Mailbag: incl. The 5 things we want in an investment. October 13, 2024

25:46And that's okay too. but you're kind of then making some decisions to move away from being passive to something. Why choose qual? Why not pick your own stocks? Or why not find the next Keir Nielsen or Hamish Douglas or Warren Buffett or Peter Lynch? Once you move away from passive, there's a million choices, not just the quality ETF. Why do ETFs at all? Why not find a managed fund? And Max, I know you want to be passive and I get it, but choosing the qual ETF is as passive as giving you money to a fund manager to manage. Now, I probably reckon this one will do better than most fund managers because it is diversified.

26:23It's large. You haven't got management risk, i.e. the stock picker could leave. So I'm not saying they're exactly the same, but what I'm saying is they're both active strategies. You're saying, I will choose this to do better than the index, which is fine, completely fine. That's what I do for a quid, right? We pick stocks. But once you do that, you're stepping off the passive train and well and truly onto the the active train. Again, completely, completely, completely fine. But that's kind of the difference. So that's why. Why would people choose? Well, I'll tell you personally. I don't own, I might own the SP500 from a young bloke.

26:56I'd have to check. I own some passive Vanguard ETFs. I own them as opposed to the quality ETF. Why? Because I want passive low cost exposure to the market for him. That's literally, I know it was a half rhetorical question, Max, but the answer is because I don't want to worry about whether or not VanEck will continue to beat the market with this strategy. I don't know if they will or not. They probably will. I don't know. But I'm not actively picking it. I'd pick stocks if I wanted to do that. So it's kind of, it's where you would draw that line between active and passive and how involved you want to be.

27:25The quality is fine. Honestly, those criteria are pretty good. There's nothing wrong with it. I'd happily own them. If I wanted an active ETF approach, that's probably something I'd look at. The other one's the Moat ETF, by the way, speaking of quality. and they're different products by different people. Morningstar, I think, is the mode ETF. Same kind of idea. If it does well, then great. I'm not against the quality ETF at all. Just be mindful of you're not passive anymore. You might feel like it's passive because it's an ETF. It's an active strategy chosen by somebody with methodology that may or may not continue to work.

27:58That's basically what you just said around. Yep, yep. I mean, here's the other thing. A lot of these metrics can throw you some curveballs. I found an example. Myers. I'm no great fan of the department stores, as you might know. Not from a consumer perspective per se, but it hasn't been the greatest long-term investment. Return on equity for Myers is in the 20s. It's very, very high. You go, wow, that's a very profitable company. Until you remember that 10 years ago, it was a$1 billion in equity, and now it's a quarter of that. So in other words, the net asset value that they're carrying on their books is diminished.

28:39So there's two ways. It's like a dividend yield. I want a high yield. Fantastic. Well, one way is for dividends to increase. That'll give you a higher yield. Another way is for the share price to halve. That'll give you a better yield, all else being equal with the backwards looking numbers that you've got. And the inference and expectation that those dividends will continue. But that's what these scans will throw up. you will get false positives and you'll get the reverse of that. You'll get things that shouldn't be included and things that should be included, but won't. Big, big, big course for whatever reason, one year there was some non-cash write down, some restructure, blah, blah, blah, whatever reason it doesn't fit.

29:18It just doesn't tick that box anymore. That, that a, that a subjective analysis of might go, well, that happened, but it's, that's okay because of this. And these algorithms won't pick that up. They'll go, computer says no, it's out. But, but, but, but, but, it's out. You know? And anyway. And look, at a mechanical strategy level, there's 300 companies in this thing. That's fine. You can miss a couple of good ones. You can add a couple of bad ones. You'll still do okay with the strategy, but just be mindful of that. The other thing I would say, actually, by the way, in the favor of this ETF, and we'll move on in a second, but what I do like about this is doing it at scale.

29:52And if you think, for example, high return equity companies tend to be good businesses. They tend to outperform because they're profitable and growing, every now and again, one will go broke. And so just because higher ROE tends to correlate with success doesn't mean you just buy any company with higher ROE and you'll do well. Even buy five of them you won't necessarily do well. If you're going to be mechanical in your approach, you need to do it at scale so the law of averages actually works for you. I've said a million times, but you toss a coin, 50 % chance of heads or tails. If you only toss it once, you get 100 % heads or 100 % tails.

30:24There is no way I can 50-50, the outcome, the odds are still 50-50, the outcome is going to be 100-0 or 0-100. so just if you're going to do something like that if you're going to make this approach and do it mechanically this is probably a better way to do it for than try to do it yourself because if you picked five or seven or ten i don't think you're going to necessarily get a representative result maybe you get the 20 you start to but you're not gonna get a representative result with less than that so if you're gonna do something mechanical using just these uh filters without using your own mouse and your own analysis maybe that's the way to do it yep mate are you ready for me to get taking a task?

30:57Oh, I'm always. All right. Let me get the popcorn. Let me get the popcorn. A question from an anonymous listener who says that at the top. Oh, you know it's going to be good. You know it's going to be good. Dear Scott and Andrew, long-time female listener, first-time questioner. Thank you for your insights and rants each week. You're welcome. I'm intrigued, and I think intrigued is a euphemism, by your recent discussions around Prometicus. I know Andrew holds the stock, and Scott, last week, this is a little while ago, Scott recently admitted to not holding it due to consistently high PE rates.

31:26ratios. He even said he'd probably sell the stock if he held it. This is baffling to me, says our questioner, as a long-time holder of the company. As you mentioned in the episode, it's a stock that has consistently performed, if not in a linear fashion, year after year. It recently enjoyed another bump to the price when it was revealed they only have a 7 % market share in the US with lots of room for growth. I just love this founder-run stock. I know there are many other examples of great stocks that have high PE ratios that have been great long-term investments. This is just the most recent example that was discussed on the show.

32:00My question is, why are analysts like Scott holding onto PE ratios as a reason for not buying good quality proven companies that have long-term growth potential? From my perspective, the use of this metric alone for selling, even if it was hypothetical, shares in a growth stock is misguided and simplistic. Thanks for our anonymous listener. I have been, I have been rarely taken to the woodshed, beaten around the head with a piece of 2x4. I mean, she's right. And I won't speak for you, but I don't think you would frame it that way that high PE is automatically bad. Correct. I've owned Amazon for a very, very long time, Matt.

32:40Yeah. Stratospheric PE is, yep. So I don't own Pro Medicus anymore. Okay. You're welcome for those most recent gains. Hang on, let me just pause the program. I'll just go and buy some shares, hang on. That's right. like um god i did insanely it's my best investment ever right like just like and i remember it was at your kitchen table yes it was it was a long time ago i remember 85 cents and i watched you do it and thought i'm not gonna do that on that you know the stupid thing about it given my lack of ability to actually sell if i just done what you've done it's still probably still hold the stock not because i'm smart i wouldn't have ever got around to it well i'm so smart that i not only bought it but I took profits along the way, you know?

33:24In which case, our listeners should be doing the podcast and you and I can have the week off. Yeah, pretty much. I mean, look, too long, you know, investing is hard, right? Yeah. So I definitely think PEs in and of themselves are horrible, horrible, horrible things. PEs with context are really valuable heuristics. PEs with context, I like it. Yeah, yeah, yeah. Really, I mean, if if if i could have a thumb suck at the rate of growth and knew the pe that's that's two pretty good bits of information to make a reasonably informed decision each of them by themselves useless no idea right so so i would much rather a pe of 100 on a company whose bottom line is going 50 compound like any day of the week particularly over something at a pe of five whose earnings were dropping by 20 % each year.

