What to expect this earnings season. July 28, 2023

27:36They always go back up. No, no, actually, numerically, statistically, no, they don't. We are very much looking at companies who, underneath all of it, they have had good years and bad years, but there has been a progression and a general improvement over time. That has to be the first truth, because nothing else, you cannot rely on the market eventually coming to its senses if that part isn't true. I'll throw out an example, which, funnily enough, doesn't get talked about too much anymore, but we've touched on it previously as a little company, well, not so little, I suppose, but a little company called BrainChip who are doing these like really cool neuromorphic chips, blah, blah, blah, blah, blah, right?

28:20And I've been more generous than many on it just to give the benefit of the doubt, rah, rah, rah. But I think you and I both were saying it went from in 2020 from like less than 10 cents up to$1.40. It was a kingmaker. A kingmaker of a trade, right? Like, there you go, I'm retiring. It's done. But it was insane. It was absolutely insane. It was multi, multi-billion dollars for a company that had zero revenue. Yes, it had potential. But the argument was, and I'm not trying to do a victory lap and ha-ha, I told you so, maybe a little bit. But I mean, it could have gone to$10 before it came back.

28:57I made this argument on straw man is that, and this is what I think is a really valuable exercise for all investors is, You don't have to know the future, but you can do what if scenarios. So you go, okay, all right, what are the bulls? You talk to a bull and they go, oh, it's going to be, they're disrupting the chip industry and they're going to, you know, claim huge amounts of market share and et cetera. So let's play that forward. So I jumped on, I looked at things like Intel, other major players in the space. Now, okay, let's say they assume, you know, they take 20 % of their market share within the next 10 years, which is an incredible achievement given the moats and dynamics at play for that industry.

29:35And let's assume that they trade on some really attractive margin. And let's assume that I want a 10 % return relative to the risk of the, you know, something like that. And you do the maths and it comes back and it's like, it's still overvalued, right? Like Charlie Munger says, you can still do really badly in a wonderful business if you pay too much. And lo and behold, it's now 34 cents. So you've done, you know, you've lost, what is it? Gosh, three quarters, two thirds of your money and not because necessarily the business's fortunes have changed radically, but because so much was in the price before.

30:12And this might actually be an example. I'll just hammer this horse, flog it a bit more until it's just bones and mush. But you start with the business. Don't go, it's gone from$1.40 down to$1.34. Hey, Scott and Andrew, we're talking about, you know, look at the business, look at your assumptions, and see if it still makes sense. And look, I would say it makes more sense now than it did a year ago or two years ago. But put it in the context of the business and start from there. I think that's right, man. I think we're using some entire hindsight bias, but we're also making it on, and try and tie that to the original point we made, which is those quality businesses that just keep doing their thing.

30:54And maybe it's not Kogan, maybe it's not Zero, maybe it's something else. but ARB is one, Dicadada is another. They're almost kind of cottage industry-sized businesses, or at least they were for lots of their time. But if you find a really successful business that's fulfilling a niche, you don't have to have world-beating potential. You don't have to be talked about in all the popular press. In fact, if you are, you're probably going to pay too high a price at some point. And Zero might be a good example. Kogan, probably a good example of that too. When everybody, what's Buffett say? you pay a high price in the stock market for a cheery consensus.

31:28When everyone's excited about something, everyone's talking about it, that's when the FOMO runs hottest. There's no, it's no coincidence that those can often be the very worst times to invest, even in successful businesses. I mean, Microsoft took 15 years to recover to the highs of the dot-com. Now, it was a great business. It was, it continued to be, it continues to be. It's probably near record highs now. But that 15-year gap of getting super excited about Microsoft because everyone was talking about it in 2000 and paying any old price, that can really, really dent your returns. I'll give you, we'll move on, but I'll give you one quick example of a great little under the radar stock that's done exactly that.

32:07It's called Supply Network. They do aftermarket supply, truck and bus parts, right? Axle brakes, or I don't know. I'm not a mechanic. Stuff breaks. All I know is you turn the key in. You press the long pedal and things go faster and you press the other pedal and it stops. Tell us about the truck supply part. Tell us about the suspension pieces, the bushes, and the axles and the studs. Axle's a singer, isn't he? I have no idea. He wasn't a stud for a while. But I will tell you this. It's a pretty boring business, right? It's an incredibly boring business. And yet, over the last 10 years, it's gone from$1.40 to$15.

32:46In fact, this company's been listed since the 90s, right? It's just gone up and up and up and up. Now$600 million worth. But again, you never hear about this. Even in recent times, you know, you said the earnings per share have gone from 21 cents in 2019 to 50 cents today. But let me be very clear here. It might be overvalued today. I don't own shares in this. But I want to make the point that you've got a business here who's generating a 35 % return on the net assets of the business. It's consistently been doing it. Something boring as boring can be and just keeps getting it done. And take my word for it.

