain stock. Because you know that, you know, in our business, you know, the best investors are wrong about half the time. Like half the stocks go down and that's just part of the business.

48:00So you get really comfortable with being wrong. I never saw him mad. I saw him mad when he identified a stock, Qualcomm, and an analyst said, no, this is really bad investment. Like, don't buy it. And then it went up 10 times because he's like, you just don't get the opportunity. to make money. And most of those type of errors, when something's not in your portfolio, you don't see it, you don't notice it's not there, but it has a huge impact on, you know, your ability to grow wealth. So I think there's not enough discussion about that. And, you know, if you look at endowment returns, I think for the last decade, they're like 6.8 % on average.

48:36And so the U.S. equity market's up over 13%. So that's a huge shortfall that if you do the math on like 30 years of 13 versus 6.8. It's like you either you're up seven times versus you're up 30 plus times. I mean, that compounding math is it's shocking, actually, even to me who I'm in this business. I know patients. I'm all about compounding and I do the math and I'm like, oh, my goodness, the amount of wealth left on the table. All right. So let's jump to our speed round and then afterwards we'll open it up for questions from the audience. I always like to get book ideas from people. Tell us what you're reading and what are some of your favorite books?

49:18Well, I'm not right now. What I'm reading is 1929 by Andrew Ross Orkin. So that's nothing new. Everyone's reading that, but I think it's in the probably help with the bubble talk. Well, it's you know, you have to be aware. And I think studying history is really important. You know, I think have you read The Comfort Crisis by Michael Easter? No. That's a really good book. And, you know, my kids get sick of me preaching. But it's all about how, you know, we are in a society where, you know, it's all about comfort and the benefits of, you know, he has this thing, Masagi, where he goes into nature and does really physically challenging things that are challenging enough that he will.

49:57And it's not his thing. It's actually a Japanese thing. But that you are most likely to fail and make it challenging enough just shy of, like, maybe dying. So again, I'm not a proponent of taking it to that level, but I am a proponent of, you know, if you listen to Jensen Wong at NVIDIA and he talks about the value of pain and suffering and he's like, he talks about being a CEO. He's like, a lot of people want to be a CEO. He's like, but the experience is not power and glory. It's pain and suffering. And like all the hardest problems come to you. So I think, you know, exposing yourself to things out of your comfort zone where you have the opportunity to grow and have some pain.

50:38I think that's kind of what makes life interesting. And so that would be a book that I would recommend. So final two questions. What sort of advice would you give to a recent college grad interested in a career in investing in finance? Well, I mean, back to my experience, I would say go for it and be persistent. I mean, we have a few job postings now. And so we're trying to fill those postings. And it's amazing to me, you know, a lot of people will go on LinkedIn and they'll blast out their resume to everywhere. And that they're putting very little time and little thought into that. And we actually have on our site, you have to email it and we're paying attention to who's actually reading that instruction and emailing it.

51:18But very few people follow up. I think we had one candidate who followed up like three times and it makes a huge difference. You know, it demonstrates interest. It demonstrates, You know, you're paying attention to it. So I would say in a in a tough job environment, especially it's it's easier than you think to distinguish yourself if you're actually interested in something. You know, perseverance, taking the time to learn really what the firm is, the person you're talking to, who they are, what they're trying to accomplish with this. It's amazing to me how little people actually spend doing that.

51:54Good advice. And our final question, what do you know about the world of investing today would have been useful 25 years ago or so when you were first getting started? Yeah, buy NVIDIA. I know you told me I couldn't do this. Buy Amazon, buy Bitcoin. Don't miss, you know. But if there's a broader point, I mean, part of it is like, you know, again, this kind of will go full circle. But the power of patience and compounding, again, And it's like, teach what you need to learn. But Bill used to tell me when I was young, because I'd be like, Bill, you know, I need to make more money. I need to find more stocks.

52:27You need to give me more responsibilities. And he's like, calm down. Like, be patient. I'm like, no, I can't be patient. It's my friend who I graduated with. He's at Goldman Sachs. He's making like$10 million a year. And he's like, calm down. And, you know, now 20 years, 25 years later, it is amazing just the power of compounding. If you find a name like Amazon or, you know, and you invest. And again, you're going to have a couple, you know, number of big drawdowns in those stocks that go up a lot, go down a lot. And that's just part of the journey. But it's so easy to underestimate, you know, just how powerful that can be.

53:02That was my live conversation with Samantha McLemore, formerly of Legg Mason and Miller Value, now with Patient Capital. I have to thank the crack team that helps put these conversations together, especially the live event. Alexis Noriega and Elizabeth Sedrin have been instrumental in making these sorts of things happen. Sean Russo is my researcher. Anna Luke is my producer. Sage Bauman is the head of podcasts at Bloomberg. I'm Barry Ritholtz. You've been listening to a special live edition of Masters in Business on Bloomberg Radio.

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