34:18Like one is just vastly a superior investment. So you can't just go on PEs alone. But yeah, look, I'm of the view that ProMedicus is, I would rate it as one of the top five best companies on the ASX. Best companies? Yeah. Wow, that's a massive call. Maybe top three. Wow. Oh, let me count the ways. Let me count the ways, sir. Not only has it done such incredible growth, it has done that entirely internally funded. There's been no very little since the early days, no outside capital since the very early days. They have underpinned that growth and paid a dividend along the way. That is very, very rare.

35:05So you choose your preferred metrics here, which we were just talking about before. These absolutely will be in the qual index, I'd imagine. Return on equity is through the roof. earning stability is up and to the right they're disrupting a very big sector with a long way to i agree i agree a long way to run yet and they've incredibly um like their nearest competitor is miles away there is huge switching costs there are moats out the yahoo like just like it is a brilliant company but i do have issue with the price now it's not that's not just like let me emphasize the initial point here you don't want to overthink the pe for a very high quality very fast-growing company, of which ProMedicus is.

35:46Nevertheless, there is a point. I don't know where that is. We'll find out where it doesn't make sense. So what are we at? Look, what are we at at the moment? So Comsec's going to tell me something like - 200 and 211 PE. This is not a startup, right? This is an$18 billion company on a PE of 200. Okay. So - In other words, by the way, If profit grows tenfold, it'll still be on a P that's about 30 % richer than the average market. Right. So profit's got up ten times and you're still more expensive than the average market. And that doesn't mean it can't go bad, right? What I like to do in these scenarios, I've probably said this before, is I just do the so what.

36:31So let's pick some stupid number. Let's go at a 2030, it's a nice round number there, and let's grow earnings at 40 % compound. at a faster rate than they have grown when they were a smaller company. And then let's assume at the year 2030, they still demand a high, but perhaps not so eye-watering and unusual sort of end of the bell curve kind of PE. You will find, I can't do the maths in my head, but you will find that if and if all of those scenarios are true, you might get a 10%, 12 % annualized return. Now, that's not terrible. That's not terrible. But I'm probably going to be in the ballpark of that anyway with an index ETF.

37:10Right. And the point is - And much, much, much lower risk. Well, what if in the year 2030, we look back and go, oh, it quote unquote only grew at 20 % compound. That's right. What if in the year 2030, the PE is at 25? Still good, reasonable growth oriented PE there. I mean, you're just going to do your dough. Not do your dough, but it's just going to be a pretty disappointing kind of return. Now, I've just randomly picked numbers there. the anonymous listener could could say well i think it's 50 compound and i think this and that by all means by all means uh we'll we'll find out no one knows the future but but it's that as i love i love to talk about as you know the asymmetry is is not in your favor there it is everything goes swimmingly well from here and i'll go okay if it doesn't i'm not gonna go great i want the kind of scenario where it's just like well if things don't go great i lose a bit of money but if it goes a little bit better than what people are expecting, I'm going to make a fortune.

38:08That's the kind of asymmetry that you want. So I progressively sold up as it went up and up and up. And as I took my last parcel and sold, it continued to go up, right? So what do I know? Only that I can't pick tops and bottoms, but I just know that that hurdle rate, if you want to call it that, it's harder and harder and harder the higher that price goes in relation to the actual earnings of the business. And this is the personal view. And so far, it's been a wrong view. So, you know, take it for what it's worth. You've done a great job of summarizing it, mate. I can't add much more other than to give my own just personal thoughts, but on the same kind of vein.

38:53The thing about having 7 % share means you've got plenty of upside. Also means 93 % of people are using something else. and if and when there's an alternative option, then there's 92 % of the market that PrimeX doesn't own yet, which is up for grabs. The other thing, by the way, is if you 10x sales to get something like that profit, that's 70 % market share. Now, maybe this is a winner-takes-all category. I don't see that it needs to. I don't really know there's network effects that are strong enough to suggest that one hospital gets abandoned from the other hospital using the same software. Maybe it does and maybe it's worthwhile.

39:22Maybe there's a winner-takes-all Google-Microsoft-style outcome here. I just I mean again I'm repeating what you said why don't I pay 200 times earnings for ProMedicus because I don't have a good enough view of the future and if someone said to me you own ProMedicus now 200 times earnings do you feel confident enough to hold this company and hope it does it no I don't I don't have anywhere near that much confidence but why because the future is unknowable it's always unknowable but in a software space man you talk about you've talked about AI a million times around how hard is it all of a sudden an AI bot to turn up.

39:56ChatGP did this just two years ago. Appen, the business, was an absolute flyer. We're going to have this same conversation about Appen. It's helping. Look at its customer list. Look how great it is. Great PE. Growing really strongly. Great business. It felt like, why did it fall over? Because AI turned up and went, we'll cut your lunch, please. Thank you. That was yummy. Off you go. You're now a labor hire company. Good luck with that. And I'm not saying ProMedics will do that. I'm just saying, if you're paying 200 times, it better bloody not do that. Because if it does, you're absolutely stuffed.

40:25Or just to my point, it's not even a question. It might be that they deliver very good growth, the kind of growth that most businesses would kill for. Correct, correct. You know, if you're doing 15, as an$18 billion company, if you're doing 15 % compound for any stretch of time in sales, that is a remarkable achievement. If ProMedicus' profits go up fivefold and is a PE of 25, you lose half your money. And I don't know how anyone can have enough confidence in, and I'll get back to that in a second, anyone has enough confidence in any business in this space where you're not reliant on repeat purchase, i.e.

41:07consumers buying more of the same thing. There's no, it's a contract business. I just, I don't, I don't, someone had this business before Prometheus turned up. Some will beat Prometheus to it at some other point in the future. and I don't know whether it is I don't know how you would I don't know how you handicap the odds I don't know how you look at ProMedicus and say I have a sense of how this plays out one thing I will say to our anonymous listener and I don't mean to be again critical or condescending but be careful of hubris is the wrong word I guess it also sounds really harsh I'm not being harsh I'm not intending to be why are we excited about ProMedicus because it's gone up a lot and we feel really good and it justifies our faith and we think we've done really well and we're really clever by picking it and so it's done well so far so of course we're going to keep doing well you mentioned last week mate Afterpay which we could have an exact conversation about until the very point at which everything just fell out of bed, right?

42:00I was banging the drum. I was banging the drum. It was the same argument. Exactly. And that's exactly what I mean. So for a while, this thing is the best thing since sliced bread. It goes from two to 150. Everyone's a genius. And that's fine, except that thereafter, everything just goes really, really, really badly. If you look at, I mean, simple example, right? When the afterpay shares that were swapped or the square shares that were swapped for afterpay$180 when they first listed now they're 94 bucks so you've lost half your money in in effectively your afterpay investment um after what seemed like look how well it's doing look at the growth rates look at the profit margins all that kind of stuff so again i'm not saying primitivists could continue to fly probably will again you've jinxed it i've jinxed it's almost certainly a thousand dollar stock now absolutely yeah so put the house on it but i i just i don't i just be careful about it's gone really well so far therefore i'm clever therefore i'm right therefore the company's unbeatable therefore i should expect it to continue that's that's my issue is if you ask me to do some probabilities on this one i don't know how you have a i don't know how there's a there's a portfolio waiting question you can take risk and do whatever you want with it i i couldn't i still would i still there's going to furia to our listener i would still sell it today if you gave me after if you gave me pro medical shares here you go here they are i look at the price and go oh i'll sell them by something else thank you very much because there's just too much risk and not a potential return the asymmetry you talk about matters exactly right and i'm not gonna keep talking because you've already covered that beautifully i will say as a general rule and this is a hard lesson as well but it's all not always it's almost always better to pay a premium for for good quality stock you know what's what's the buffettism here it's better better to buy a wonderful business at a fair price than a fair business at a wonderful price correct that's true 100 agree with you it deserves a premium right Right.