33:21While we say these kinds of businesses are rare, there are dozens of them that are out there, right? 2 ,000 stocks on the market. Your job is to say no to the most. But every now and again, Objective Corp, OCL, another great example, right? Dick Adati, you mentioned. There's a bunch of them out there. There's something that's clearly, we don't know the future, but there is clearly something going on for businesses that sustain really high returns on equity, high profitability, very judicious in their capital management. It's not just, oh, look how much the share price has gone up because brain chip went up a lot, right?

33:54And that's been a disaster for anyone invested a couple of years ago. But these are the things that you sort of, you know, you had my curiosity, now you've got my attention kind of thing, right? And then it's then and only then do you really bother to sort of say, well, what would I pay for? Valuation is the last step of the game, really. up until that point it's like do i want to own the damn thing you know uh i don't care what some dodgy business is worth if if i'm not interested in it at all um actually nice little segue um let's you you touched on west farmers before let's talk about kmart and target in one second because i wanted to go back to supply okay for one second i know we flogged the horse and we flogged it um you mentioned now it's 600 million dollars yeah and i want to let our listeners know that's still really small yes so for 24 years as a listed company this business has grown sales and profits i don't know about in a straight line probably is but i don't know now worth 15 dollars a share listed at 20 cents right it's up 75 times in value over that period of time but here's so a couple things firstly here's the thing uh three things firstly it's still only 600 million dollars now much will be too expensive and maybe it's filled as an issue maybe that maybe the growth is over but it was a really really small company that just got slowly larger over well not even slowly very quickly larger over a long period of time you didn't need this to be a seven trillion dollar business to make 75 times your money no right so that you know you can you can you could have found small caps right secondly 20 cents at listing in 1999 it gets to a dollar 60 it's already up eightfold oh i guess there's no opportunity left then yeah it gets up too late gets up to $4.84 in 2018.

35:37Oh, I guess the opportunity is gone then. It gets to$9 in 2022. Oh, I guess the opportunity is gone then. Now, again, we're looking at hindsight. So second point is just because the share price is up, don't think it can't go further. The last thing I want to just make the point is if you think about these sorts of businesses and you think about where they are today, it is very much, you've got to keep looking forward. None of these are reasons to invest in anything because it could have been over. it could still be over. But a business getting it done that continues to get high returns on assets, continues to grow, you know, sometimes, you know, there's the old social media thing.

36:18The first time someone tells you what they're like, believe them. I don't get that necessarily, but that kind of comes to mind with this stuff. This business is just consistently growing profitably. You can bet that it's over if you want. I don't know shares either, by the way. But the chances that it's over are probably not as high as you might assume. based on its ability to continue to grow. And frankly, even if the growth slows, and it probably will by definition for every company, it's earning a very, very nice return. It's going to continue probably to earn a very nice return. And at whatever point in time, it can't reinvest those profits successfully.

36:50It's probably going to pay them back in dividends. So just supply networks, boring, truck parts, who cares? What about AI? Let's all talk about that instead. I don't know. I reckon you're probably running the risk of missing it. Speaking of West Farmers, though, as you did, mate, let's let's uh let's move to that um yeah i've seen some really bad takes on social media by the way about what oh lack of competition and what's the a triple c doing and like uh they're actually owned by the same company and have been for like a long time and i'm all for competition and i'm you know i think the a triple c is a very important institution and i'm all for sort of limiting unfair market power but it's like you you you you're you're barking up the wrong tree yes uh so this is owned by west farmers they are and look for all of the stories that's slow news week for all of the story what they're really doing is combining the back office they're basically saying okay well well these two businesses they're both general merchandise businesses which is a generic name for a department store that sells everything other than food so you know clothing and supplies and stuff you know everyone knows what they sell um you've got these two business running side by side effectively, you know, and you're duplicating everything.

38:01And Westwomen said, hang on, we don't really need to run two separate back ends for this thing. It's, you know, we could run two brands. Now it's not, I mean, you tend to think of Qantas and Jetstar. They are genuinely one of those different businesses for the most part, before you get back to the really, really back off the stuff. But Target and Kmart are very, very similar businesses, probably duplicated suppliers, probably in similar shopping centers. You drive past one to get to the other. It makes a heap of sense, doesn't it, to combine the back ends of this thing? It does. I mean, there are differences, right?

38:33So I'm going to get mixed up here, but I believe Target has much more of the own brand. Is it Anko that they do?

38:44I'm not an absolute expert, but I did spend a bit of time in the FMCG kind of space. Yeah, Target has a lot of home brand. Kmart, funnily enough, has more home brand, but actually no home brand at the same time. So Kmart, one of the big, and Kmart by the way was something like a quarter or a third of West Farmer's profit last year. It was extraordinary. The big change they made a decade or so ago was they threw away almost every brand they stocked. So think about people our age, mate, you already mentioned we're old. Think about Billabong and Rip Curl. Those kinds of brands where you pay 40 bucks for a Billabong or Rip Curl t-shirt or maybe you pay more now, I don't know, it's been a while.