43:49But then you just got to decide. 40 times earnings, I'll back up the truck. Oh, hell yeah. Oh, my gosh. I was just looking at the forecasts from the analysts that cover it. They're expecting the per share profit to double in the next three years. Yeah. I believe it. So then it's on a PE of 105. After three years, the market's probably gone up 40%. So again, the PE is, let's assume it's 50, the PE, and profit does double. Yeah. You've lost half your money. Correct. And again, that's, that's, that again, and you go, but, but, but, but the company did really well. Yeah. But mood change. Here's, I suspect, look, this is all guesswork.

44:29Sam and the other co-founder I've gone blank on at the moment. I've had the pleasure of meeting them. It was just really humble. Really. I really, I mean, I just really do. Let me, let me emphasize. I love the business, right? I think it's great business. They own half the company. So there's not what the traders like to call free float. So there's not a lot of like this, you know, 100 million shares on issue, but half of them are locked up. And then of the remaining 50 million that's on issue, there'd be some held in managed funds. There's not, it's the scarcity argument, right? Like there's just not a lot there.

45:05So when you have a few diehard passionate believers who are sort of price agnostic buyers of this stock, And I've got a friend who is that, you know, best company ever, bye, you know. And like, okay. And again, I'm not criticized. They've done extraordinarily well. And I'm just jealous that I didn't capture the full upside. That's right. But it does exaggerate things, the lower liquidity. You don't need as much dollars to flow into the stock to affect these kinds of price changes, which is fine. but just also remember that it cuts both ways it won't take a huge stampede of people exiting or locking in profits or whatever for that exaggeration to happen on the other side there's so much faith losing any of that faith can be can be pretty ugly i mean look let me say again that they have got they have not only got an incredible business incredible runway and all the nice things they've got all kinds of optionality up their sleeves we talk about ai like they're doing it right in partnership with a um is it the mayo or someone i forget now but it's just like analysis of image data is just that's what ai eats for lunch right it's perfect so we need someone who's got really high quality medical image data and a massive library that we can train ai yeah yep that's going to create a huge amount of value so when you look at program and this is the bull argument right so so just to be fair here people people looking at this you need to look beyond their current source of revenue and there are additional sources of revenue.

46:38It may well be that they're just going to plug a model into this, which is now 20 times better at detecting breast cancer than the best surgeon in the world. Is that valuable? Yeah. So again, we're kind of giving mixed signals here, and everyone will form their own conclusion. And I don't want to tell people what to think, especially given my track record on this, right? Like a completely bought like a genius sold like a moron um well no i think i know you're being self-effacing mate but you sold a business at a p of 100 plus that is that is not a silly idea at any point in time probabilistically if i i would suspect if i'd have sold shares in every business with a p over 100 i'd be better than having held them well actually so i'll be okay i'll be a little a little i'll be a little bit cocksure, which is I did really well out of Pointera, 3DP.

47:35Now, if you look at the chart of that, you'll see nothing, nothing, nothing, to the moon, nothing, nothing, nothing. And it's a whole saga and story. And I bought back in when I shouldn't have. And, you know, but in dollar terms, I did really well, really well. And I did really well, not because I picked the top or the bottom, but it just sort of like, wow. 84 cents down to 5 cents over the last three years. yeah yeah yeah so i was still i can't remember i'd have to look up my share side account but you know i i think i was four five cent average buy price i sold some at 20 some at 30 so again i completely stuffed up the time i'm not i'm not a i'm not a trader i'm not a timer of my clearly not a timer of of markets but you've got to look at both exactly you it's easy for me to look at pro medicine go oh i could have would have should have yeah there's there are other examples we're doing that actually did did was the right thing to do this wasn't the case where you i misunderstood stood the business in the slightest, mate.

48:28This is a case when you went investor sentiment is simply on a risk reward basis, not attractive enough for me to buy. I think that's exactly the right thing to do. If the alternative is, did I time the market perfectly? And if I didn't, I made a mistake. Well, then we're all stupid, including Buffett. And let's give the whole thing away. It's literally a case of even the best business, or maybe the best business, any business with a PE of 200, the odds are pretty ordinary from that point. Doesn't mean none will make it but plenty won't and you know it's it's always going to be a judgment call but i think i think you absolutely did the right thing well we'll see yeah but again i think well can i i'm just going to quick tangent i don't think we will see in other words we've i've used the example before i've got a thing called eventing it's described by any duke in the book which is a name i can't recall the book good book uh i go about three cars away through because it's repetitive and boring but really read the first half and she talks about you can't tell how well like a hand of poker is played by the result you can have the best hand in the world or maybe the best hand a great hand play it perfectly and still lose because you the odds aren't perfect you know what the other guy's got she's she is actually a poker player right she is as well she started something else and became a poker player i can't remember the story anyway yeah um you can have a terrible hand and still win you can play a terrible hand terribly and still win and if you were to do that and say see i was right just because you played because you won doesn't mean you had a good hand or you played the hand well yeah just because you lose doesn't mean you had a bad hand or played it badly there is can i tell you a quick story last time i got together with some mates from school last year we had a poker store yeah all right i had four of a kind oh You didn't get beaten.

50:16I got beaten. By what? I can't remember the circumstance. No, no, no. Sorry, sorry, sorry. They had four of a kind, but I had what appeared. I remember looking at the cards and going, the only thing, that's right. The only thing that can beat me is four of a kind. And so I'm all in, all in, right? And I lost. And he's gone, I can win this. But that's always the most interesting hands when both people think they've got a can't lose hand. Now, sometimes there is, I can't lose. They're like, there's nothing that beats this. We're all flush at home, yeah. You know, kind of thing. But, you know, there's a lot of, ah.

50:56But, you know, no one bought it at the time, but I was there going, well, actually, actually, I did make the right decision. Did you? Did you, mate? Did you? And like, and that's exactly to your point though, right? Because, you know, I'm just trying to save some face here. It was just like, well, who wouldn't go all in with that hand, right? Like it is the right thing to do. But sometimes you can do everything right and get the wrong outcome. That's what I'm saying, right. But you still should do it and you should still do it again next time. Because if you play that scenario out a thousand times, 998 times you're going to win, right?

51:30So it just happened to go against you. And that's 100 % my point with Prometicus, mate. You play, it's a game of odds. It's not a game of absolutes. So you play the probabilities and you play them. Well, you've played it 100 % appropriately. You didn't sell it at ProMedic at 18 times because it was slightly higher than 15 times and it was a market average. Sure. You didn't sell that because you went, oh, growth is okay, but maybe it won't be good next time and you didn't duck it. You know what? This price is not an attractive price relative to any other investment opportunity. Could it go higher?

52:00Of course. Could it go lower? Of course. I got it at a price I felt was probabilistically appropriate. That's always the right thing to do. It's like betting on a loaded coin. You can have a 60-40 loaded coin. you'll still lose four times out of ten. It doesn't mean you did the right thing by betting on it. Not every probability is going to play out in your favour. Oh, man. I just opened up share sites. I saw you look at your face like that. That's what you were doing. If I never sold, I mean, I'm on an island right now. Except if you haven't sold, then you're probably not selling today either, mate.