39:21They used to stock all that sort of stuff. And then Kmart basically said, all of you get out. We're going to bring in generic designs without brands at super low prices, sourced largely out of China, but also much of the rest of Asia, and sell them really cheaply. So you went from, hey, we're a bit cheaper on Billabong T-shirts to you buy a T-shirt at Bunnings. A T-shirt that came up for$9. A pair of shorts,$4. A pair of thongs,$2. A bowl,$1. And they literally did away with the middleman. And Kmart are effectively the most pure version these days of simply sourcing unbranded stuff out of very, very, very cheap factories in much of Asia.

40:01Cutting out the middleman and bringing it straight in. That's almost entirely their new business model. So yeah, you're right. Target still does a bit of branded stuff and a lot of our own brand, as you say, but where brand matters. Kmart's almost got exclusively the other way and said, we're not branding much. most of it is going to be you want a t-shirt it's a blue t-shirt with a surfer on the front and it's nine dollars and that's you know increasingly i went um years ago to it was hamilton island i think for a holiday like this is almost a decade ago now and i yeah it was you know kind of i had to update the old summer wardrobe i reckon i bought half a dozen t-shirts some shorts uh pair of boarders and thongs i probably got out of like 40 bucks i was blown maybe it was 50 bucks, I was blown away.

40:45And that's their core offering these days. Yeah, so look, we're getting a bit into the weeds, but it absolutely makes sense, I think, to do it. There's no reason why you need to duplicate so much back end. So it's a sensible rationalization. I think from the consumer perspective, a lot of people are jumping up and down for really, it's not going to make, from your personal experience, it's not going to make any difference. I think there's another, yeah. I was going to say there's an observation someone pointed out to me years ago and it's always stuck with me that if you're in retail, you want to be cheap and cheerful or premium and expensive and you don't want to be in the middle.

41:21When you're in the middle, you get attacked from both ends. There's always – you're either someone like me who's a tight ass or you're someone who's very quality focused, right? And if you're someone like me, I'll always go to the – actually, I'm changing on this perspective. But anyway, you'll go to the cheaper. There's always someone cheaper. So you want to be at the brutal end of that spectrum. Or you're going to be premium, in which case you're going to charge a hell of a lot because you know that people will value the quality, the product, the prestige, the brand, all of the differences here.

41:52And so I know that I've – just general conversation about this, people go, yeah, but it's all really crap stuff. It's like, yeah, it's terrible. It's awful, awful quality. It's awful quality. You know, and where I feel as though I may be maturing a little bit more is the recognition that it is a false economy. because I get my T-shirt for five bucks, but three weeks later, it's tatters. So I should have bought the$50 T-shirt that I'll be able to wear for three years before I finally sort of throw it out. There is a false economy there. But my point being is that West Farmers know full well what the value proposition is.

42:25Oh, yeah. They're not going to, you know, it ain't broke. Don't fix it. They're going to change it. And I should probably make comment before others write in and tell us. And I'm under no illusions that there's probably a fair bit of human suffering in these global supply chains to make a t-shirt so insanely cheap. And it gets done because there are certain child protection, labor laws and whatever that aren't apparent in other jurisdictions, which is a shame. And I'm sure if there was someone from West Farmers, they'd go, no, no, no, no, we've got this and that. And I don't know how, I just don't know how you make something that cheap without some kind of exploitation.

42:57If it was, we would do it here, right? I'm getting into dangerous waters here, I know, but I'll let you take it. before i dig too deep a hole i know i think you're right well i mean look there is there is obviously the exploitation stuff then there's it's funny you know um arbitrage is is a is a fancy finance word for exploitation sometimes but you know there's i mean it's not necessarily just um just exploitation the arbitrage wage arbitrage been happening for years it was japanese cars way back in the day and then it was chinese products and then you know shirts are included made in bangladesh and other places where labor is just cheaper and this is that that is the reality i mean kmart's business model relies on wage arbitrage because you can't make cheap t-shirts in australia they're not available so you and frankly let's be honest the the others the billabongs the rip curls are sourcing their products from similar kinds of places uh whether it's exactly the same place is probably an open question i'm not sure whether that's entirely entirely true but that's the sort of situation i think sometimes you find yourself in with some of these situations you need to um you need to break it apart but it doesn't undermine i don't think what's happening now with kmart and target i think the reality is kmart and target are doing pretty well um they are but particularly kmart i here's my here's my question to you andrew after all that is how what are the odds do you reckon these two brands exist separately in seven years time oh i'd say pretty good odds do you reckon very okay i'm going to go uh i'm going to go the opposite actually i'm going to say i reckon that the target brand is on life support i reckon i reckon target ends up being subsumed so i will say in 18 cases target stores have been rebranded my local one down here in barrel in new south wales was a target country now it's a kmart hub uh i have a i have a relatively deep suspicion the next year they'll be happy to take an agnostic view on what happens next i i think if kmart continues to prosper at some point they may well decide that there's not enough space for both brands.

44:58But I could be wrong. I think, well, this is the beauty of being the same owner, right? So you can say, well, we're doing this thing over here and we've got a slightly different strategy over there and one's clearly working. Now, if this was different owners, there would be, well, the better offering is going to win. When it's all owned by the same people, what you could probably do is sort of say, well, maybe it just makes sense to rebrand it all as the one yeah but then but then there is that at the moment we have the illusion of competition yeah yeah 100 as evidenced by the reaction on on the media and social media and the rest of it so there's there's a cynic inside of me that goes i think the powers that be go let's just keep it separate and and what we what we can do is we can change the business model we can you know whatever we're doing at target's not working as well so So let's just, what we're doing over at Kmart, now it's all the same centralized back offers.

45:55In fact, maybe that's easier. Let's just do the same thing. I know a lot of companies do that where they have a multi-branded strategy and it's kind of like, one, it sort of, it gives the illusion of choice to the consumer. It's like, I'm going to shop, super sensible, right? I'm going to shop around and see what the best deal is. Oh, they're offering this, they're having the aha. And I've done the prudent consumer thing. And in the meantime, it's just like, it's like that old cartoon at the restaurant with, you know, there's the chef in the back with one big pot and there's two pipes going out.

46:26And there's sort of, you know, I forget the labels, but there's sort of like there's two different sort of items on the menu. It's all the same thing, right? And this is a horribly cynical take, but I do wonder if there is a part of them that goes, actually, it's nice to sort of at least have that illusion of choice. One, from a regulatory standpoint, and two, just from a consumer perception standpoint. I do wonder to the extent that ends up being true. Anyway, wasn't the old rumour that Crown Lager and Fosters were the same? That's right. Was that supposed to be the same? I don't know if that was ever proven or whether we're just repeating an urban myth.

46:59But you're right, the same things tend to happen in different places. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

47:12Mate, I want to talk a little bit about earnings season. And just as we are going to get into it, we'll talk about it a lot over the next couple of weeks because earnings season, in quotes, starts on the 1st of August. And it doesn't really, except that's when companies tend to report. We've said before, but for new listeners, companies on the ASX are obliged to release their financial statements effectively within two months of the end of their financial periods, the half and the full year. Now, for most companies, not all. Most, that is June 30. In other words, if I add two months, they've got to be done by August 30.

47:42If they don't, they get suspended from listing on the ASX. So it's a big deal. They're obliged to do that. Most of them take more than a month to get their stuff together because they're big, complex businesses. So they've got auditors involved and financial accountants. You've got to write all the stuff. And it's a pretty big process. I've worked for a couple of companies that are listed, and it's a pain in the neck. But it takes a bit of time. So what ends up happening is most companies, or very few, release in July. They've got to be done by August 30. So therefore, we call August earnings season.

48:11It's a nice little name that we get to use as a shortcut But to make that work, it's going to start, mate, in a little under a week. In fact, next Tuesday is the 1st of August. So we might see a couple go early. Most will come out in probably the middle of August and a couple of the stragglers at the very, very end. What is, I guess I'll ask you broadly, mate, what is your firstly approach to earnings season generally? But also, what are you expecting to see or looking out for, or fearful or excited about, this earnings season in particular? Yeah, I mean, for a lot of the companies I follow, before earnings season, we have something that's colloquially known as confession season.

48:49So if you've given any guidance to the market, you reach a point where, I mean, you might not have formally put the books together and had the order to look over them, but you know, right? It's like, well, we're not going to, we're not, you know, in January or in February or March, we said this was going to happen and we're just miles off, right? So you sort of have to release that. So a lot of the high level stuff is often known. So I guess you want to sort of see, there wasn't too many nasty surprises. There usually isn't. What's more interesting is the detail, I find, and also the outlook statements because the market's always forward looking.

49:26So it's interesting. I'm with you. I actually think most companies do themselves a disservice by offering too specific guidance that's out there. But I do like an outlook. I mean, again, if I own the business outright, I want my management team to sort of say, hey, well, this is how we're sort of placed and this is how we sort of see things. Don't give me eight decimal points worth of earnings guidance. But, you know, I'm keen. What's the lay of the land? I'm kind of curious for that. I'd rather be descriptive rather than predictive, though, mate, I have to say. Yes, me too. If I said to my manager, mate, what are you going to happen?