52:32That's what I mean. I had 10 ,000 shares. Oh, dear. What? Oh, my God. I don't want to oh man should I move on yeah please move on Motley Fool Money for more subscribe to the free newsletter at fool.com.au forward slash listener

52:54Emad sent us an email and said hello operators of the pod machine he says in brackets I imagine you turning giant wheels like in a Charlie Chaplin movie that's pretty accurate actually thank you again for informative and entertaining rants I've got to stop here by the way Andrew is not going to sleep tonight I just I was in the face after that. He's going to try not to mention his wife. He's going to mention to his wife. He's going to feel even worse about it. It's going to be messy for a couple of days. Back to email. You have recently discussed the pros and cons of investing in Australia versus the US.

53:24You have briefly mentioned franking credits. I believe you and most investment advisors I read underappreciate the impact of franking credits. Let us imagine two companies in the US and Australia in the same industry, say an oil producer. Let us assume they are both priced at$10 and pay a$1 dividend. He's put this in Australian dollars to keep the maths easy. And he said he knows it's too high, but he's keeping it that simple, which is fine. An Australian investor will receive 70 cents from the US company, which is the dollar minus 30 % withholding tax, while receiving$1.43 from the Australian company, which is$1 plus 43 cents in Frankie credits.

53:59So for that investor, investing in the same industry, the Australian dividend is more than twice the US one. To add insult to injury, high tax bracket Australian investors may have to pay some tax against that 70 cent foreign income. Charts comparing the total returns of the US and ASX investments over the long term ignore the impact of withholding tax and franking credits on Australian investors, as far as I can tell. This makes them misleading. Am I missing something here? Fool on, Emad. I'll go this one first, mate, then you can jump in. You are missing a little bit, Emad, if you don't mind me saying so.

54:33A couple of things I will... So firstly, franking credits make dividends from Australian companies far more useful and valuable. You're a million percent right. So conceptually, zero impact with your comments. But if you filled out the appropriate form, there is a 15 % withholding tax, not a 30 % withholding tax on US dividends. So that's the first thing. It'd be 85 cents, not a dollar. Second thing is you can offset that withheld tax against your Australian tax bill. So it works the same way as if you'd got the whole dollar and you've paid 15 % of that already in tax. So you don't lose that money.

55:09You only lose 15 % of it, but you get it back as a tax credit when you do your tax return. So the starting point of the US number is different. You basically get the full dollar back and you pay 15 % tax to the US and you need more tax on top of that to the Australian government. Similarly,$1.43, which is grossed up for franking credits, you then have to pay tax on that as well. So you're paying tax on the$1.43 from Australia, and you're paying tax on the dollar out of the US. That is different, absolutely, but the difference is only 43%, not double. So that's a meaningful distinction in the illustration you've given.

55:43By the way, usual writer, I'm not a tax accountant, right? So don't take tax advice from me. But I invest in US stocks. So you get that benefit. So it's$1.43 versus a buck. And then you're right, you do pay tax at your marginal rate on top of that. So you're 100 % right. A dividend from an Australian company is worth more, a fully frank dividend, is worth more than a dividend from the US company, just not buy it that much. But, or and, depending on which way to look at it, the two companies are not going to pay that same dividend. The US companies don't pay as much as a dividend yield as Australian companies, largely basically because of the franking credits, but also because that's just the culture of the US.

56:22So what does that mean? Well, if you had exactly two companies who are exactly the same, paid the same dividend with that same tax situation, you're 100 % right. But if I get a dollar dividend from an Australian oil company, a dollar dividend from a US oil company, I'll take the dollar from Australia because I get the trafficking credits. But if both of them are priced at 10 bucks, the dollar dividend you're getting from Australia is going to be probably 40 cents from the US. I want to say the average, I can't remember, the average dividend yield in the States is about 2%. The average dividend yield here in the A620 is about 4.5%.

56:53So it's a meaningfully lower starting point. As a result, most of the US gains are capital gains, not dividends. And those capital gains are taxed at the same rate here as they are in the US. So I don't want to complicate it, particularly in an audio format, because it's too hard, EMAD. But what you'd want to do is say, right, I bought both of them for$10. I got$1 to demand from the Australian one,$0.40 from the US one. Then the US company grew faster than the Australian company was worth$25. The Australian one was worth$15. Now I'm paying the tax on both. Now what is the result? And so it's very, very different.

57:24So you are right if you assume those assumptions are correct. All things being equal, Australian franked dividend is worth meaningfully more than a US unfranked dividend. But not everything is equal. And there are definite differences in terms of the capital allocation policy, the growth rates. And if you look at it, for example, and this is horrible short-term revisionism, you look at the last five years in the US market versus Australia, the US market has grown much faster than the Australian market. So even if you paid tax at that higher rate, you still would have been better off to invest in the US than here.

57:58Am I saying this is going to happen in the next five years? No, absolutely not. It's as flawed as saying, if I assume two companies are exactly the same, the same as saying the next five years, the same as the last five years is what would happen. So you're not wrong to think about it that way. If you want frank dividends in particular, specifically for your own investing purposes for passive income, you're probably in Australia anyway, because you're getting a 4.5 % average rather than a 2 % average. So you still want to start there, plus the franking credit. So I'm not arguing the income investor should probably or at least consider being more heavily invested in Australian assets than the US assets if the cash flow specifically from dividends is what you're looking for.

58:34If you want maximum returns, it's much, much, much murkier than unfortunately you suspect, EMAG. Ram? Yeah. Gosh, I hope I didn't suggest that you should not value franking credits because yeah, you should. They're very real money. Yeah, exactly. they definitely have a benefit. I mean, the art of investing is, I often like to just talk about opportunity cost. There's thousands of investment opportunities around the world, easily accessible through any online broker. And I've only got so much capital. And even if I had a billion dollars worth of capital, I wouldn't want more than a hundred stocks.

59:13It's too hard. So it's always a question of looking at the available items on the menu and saying which offer the best risk adjusted return potential yeah and when you do that whether it's paying a frank dividend or no dividend or unfranked dividend i here's my return expectation factor in the franking credits by all me oh my goodness factor it in but then But then compare it with what else is out there. And I think sometimes Australians are so focused on franking credits that they will actively choose lower return potential investments because they get franking credits. And I would - It's negative gearing all over again.

59:56Yeah. It's negative gearing all over again. Give me, I would rather, I can't do the maths in my head, but I would rather a 10 % unfranked dividend than a 5 % fully franked dividend. Right. And I would bet you could have a very large amount of people when given that choice will go, all else being equal, no, I'll take the franking credits, please, because franking credits are good. Yeah, they are. But what matters the most is your after-tax return. Correct. Period. Like, however you get there is kind of beside the point. I put all this money in. I made a bit of a profit. I've got to pay a bit of tax to the tax man.

1:00:29What am I left with afterwards? That's what matters. That's the only thing that kind of matters. The tax return is the only rational measure. And regardless of source too, by the way, no dividends, just across the board. I don't care whether I get my returns for capital gains or dividends. I don't care if the dividends are franked or unfranked. I don't care if it's American dollars or Australian dollars. All I care about is what's left after I pay tax. And that's it. The one that gives you the highest number is the one you want to invest in. Yep. Over the long term, of course. So I don't think any of us are in disagreement.

1:00:54Emad, yourself and me, we're all on the same page here. Yeah, franking credits are valuable. They form part of the consideration when you're trying to estimate returns. and that should absolutely be the case. Just don't do what a lot of people do, which is I am only going to look at frank dividends because that is severely hobbling yourself for no good reason. And by the way, there are some great companies that pay frank dividends. There are also some crappy companies that pay frank dividends and their high yield and the yield is high because the growth is low and sometimes that can be a reminder.

1:01:23If that's fine, that's all you want, but just be mindful of that. The higher the yield, generally speaking, the lower the growth. Why? Because the share price is lower because the market's already marked it down for not having a particularly bright future. So just be mindful of that as well. Yeah, I mean, a lot of good examples. I mean, I mentioned, was it this pod or recent one? I get all blows into one, but it's about trans-urban, right? They don't pay for a very low level of franking. It's almost zero, if not sometimes, every now and again, they get a few, but it's 5 % unfranked. Well, that's the equivalent of 3.5 % franked, roughly speaking.

1:01:59So what do you prefer? 5 % unfranked or 3.5 % fully franked? The answer is, shouldn't make a difference. Well, the other answer is, it depends which of those companies is going to grow its dividend fastest. Jet price fastest, right? Without you know, I just, yeah. Actually, I'm so glad. That's the other thing you mentioned before running Dividend Investor. There was a lot of picks that I put forward which surprised people because the yield was low. And I was like, wait a second, it's a dividend service and you're recommending something with a 3 % yield or something. And it just, the ration, whether it was right or wrong, you know, time would have told on each recommendation.

1:02:34But the point is, and again, I can't do this in my, the maths in my head fast enough, but I would much prefer a 3 % yield today based on my purchase price, where the dividend is increased by 20 % per year, than a 6 % yield, double the yield, where the dividends aren't like Telstra. They're just going nowhere or declining. Like there is like, obviously in the first few years, one is better. But when you chart it out, those lines cross not that far out. And one is just vastly superior. Do you want an income return? And are you thinking over a five to 10-year period? Then ironically and unexpectedly, not ironically, what's the word for it?

1:03:18Surprisingly, the lower yielding investment starting, because it's a starting yield, what will I get year one, assuming they pay the same dividend as last year, may actually provide you a lot more income over the fullness of time. And again, I was just going to say, I rant a little bit here because I've had the conversation with so many income investors that go, fully franked, high yield, that's all that matters. And it's like, well, I get that you want lots of after-tax income, but that's not always, in fact, surprisingly often, that's not the best way to go about it. Not only that, mate, but a company that has a rising dividend over time, those lines do cross over, almost certainly is going to have a higher share price as well.

1:03:55so you win twice yep yep alright last question this one's a big one you and I we're gonna make Frankenstein's monster are you good with that? yeah let's do it alright first name only please this is Scott he says Scott from Campbelltown sorry I assume I can describe him as Scott from Campbelltown here's a question for the pod machine good man to Scott and Andrew long time listener big thanks for the content and jovial nature both entertaining and informing I shake my fist in the air with you during your rants Rampage give it to them He doesn't need any encouragement, Scott. Thank you. A while back, he says, I remember you talking about a study that found out people who invest on fewer basis points tend to feel better emotionally and do better financially than those who investments are based on more points of data.

1:04:40He says in brackets, something to do with the paradox of choice, five being the Goldilocks number. Oh, yeah. I don't remember that. Maybe in your comment. I've referenced a study before that when people were given a small number of data points and asked to guess an outcome and then give a confidence interval, the more data points they had, the confidence went up, but the guess didn't get any better. Yep. So it's kind of like a small number of data points. And you've said this a million times, it's the 80-20 thing. It's all that. You get close enough with a few data points and then more than that, not only are you less likely, you're not any more likely to be more right.

1:05:12You're just going to feel more confident, which actually potentially blinds you to when you're wrong. Yep. So I don't know if you said something different, maybe that was my version. I think that's my – I've definitely ranted on that before. Yeah. So this is Frankentine's monster time, right? Given that, says Scott, if you were to invest or not in companies based on only my five areas, what would they be? So you and I are going to come up with a couple each and try and see if we can come up with five in a reasonably quick succession. This is not well thought through, researched ideas. I'm going to make you go first, mate, just because I can.

1:05:48Give me the first – I'll write this down as I go because I've got an LG warranty card in front of me. For those who can't see this at home, everybody at Ram can see it. I'll write with a pencil on my LG warranty card. Let's go with five characteristics. What's your first one? I will just frame it by saying as a younger man, I was very much a financial metric that I would choose. And now I choose the softer, qualitative, fuzzier, harder to pin down stuff. So I'm going to start with that. I'm going to say I want large inside ownership. Nice. In other words, I want the board and senior management to have some serious skin in the game.

1:06:29Not because you've got a big package. I want them to have taken money out of their pocket and bought shares. Not that you get a sign-on bonus or something. You will treat shares that are gifted to you very differently to shares that you have paid for. And for a CEO who has taken money out of their own pocket and bought more shares than they would just get by as part of their remuneration package. It's not everything, but it's a good start.

1:07:03So I was going to say, found a CEO. Can I have that or is that too close? It's a bit of a note. Often they're the same thing, but not always. Not always. Can I have that then? Yes. I think we've got a bit of a lag going on. If anyone's, I don't know about if there's a bit of a gap between our sentences, but I think we've got a bit of a lag going on. Oh dear, okay. That could be bad. We'll see how. Link will sort us out. I'm sure he'll fix that for us. Yeah, no, so let's go with that. So we can throw more out there. Let's bundle it together. Founder with a lot of inside ownership because it allows us to throw more stuff at the wall.

1:07:43Okay, fair enough. So, Zaman, it's mine or yours? Okay. I'll go again then.

1:07:54I want a business with high reinvestment potential. Oh, tell me about that. And how would you measure it, I guess? Or how would you define it so that it looks for long? Well, defining is easier. So, defining is just basically saying, like, I make a profit, hopefully, profit at the end of the year, I can give that to shareholders or I can invest it back in the business. And if I've got an opportunity to invest that into a new factory, a new product, a marketing launch, move into a different geography and get a very high rate of return, return on investment on that capital spend, that is going to drive return on equity.

1:08:32That's going to drive earnings per share growth. That's going to drive share price. It's going to drive dividends. It's going to drive everything. In fact, if you were really, if you really wanted to say, what is the thing that characterizes, you know, the monster beverages, the Amazons. It's that, it's that. We all know about compounding. This is compounding internally, you know? So this is, I make money and then I throw it back into the business and I make even more money. And of all that more money, I take it and I invest it back into the business. Conversely, those that have really been terrible investments is a really a story of very poor capital allocation from from management who go i'm gonna do this and they take all this money and they invest it in some stupid project and it blows up and it's like you should have just given me the dividend because at least if i just put it under the mattress i would have done better a lot of most shareholder wealth has that has been destroyed has been destroyed through the poor investment decisions of management so it's a very fuzzy it's easy to define but it's a fuzzy thing to to uh um to identify if you wanted to identify it.

1:09:40You could use things like return on incremental equity, those kinds of metrics, which are handy. That's a great one. Which is kind of like return on equity, except you're just looking at the retain, you know, and Google it. It's too hard to do verbally. But that's what I want. A business with high reinvestment potential with high returns. Nice. I'm struggling with the next one, mate, because you've talked about, we talked about debt to equity before with the question about the quality ETF. And I find this difficult because a bit like the ETF itself, you're excluding stuff you don't need to exclude.