49:58Oh, we think it's going to be$100 million. Really, what gives you that confidence? I'm just kind of guessing. All right, well, how about don't guess? How about tell me how things are placed right now? And that's the only thing I would add to that is just every management is going to be optimistic. Everyone wants to deliver great things. Everyone wants to see growth. And so you kind of go, okay, fine. But if I said, okay, on what basis is that confidence placed? Yes. And they start to fumble and excuse themselves and mumble. I'm like, okay, let's stop. Let's cut the BS. And that's my issue with earnings guidance generally is almost no company is well placed to have any confidence in that whatsoever, other than the lack of extrapolation, in which case we're all wasting each other's time anyway.

50:36That's my biggest concern. And here's the, I mean, this is what really does my head in. There's no benefit to it. That's right. So let's say that you come out and say, oh, it's going to be great. And you're not being dodgy. You're just hand on heart. It's like, wow, things look great. So the market reacts. And let's say you're right. Let's say you're right. And things are great. It's like, all right, we expected it to be great. There's no benefit when it eventually happens. But you set yourself up for failure when it doesn't happen. In fact, to do well from that point, you kind of need to do even better than the impressive result that you sort of forecast.

51:11And so it happens all the time where people who are new to the market often ask, wait a sec, their profit grew 20 % and the shares fell 10%. What the hell's going on? It's like, well, they guided for more. They gave a very strong impression to the market that they would do 30 % growth and they only did 20%. And that's, in fact, it's a perfectly rational thing for the market to react that way. So don't do it. Just don't do it. I mean, as you say, give me the broad lay of the land. Business conditions are okay, they're tough, whatever they are, you know, and then stay away from any specifics and then we'll get the results when we get the results.

51:45It's either the market reacts now or reacts later. And you can react in terms of intentions and forecasts or you can react in terms of actual fact. And I feel as though for a company, it's just better to – you create a rod for your back more often than not. Yep. And what worries me most is then it becomes those kind of, you know, everything gets thrown out. I've been out getting other and similar lists of companies where we have done stupid things to achieve a result that is actually damaging the long-term health of the business, but was done because we made a promise and we wanted to keep that promise.

52:23Where if you looked at holistically, is it a bad thing to keep a promise? A bit like the bloody politicians, right? Do we want to keep their promises? Yes. If it was a stupid promise to make in the first place, what's more damaging, keeping the promise or breaking the promise? Exactly. And there are people out there who will say both and I don't really want to get into the politics of it. But it's the same kind of idea of, you said this was the earnings forecast. There is no sensible, sustainable way to get there. So you can either do damaging things to get there and worry about it later, or put your hand up and say, made a mistake, shouldn't have made the promise, I'm out.

52:53No, almost no ASX CEO will do the latter. They will do whatever stupid things they have to do to get the number, hoping, believing, deluding themselves into thinking they can somehow make it up. There is some magic ball they can find later to solve the problem. I've been in businesses that, and this is, I kid you not, mate, I'm not going to name it because I don't want to get in trouble. I think I might have said this before. They used to invoice an order the day before the end of the financial year and send the truck out with the order. And when the truck came back because there was no order in the new year, they would simply refund the order and start with sales and the negative for the new year because they had to refund the order that didn't go to a customer, right?

53:29So again, desperate to get the number. Is that fraudulent? Probably. I don't really know what the accounting rules and the legal rules are about that, but it sounds pretty dodgy to me. But it's what they used to do, right? And it's just that stupid idea of trying to hit these stupid numbers for everyone's sake, knowing there's no value to it, knowing it's probably value destructive, knowing it makes the next number harder to get. But it kicks the can further down the road. And again, speaking of politics, we used to that one as well. It's insane. It's insane. I mean, so why does it happen? I mean, it happens because when the ducks quack, feed them.

54:01I mean, Wall Street figured that out a long time ago. Yeah, totally right. Right. And you've got a bunch of analysts and brokers that need to justify their existence. And they're like, tell us, tell us, tell us, tell us. Okay, well, we'll kind of – it probably doesn't – you've got to – I'm very fond of something called Hanlon's Razor, which is never ascribed to malice what can be adequately ascribed from incompetence or stupidity or something like that. Such a great one. There's no conspiracy here, right? It starts off for all the best intentions. And a lot of founders, I think, are fairly well manipulated by incumbents in the market.

54:41You've founded this incredible company. It's done really well. You've listed it on the ASX because you need some growth capital. And all of a sudden, you're dealing in this world that you're not used to. You've got investor relations people knocking on you. You've got analysts calling up, oh, we need to know this. What's your – oh, okay. This is how the game is played. Okay, well, I think in the next quarter we should do this. I don't know. It's my best guess. I've never had to do that before, but this is how the game is played, so I don't do it. And you find yourself stuck on this treadmill where – and there are beautiful exceptions to the rules where there are some – what's the word?