1:10:20So whenever you say, I want this, you say, well, I don't want stuff that doesn't meet this. And I can think of, even with the ones you've already given us, high reinvestment potential is great, but if you're paying out 7 % dividend and you're running this thing for cash, that could also be as beautiful. If you want one or the other, I'll take both. Right, right. So I'm going to say, just for the sake of it, and with almost a stammering over my own words, because I don't want to say it, but I will. I'm just going to say low capital intensity. So I like businesses that, to your point, can reinvest themselves and grow.

1:10:51Even more than that, I like businesses that don't reinvest themselves because they just can't use the money. If you're generating - Yes, a million times, yes. If your capital intensity is so low, you don't need the money. I've already built the mousetrap, right? I've written the software. That's pro-medicist. I can pay 100x, 1 ,000x sales. Exactly. And not paying an extra cent. So now they can't reinvest themselves because they haven't got enough stuff to do, which is lovely. It's great. So as much as I want to, if you can reinvest high rates, you do it. If you can get those high rates growth without reinvesting, that's even better.

1:11:26Yeah, true. Because that means it's simply throwing off so much cash you couldn't use it if you wanted to. So I'm going to go with low capital intensity with the very clear sense, by the way, that I do like some business with high capital intensity which get great returns on that capital. So it's not, you know, I don't want to exclude stuff, but if you ask me to pick some characteristics, I'm going with that. Yep. I was going to say capital light was going to be the phrase I used. Yes, same thing. Same thing, right? So look, you might make a fortune building a railroad. Well, actually history would suggest not, but, you know, in theory you could.

1:12:00Well, they broke up the rail trust. They made a fortune for a long time. Well, that is true, right? Yeah. But it's a lot of, I mean, you've got to spend money to make money, right? But there are some businesses you don't have to spend that much to make money. Yeah, exactly. And that's the one I want. And then you make money and make money and make money and make money. Yeah, exactly. Yep. So capital light is always, if you can, is a better way. Your turn. I'll throw out businesses that have operating leverage. So operating leverage isn't leverage in terms of debt. Operating leverage is that for every incremental dollar of revenue, more of that pops out the bottom end as profit.

1:12:45Dollar revenue turns into$2 of profit. You know, so it's kind of – how can that be? Well – Gross, sorry, not total gross. So software business is the easy example here. So I'll use my business as an example. So straw man, you know, we've got a certain cost base. I've got to pay Amazon a bunch of money. I've got to pay those buggers at S &P some money. I've got to rant on that one of these days. You know, the ASX gets their snout in the trough. Anyway, but if whatever reason I had 3X members, my costs don't increase at all. So for the first, whatever the number is, all of those sales just cover my costs.

1:13:28Can I have some numbers that people just kind of visualize it? So you do$10 in revenue. Yep. You got$9 in costs. Yes. So you make a dollar in profit at the bottom line. Yeah, not bad. 10 % margin. That's pretty cool. Now you get an extra$10 in revenue comes in the door because you've doubled the number of members who are members of strawman.com Australia's premier online investment club. And so now your revenue's gone from 10 to 20. You've probably got a few extra costs. Maybe you give yourself a pay rise because you're doing a good job and maybe, you know, you're - Oh, you might need some extra.

1:13:54Like, honestly, you will always have some extra costs because there's more clients to service. So, let's say that next$10 of revenue, you have$4 worth of extra costs. So, is that$13 in costs now? Yeah. So, was it$9 in costs? So, I had$9 in costs and now an extra$4 in costs. So,$13 in costs. Yeah. So, you've got$20 in revenue,$13 in costs, and you're keeping$7. $7? So, wait a second. So, your sales are up. Yeah. Go on. Well, sorry. I think we've really got a lag here. So that's why we're talking over each other. But my profit has, my sales have doubled. My profit has more than doubled. And this is going to throw you as an investor, particularly when you're trying to sort of guess at growth rates and you look at some numbers and go, oh my God, how can they possibly grow that fast?

1:14:41Well, for some companies that are able to flex their fixed costs very effectively, you don't need much at the top line to get really strong growth at the bottom line. And that is a beautiful business where you can unlock that leverage or what you might probably call in another way scale advantages as well. It's just like I've got the factory. The factory is sitting there, right? And it's churning out widgets, but I could always throw on a night shift. So, okay, I've got to pay. My payroll goes up a bit, but I don't need another warehouse. I don't need more machines. The incremental profit on each dollar of revenue is beautiful.

1:15:23Now, a lot of companies, most companies will experience this to some degree, but some companies really, really have that. And they can be things of beauty. Can I also throw one which is unusual and you've got to be a little bit careful with it. But you talk about software companies and other things and that's great. The other big one actually, ironically, is really low margin companies. Yeah. Because if you're Woolies, for every$100 in sales, you're keeping$4 roughly, maybe$5. I'll call it$5. You're keeping$5 in profit, right? So you lose$95 on the way through. Now, even if you only keep 80 % of the next dollar, the incremental profitability, a really small growth in top-line sales can lead to a really meaningful – if their margin improves by one percentage point from 5 % to 6%, you've got 20 % more profit.

1:16:21And so that's kind of, you know, it's leveraged in a very, very different way. And I don't generally love low margin businesses. They can be, you know, more vulnerable in times of downturn. There's not much there to play with if another competitor comes in and drops prices. It can get messy. But if you've got a low margin business, and even by the way, time for a drink, Kogan, not so much low margin necessarily overall, but it went from loss to profit. and so that scale went loss loss loss a little bit of profit oh now a lot of profit yeah and it was just because it missed it moved over that tipping point where the costs weren't covered by revenue then they were yeah and so the increase from there it wasn't even that it was a again software companies are a better example or a higher quality example because you've got a profitable business you just keep growing that scale but lost to profit companies that kind of move from that losing a lot losing a little bit making a little bit making a lot that swing can happen on relatively small revenue.

1:17:12And so that can, you can get some opportunities for potentially big changes in share prices once the market realizes, hang on, you were doing$100 of sales and a dollar in profit. Now you're doing$105 of sales and$2 in profit. You just doubled your profit. And now we're off to the races. Yep. And as I say, PE of 50 doesn't look so high anymore because it's just dropped overnight to 25. And you go from two to four or two to three. Two to three goes from 25 then to 16. I mean, very quickly, you're probably at ProMedicus, by the way, and for all of my concerns about it, if it can genuinely run like that, it can 10x profit at only probably 2x or 3x sales.

1:17:46And now we're talking. Absolutely. Look, a very significant part of my investing checklist is, particularly because I like the small caps, I like the earlier stage companies, I love looking for companies that are approaching that inflection point of break even. Because the market looks backwards. Oh, it's making a loss. You know, sales are only growing this far. Why would I do it? And you think, well, actually, all they need to do if they can maintain any semblance of sales momentum, they're going to tip over that break-even point. And they go from loss to profit to lots of profit in a very short space of time.

1:18:23And it just catches the market off guard. And there'll be the crusty old value investors going, oh, it's on a price to sales of five. That's really high. And I'm like, yeah, but the PE is going to go from negative to high to low in three years. And then everyone's interested. And it can be incredibly profitable. Now, I've had plenty of investments where I thought, ooh, this is about to happen. And they never, you know, they always add some extra costs. Oh, don't they? There's nothing worse. You know, what are you doing? And it happens. It happens. It's a lot. It's frustrating. But when you get that right, it's beautiful.

1:18:56So I've whipped this horse too hard. But operating leverage, look out for that. Nice. I will say, by the way, just on that loss, sometimes they spend more money and don't quite get to profit. They still should do that if it's long-term in the interest of business. It's like your life as a shareholder, a bit tougher for another 12 months or so. Yes. And we do want them to do that, by the way. And obviously, they should. You actually do want them to do that. It's worth waiting another year for that profit if they are investing for serious long-term value creation. Yep, 100%. I'm going to throw one in, mate, which is not going to be a surprise to you or our listeners.