55:15Mature, wise enough owners, board members who go, I won't use the word I was going to use, like bugger off. I'm not telling you. I don't know. You'll find out. I'll report what I – Look, mate, if there is anything worth knowing, I will comply by the ASX rules and I will release a statement to the market. You don't get to know any of anyone else. You don't get to know any quote unquote color. You don't get to know any kind of general indications of this. Things have been cleaned up a lot over the decades, but it's still pretty awful. And I think for me, we talk to a lot of CEOs at Strawman. It's part of the value prop.

55:55We line up meetings all the time. we speak to small cap CEOs and we get a lot of value out of it. But I tell you what, as a general rule, I have, my interest goes up exponentially when you have someone who really downplays things and the red flags go up when you go, oh, we're going to do this. No, they don't say between you and me, but you know, they're reading between the lines and there's all this stuff. I'm like, stop it. Stop right now. Because one, I'm not that dumb. Two, if you're telling me this, you've only just met and there's absolutely nothing that you owe me or I owe you, how many other people have you whispered this to before?

56:33And it's just like, and even if you're right, you've told that many bloody people, it's already going to be factored in anyway. Just it is, I hate it. I really, really, really hate it. And so back to the question, what am I looking for? I'll add this flavor to it as well I think anyone out there who's run a business whether it's a donut you know caravan in or it's a multinational fast moving consumer goods company I don't care who you are business is variable and it's tough you have good quarters you have bad quarters not because you're a good business or a bad business necessarily it's just like any business is going to have tough periods because the economy moves in different ways at different times some people are some your customers are more have a higher propensity to spend at other points.

57:21So the best, best, best companies in the world are going to have awful quarters and halves and years. And the crappiest companies in the world are going to knock it out of the park sometimes, right? And the market just gets so, oh, look at that, sales up 20 % and then off to the races you go. What I want to know is, is the business more or less on track? If things have gone well or bad, how much of that is a consequence of prudent management decisions and how much is a consequence of Johnny on the spot, you know? And a lot of the time, it's Johnny on the spot. And these are the really interesting setups is when you, I shouldn't use that term.

58:00It's a horrible trading term. But the interesting situations are when you get a really good quality business that's delivered a quote unquote disappointing result, not because of anything the company has done, just because it's tough out there at the moment. We've talked before about a number of retailers that have probably put in that category. It's not, you know, retailer X, Y, and Z's fault that Phil Lowe's gone hard on interest rates and no one can afford their mortgage and no one's spending it. It sucks to be a retailer. I don't care who you are. Some will do better than others, rah, rah, rah.

58:30But I'm not going to instantly blame management for a rough six months. In fact, it would be stupid for me to expect anything other than a rough six months. I'm more interested in, have you got the kind of business that when the inevitable tough times come along, you're able to weather the storm? because you've got a good balance sheet, because you've got reasonable cash flows. Profit might be down, but there's still profit, right? You're not going handing cap to investors to raise new money or to beg for a debt from a bank or someone at very userist kind of terms. And that you're actually, I think the really good companies are the ones who in tough times, they lay the foundations for the next leg of growth, where you've got the other competitors who haven't been so prudent, doing it really tough, pulling in.

59:14You're making investments. Maybe you're even buying out some of your competitors. Yeah, your results are pretty ordinary, but your vision is you're doing the five-year plan, right? Well, you're not looking to the next quarter, the next half. It's like, well, we're doing this because we see an opportunity in this. We've got the capacity to do this. Sucks that we're not going to increase the dividend this year, but that's how it is. And anyone running a business outside of the share market, I think this is like, well, of course, that's how you do it. But when you get into the market, you get sucked into this game where you've got to please all these quacking ducks about, oh, what's happening next quarter?

59:45And what's happening in this? And well, you said that. And now you said it's like, it's a forest for the trees kind of stuff. So I'm looking for the businesses that, look, don't get me wrong. I want a good result, right? It's always nice when results are attractive. But I want something that shows me that the business has performed well in the context of the situation it finds itself. And that when you look out over a cycle of three, five, seven, 10-year sort of time horizons, these kinds of things that are more meaningful, that the future remains bright. And in fact, isn't that nice when that situation is true and the market drops 20 %?

1:00:19Like, I'll take that. Thank you very much. What do you look for? It's a good question, mate. So I think the things we look for generally are probably, you've done a nice job of those. I'm going to take a slightly different slate of the answer and feel free to do the same again after I've finished. This earnings season, I'm going to just say to our listeners, I would be a little bit careful to, as you look at the numbers that are being provided by the companies this earnings season. So let's remember that we're talking about businesses that are end of June 30, they're half. So January 1 to June 30.

1:01:01And then think about, you've already mentioned interest rates, Andrew, the economy, inflation. Think about what that six months period has been like. And then ask yourself whether it's reasonable to say that is a reasonable summary of a six-month period on average. And let me give you a simple example, right? If you were to take a seasonal business, take the half's hard. Let's take, I'll go back to, I used to work for Heinz many years ago. The canned tuna business, right? So, you know, John West, Green Seeds Tuna, had always done really well in March and April because there's still a decent cohort of the population who observe Lent, one of those kind of Christian periods of sort of semi-fasting.