1:19:23I'm going to throw moat in. Oh, that was the next one on my list. Ah, sorry, mate. Sustainable competitive advantage. And this is, again, hard. Well, see the old judge talking about the adult photo saying, you can't define it, but you know it when you see it. it's kind of like that, right? So competitive advantages tend to show through in higher profit margin than a competitor in a space because it generally confers higher pricing power, more often than not, or lower costs. But either way, it tends to show through in greater levels of profitability. So you could, on one level, say, we're just great at profit margins and go straight to the result rather than the cause.

1:20:00But I think what you miss, and this is not only the moat, but Buffett's quote to his managers, we've talked about this before, when the September 11 attacks happened. He said, look, I don't know what happens next. No one does. Here's what I want you to do. I want you to widen the moat. That was it. Don't do anything other than be more valuable to your customers. Put yourself further ahead of your competition. Give yourself more safety from the competition. Do the things that make your business more valuable. And so for me, often that's brand. This is the major one in my opinion. Low-cost production.

1:20:33Arguably, our iron or miners actually have a decent moat. Now, whether that's enough to be an investment, Again, none of these are investable in isolation necessarily, but you can't beat the cost of Fortescue and BHP. I own Fortescue shares, as everyone knows. I own Kogan. I haven't said that, but everyone knows that too. Yeah, I mean, so there is a competitive advantage there versus their competitors when it comes to the cost of their product. But generally speaking, anything that gives you a – Network effects, a huge one when it comes to – Oh, the two most beautiful words in the English language.

1:21:06network effects when you have more customers there are more suppliers and more suppliers there are more customers the easiest one is Facebook for example I'm on it Andrew's on it so our friends want to build it so we can both all talk together the as good is seek as employment website employee or you know applicants go there and because the applicants are there the employers want to go because they want to take to the most applicants and so because all the employers are there the applicants want to go there because that's where the most employers are and it's a beautiful feedback loop marketplace businesses can be lovely right yeah beautiful so and plenty of those and try to classify it more broadly.

1:21:36Yeah. So moat, look for things a company has that gives it an ability to beat or stay ahead of its competition and they're hard to erode. Nothing's permanently impossible to erode. MySpace was there before Facebook. You know, we've used that example a million times, but look for those moats. And generally speaking, so this kind of goes into maybe another idea, but I'll use it here, which just look for longevity of the moat. Look for evidence that it has been tested and has been found to be strong. It doesn't mean it can't be eroded, but you don't want to assume it's got a moat and then see it fall at the first hurdle when it's tested.

1:22:10That's why it's often preceded by durable competitive advantage or sustainable. That's a very important part of the sentence. And just quickly, too, on Seek, just a single example, I don't know, in the shares, but there was a US mob, I can't remember, was it Monster Board was the first US one that were going to come here and beat Seek. And then it was going to be something else. Then it was going to be LinkedIn. And then it was going to be... And at some point, you kind of go, CarSiles is the same. CarPoint was around. CarPoint was free. You could advertise for free on CarPoint. You had to pay on car sales.

1:22:36Yeah. Car sales won. Why? Had a network effect. Yeah. And so it didn't matter how cheap it was. People weren't bothering to put the car in both places, but I can't bother. Everyone's on car sales already. Let's just do that. When you're free and you can't beat the competitor, that's when you know they've got a serious moat. Yeah. Are we up to five? Of course, I've got more things I can throw out. Well, that's five. Go on. One more. Well, I'm going to throw in two because - Oh, okay. We've got five. We've given him six because we already combined the first one. So we've got five, which is really six.

1:23:04And you had two more. Go on, go on, go on. Well, I like easy to understand businesses. Yeah, nice. I'm not smart. I'm not that smart. And there are some businesses out there that are sort of objectively wonderful just by looking at what they have managed to achieve. But from the outside, maybe it's a business to business kind of operation in a niche sector, which I have no experience in. I've got no context. I don't understand how it works. It's super complex. It might be great, but if I can't understand it, I've got no business doing it. I want things that I can wrap my head around so that when I'm speaking to my teenage son, I go, what do they do?

1:23:44They do this. Like, oh, okay, that's pretty cool. You know, I get it. Now, you don't invest on that basis alone, but gosh, it makes it better. And the only other thing I wanted to add was balance sheet. I think we love income statements as investors. We love profit. We love revenue. We love growth. We love all of those kinds of things. And we don't think about balance sheets until it's too late. I wonder if our former colleagues, Joe Maga, would say that in the good times, everyone wants to talk about the P &L. In the bad times, everyone wants to talk about the balance sheet. I picked it up from him originally, right?

1:24:14It's a lesson that stayed with me, which is it's not that a company with a good balance sheet, which is just another fancy way of saying lots and lots of good quality assets and not much liability, which is like, well, duh. Yeah. Yes, please. I'll, I'll take that. You know, I've got a lot of cash on hand. Again, a lot of investment bankers will tut tut and say it's lazy and, you know, you're leaving money on the table. I just think, I think that offers you a resilience that when the black swan comes as it will, you know, they're the companies that go, oh, that sucks. My profits are down, but I'm completely fine.

1:24:49I just ride right through that. Can I mention an example of corporate travel management? Yes. I think because during COVID, there were three large travel businesses in Australia, Webjet, Flight Centre, and Corporate Travel. Webjet and Flight Centre had to double the share count, dilute their shareholders by 50 % to stay alive. Corporate Travel had to cut stuff. That's it. No capital raising. No dilution. Acquisitions, right? During that period, and it's not a perfect business. I'm not saying because I own it. It just so happens. That's exactly your example, mate. For years before that, it would have been flight centers geared up the balance sheet, web jets, right nice and efficient.

1:25:26Corporate travel is a bit of a lazy balance sheet. You've got too much cash. They're not really, they can really stretch. The investment bankers, we're knocking on the door. Mate, let me raise some debt for you. Pay out that special dividend. I'll raise some debt. You'll have a much more effective balance sheet. People will love your ROI or go through the roof. But that's the other thing about return on equity is it can actually be depressed by conservative balance sheets. So be a little bit careful with that too. If it's too high, just make sure you do those two together, ROE and balance sheet.

1:25:49If there's no equity, you have a very high ROE, right? It doesn't mean it's necessarily a good business if it's not a high quality one that can withstand cyclical downturns and just vagaries of consumption and customers. All of that is true. And it's even better because it's not just gives you the capacity to withstand negative shock, but it gives you the capacity to opportunistically prosecute opportunities there's a reason though when the next recession comes and wall street is in flames that people pick up the phone to buff it and say well my god we're desperate help us out and he will go no problem here are my terms well no no no that's We can't, all right, call someone else.

1:26:41Yes, he survives because, I mean, what's his cash pile up to at the moment? It's an ungodly amount of something insane, right? And it's just sort of just a massive pile of money. But it's not just the resilience. It's that when there's blood on the streets, he's like, I tell you what, that company that I wasn't really interested in at 30 times earning is now eight times earnings and they're desperate and it's a buyer's market and I'm going to set the terms or they can, here's your choice. Go bankrupt or take my terms. I'll give you 10 seconds to think about it because I've got another 500 phone calls.

1:27:20And that is, it is just, it is not praised enough. In fact, it's criticized. That's the thing that blows my mind with all of these things you know and it's just like yes it's not as highly optimized for profit but it is optimized for long-term uh resilience and and and the complete um shareholder return over over the full stretch of time that's that's what matters i mean i i can tell you just my business there's more cash in the bank account that i that i need yeah and i i look at it with envy and covered his as to some of the shareholders, but no, it's staying there. I don't know what's going to happen next year.