1:01:45And a lot of people have, you know, don't eat red meat during Lent. They eat a lot of canned fish. And so there's a really big period during March, April, during the kind of lead up to Easter, where people eat lots of fish. If you said, okay, well then double the first half, what do you get? In other words, the January to June, you get a very, very misleading sense of what the year might look like. You can't just double the first half and say that's what happens with fish sales. You know, same as winter products. Think about soups in winter. Same thing, Heinz soups do spectacularly well. April, May, June, July, August, and no one eats soup in December and January, right?

1:02:16And again, no surprise. I use those as examples to then talk about the first half, not from a every year seasonality, but think about how much stronger the economy might have been, how much less impactful inflation was in January compared to June. And then ask yourself, if you're going to look at the year-on-year growth of that period, so first half this year versus first half last year, the first calendar half, in other words, January to June, Oh, sales are up by this or down by that. I would bet you a decent amount of money there is a not inconsequential number of businesses on the ASX for whom their success year on year in January was much, much better than during June.

1:02:50And we've seen that. You mentioned Adair's earlier. It had a really good first three months and a very ordinary last three months. So if you look at the half overall and say the half is this, therefore sales growth is that, you're missing the seasonality entirely. Not even the seasonality, the volatility driven by economic change. So I would just say to people, as you think about listening to companies, looking at the numbers, looking at a six-month period and either extrapolating that or looking at the growth year on year or making conclusions, just be really, really careful. Not only was the last year still COVID impacted, the year-on-year comparison, but this year is very, very, very different when it comes to the way you can extrapolate out what sales performance, profit performance might look like.

1:03:31Think about costs in the same way. It's exactly the same problem. So just be very careful that you don't look at those numbers and assume anything without really doing the thinking, doing the work. Yep. I love that. I love that. Another thing I would add is management will always point you towards the most attractive figures, right? And there's a lot to choose from. You can focus on your sales. You can focus on profit. You can focus on EBITDA or EBIT or any kind of things in between. And there's nothing wrong with that. I mean, all the results are there in the full financial statements. But I do find it a little bit of a red flag when the preferred benchmark changes.

1:04:11We've talked before about EBITDA, you know, because Buffett calls it BS earnings. I won't use the full phrase, you know. And it is, right? Because, I mean, depreciation costs are real. Interest costs are real. There is something to be gained from EBITDA if you want to get into the weeds. But, you know, it's going to be more often than not the most favorable of measure. And that's fine. If a company has always reported that and that's what they do and all the other numbers are there, fine, fine. That's just how it goes. But if you're like one year we're focusing on this and then we focus on that, you know, that's just moving the goalposts.

1:04:46And you'd be surprised how often that happens. The other thing that you'll see a little bit too is that a company may have made this huge acquisition. And they'll talk about how their sales are up 40%. It's like, yeah, but what was it excluding that? What was it on a per, like if you've issued three times as many shares as that, maybe the per share things have gone backwards. So you need to sort of cut through all of that guff to get at what's happening. It's easy for me. I could be the CEO of West Farmers and I could put some ridiculous offer for Woolies, right? And buy them out at an offer that's just insane.

1:05:21You'd have to be mad to resist it and assuming the ACCC let it go through. All of a sudden my sales are massive. but it's just that I've issued like a gazillion more shares to do it and everyone's much poorer at the end of the day. So be on the lookout for that kind of shenanigans. Yeah, I love that, mate. That's a really, really good point. The other one, just quickly on the changing the lens. One of the least obvious ways to do it, but one of the ones that's more often abused, is for businesses with international sales who choose to report either reported currency or constant currency sales and profits.

1:05:53Be a little bit careful there because they'll always say to you, when the dollar goes against them. Oh, but in constant currency, we're this. And when it goes for them, they say, our total sales are that. Yes. And neither is wrong, as you say. And the casual observer might say, oh, they're reporting sales, they're reporting profits. Okay, that all seems reasonable. Just look out for that one. If there's a business you follow or own shares in or want to look at with international sales or international costs or both, just look at how frequently they use the same metrics. I'll give Saltpats a massive shout out here, mate.

1:06:25I'm a big fan, as everyone knows, but they report, what do they call it? Is it normal profit, I think? I think they're called normal profits. It's almost like it's Buffett to owner earnings. Yeah. But yeah, they've got their own term for it. Yes. Yeah, but even when they have big, you know, A New Hope has often good and bad, you know, cold periods and there's write-downs or whatever. They are very clear to always talk about normal profit. Even when it's been a great year, they'll still say normal profit is this. They don't overhype the good years. They don't hide the bad years. that normal profit number is delivered as a normal profit regardless of what else is going on.