1:28:01It just gives me more breathing room, and I'm very happy with that, right? Like it's just – anyway, I think we've – I know it was five, and we've probably snuck up to eight. Well, yes. And if we were to keep talking, we could keep going on. But I reckon they're pretty good places to start. Let's summarise them all. What do we have? Before we do, can I just tell you really quickly? Buffett's cash pile is$276 billion US dollars. He could buy BHP and Rio for cash. For cash. Yeah. I mean, he wouldn't. No, he wouldn't. But two of the largest companies in Australia, I thought I'd go to the top of the tree and find out what.

1:28:38I mean, you could buy probably the entire ASX 300 X the first 20 or something and have all enough left over. It is such a huge amount of money. And I'm sure there are shareholders saying, give us some dividends. Oh, go ahead. Give it to me. And maybe there's a point to be had at that, but, you know, I just don't go changing, Warren. Don't go changing. All right. Our eight, five most important data points were, we combined the first two, large inside ownership and having a founder CEO. We kind of called that number one, but make your own numbering system here. One A and one B. Second was high reinvestment potential.

1:29:15Yep. The third, low capital intensity or a capital light business model. Number four, a business with operating leverage. Number five was a business with a moat, a sustainable or durable competitive advantage. Number six, a business that's easy to understand. Is it Peter Lynch you should illustrate it with a crayon? Yes. You can't draw the crayon. Number seven of five or eight of five, a strong balance sheet. I reckon that's a very, very good list, mate. Yeah, I'm pretty happy with that. You know, here's the funny thing. I'm thinking to myself as you read that out, that company that I own doesn't meet.

1:29:53That company that I own. Why don't I use this list? Exactly, exactly. And this is just the reality of investing. There is the company you would like to own, which ticks every box, and then there's what's available. We never talk about price, by the way, because that's the other thing. Oh, how did I not mention? Well, you can't really, because how do you price any of this stuff? But yes, I mean, a fair price. We'd both say fair price, wouldn't we? Yeah, I'd say fair. I mean, I'll take a screaming bargain, but if it's not on offer, I'll take a fair price. But the point I was going to make is that the perfect company doesn't exist.

1:30:28I think you pick any company, you'll find hairs on it. There'll be some aspects of any business you care to point at. There'll be elements of Pro Medicus. I just gushed all over, you know, effusively how great this company is. There's aspects of it that I don't like, you know, and that's always the case. So you've got to be pragmatic at a point. 100%. The other thing is that in investing circles, what we just said is no great secret. Yeah, exactly. People are going, oh, wait, wait, wait. Slow down. Let me write this down. The dudes in Macquarie, they're not like, oh, wait a second. Geez, I hadn't thought of that before.

1:31:07The secret is out, really, along a lot of people. So you do find that some of my better investments have actually been things that don't conform to that. But you can see a line of sight towards that. Back when ProMedicus was$0.85, I tell you what, it didn't tick some of those boxes, right? It just didn't. And therein lies the opportunity, right? Like it's kind of – That's true. So it's just – I just wanted to articulate that point because others have rightly pointed it out to me in the past because particularly on Strongman where you can see what I'm holding. they'll go well you say that but then you hold back they're like yeah yeah that's true you take those criteria you apply as many others you can make fit i don't think any of those without would be an absolute no right like any of those like oh if you don't have that i'm not gonna buy it oh yeah no so it's it's also you know we look for the best combination of the of that group yep absolutely and just at least that that line of sight on getting to that point is like yes they You know what, if I was to really – thank you for the question, and I'm sorry we're so far over time, but it's just such a great question.

1:32:14The more I've thought about it, and it's so fuzzy and hard to pin down, but really what I want is I want to understand what is the value that is being created. Not the value is internal rate of return or something like that or discounted – no, I mean who's the customer and what value are you creating for them? I don't care what business it is. You're solving a pain point for someone. If you can solve someone's problem or deliver to them some kind of experience that they will subjectively value, that's it. I mean, the rest is detail. The rest is detail. So that's the fundamental point, I think, of what you really want.

1:32:55When you look at your business, whenever I interview a CEO on Strongman, it's like, what do you do? Who do you do it for? What else are they? What are their other options? And why would they choose you? I mean, you know, I'll use different words at different times, but that's what I'm really trying to get. It's a dumb, it's almost an embarrassingly simplistic, dumb question to ask. But I feel if you can't answer that, if you can't tell me, you know,

1:33:23the problem you are solving, if you're REA group, what problem are you solving for your customers? Who are your customers too? That's the other interesting one. Sometimes it's deceptive. We spoke to Foz Capital recently. And they do, it's a lighting shop, very small, owner-led, takes a lot of boxes we just sort of spoke about. Please don't run out and buy it, hyper liquid. I'm just, I don't own it. Please, I've got to be careful when I say this. But it's just like, no, the people to watch there are the architects and the lighting engineers. It's not so much the person who's paying the invoice.

1:33:54And I was like, what? Explain that to me. And it just, again, I don't want to get into it other than just to say that was incredibly valuable signal for me because you look at something like that and you go oh well they're the customers like are they though are they really the customer you know is is the customer of pro medicus the person who's getting their their scan nope it's the hospital you know that's maybe a more obvious example but but a lot of the time really really good in the food industry uh i saw the food game years ago there's the shopper and the consumer yes and the easiest example is baby food right yeah baby food is designed for mom not for the not being gendered it's literally what they do because moms tend to be the person who buys the baby food.

1:34:33They're designing for mom. They want to appeal. The packaging, the kids don't care about the packaging, right? The packaging is all about the shopper, the person buying the product. Yes, the kid's got to want to eat it, but the battle is one on the shelf. The battle is not one out of the can with the jar with the spoon. Absolutely. Absolutely. Oh, man. This is why I love investing, right? Because it takes you so far beyond I want to make money, which I just think is such a... Yes, of course I want to make money. Yes, I do. I'm not that high and noble, But it is the intellectual journey is just so fascinating.

1:35:06And it just gives you a lens on how the world works, right? And like what are the things that matter? If you were to be an alien and you just landed on your rocket ship on Earth and you look around and go, well, that group of hairless apes have a much more comfortable standard of living than those hairless apes over there. They're genetically identical for all intents and purposes. Why? Why is that? What is going on there? And there's a reason for it, right? And it might not be fair and it might not be appealing, but there is a reason for it. And when you have a good model of the world, it's a superpower.

1:35:40And I'm not saying I do, by the way, but I'm saying if you do, it's a superpower, right? Because you - It's more working towards. Yeah, absolutely. And that's the North Star. You've got to try and sort of get to the truth because the person who understands the way the world works has an incredible edge in all kinds of different things. and you won't help but create a lot of value for yourself and others if you can recognize that. So what you're saying is the truth will set us free. Exactly is what I'm saying. Yeah, just strive towards truth is what I'm saying and be humble. This has been an excellent conversation, Scott.

1:36:15Thank you for the question. I enjoyed it thoroughly. I sprung on RAM. I hadn't read it either, so we just did it off the cuff. I hope you got a lot of value from it. Again, for those three people who are still listening, which is actually maybe two or now one, Not sure. But thank you for spending a bit of time with us. Absolutely fun podcast. And we'll see you on Friday. Fool on. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned. General advice only. Please speak to your financial professional to understand how it may pertain to your situation.

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