1:06:57You want that company, you talked about the business that say no go away I can give you guidance. Same thing for business that give you the right appropriate metrics all the time. Here's what you need to know. These are the real numbers. This is what happened. If you love us or hate us as a result you're the wrong shareholder for us. That's the other thing mate. You want a business who wants to choose the right shareholders for its company. You get the shareholders you deserve. You get the shareholders you deserve And if you're going to play to the hot money, don't be surprised when they abandon you in droves at the first time of trouble.

1:07:28Exactly. And they will. They will. They will because you've attracted, you know, it's like the, what's Buffett saying? You know, it's like the person who frequently engages in one night stands who considers themselves a romantic or something to that effect. You know, it's not like it's, whereas the people who are consistent in their messaging, they will attract a much more thoughtful shareholder, which means that they could probably see their market cap improved by tens of millions of dollars if they just engaged in a little bit more hyperbolic kind of messaging. But they don't. And the value of that is that when they do have a disappointing period, you don't get the people who are just going to turf you out of bed the next morning straight away.

1:08:15I was disappointing. Boom, you're gone. It's like, no, no, no. You get really good quality shareholders. When you're doing to raise money for whatever good investment opportunity, they'll be more than happy to tip it in. I think it's also just telling of the kind of lens that board and management look through. It is a very good tell of long-term thinkers. And if I want anyone running my company, it's a long-term thinker. One more point on what to look for this earnings season. We've talked about the results. be wary of this is hard to do because information is only a click away or a swipe away but i try to it's not easy to do i try to look at the results before i see the share price reaction yeah because i will be tainted by it i just will be right point yes share price oh it must have been good and as i'm reading the results i'm i'm trying to fit it to that context whereas the market could be completely bat poo crazy on, on, on what's happened.

1:09:14Right. Um, another thing, um, uh, shout out to Mike Brizzy, one of our straw man members, he said this recently as well. He's like, before the results are even out, sketch out what you want to see broadly speaking, you know, so that you can decide whether it was a hit or a miss, you know, uh, you can decide whether it was good or bad. What were you expecting? Too often we see the market reaction and that is, oh, therefore it was good or therefore it was bad. Can I, let's do some real time analysis here because as you say, it's Tuesday morning. I own shares in a company called Ava Risk Group, relatively small company.

1:09:52Anyway, they've come out with their fourth quarter trading update ahead of, smaller companies have to do quarterly updates. So they're before their full year results. And they've said, we expect our full year revenue to be between 28.4 and 28.7 million. And it's like, okay, that's pretty good. It's a narrow band. Well, yeah. Well, it should be pretty narrow by the fourth quarter, right? I suppose. But yeah, it's like$300 ,000. That's kind of, you know, I don't know. Go on. Yeah. Yeah. Anyway. So at the end of the third quarter, they said, actually, we expect it to be between 27.6 and 29.6. So like bang on in the middle, right?

1:10:24Bang on in the middle.

1:10:28Confirmed sales orders received during the fourth quarter up 41 % on the previous year. It's not bad. Now, to my point earlier, actually, we did – there was a new acquisition, JGD, acquired in August of 2022. If we exclude that, we had a 13 % increase. So they're pointing out that, right? And we're still seeing a double-digit increase here. So I'm not trying to pitch this company. I'm really not. Please don't buy it. But my point is – so no surprises there. Good sales orders. in fact full year sales orders up 71 % altogether 36 % excluding the eliminate segment and we've got a sales order backlog of 3.5 million dollars not bad shares down 2.5 % okay you know it's just like the initial reaction is oh what's gone wrong wait a second what's bad this has come out while we've been talking so So this is a very dangerous thing for me to do.

1:11:28But what I also note is it's a very illiquid stock. 10 trades worth a combined total of$6 ,700 have gone through the market. So in other words, it's irrelevant. 10 people, maybe it's the one person 10 times. Literally 6 ,000 bucks, 7 ,000 bucks worth of trades have gone through. It tells me nothing, right? I'd actually say at first glance, that's pretty much what I was hoping to see. And isn't that a great thing? Correct, correct. I will only add one thought, mate, to that, which is just that I don't think I have ever made a decision about an investment on the basis of one period's earnings. Oh, no, me either.

1:12:09And so I guess that's the other thing. It's not to disagree with anything you just said. It's perfectly small. No, you're right to say that. Other than I would just, I don't actually, so I'm going to actually disagree entirely with your Stormy member, actually. I am? Only in the sense that I don't have a view on, let's pick on Kogan, because you talked about it earlier. I don't have anyone on Kogan's sales that's going to be this half. And all do I really care? And that sounds negligent or stupid or thoughtless or something, right? But the reality is I've owned Kogan shares based on a five-year outlook.

1:12:38Now, I hope sales growth is good. I hope there is, you know, a spectacular return to profit. I hope their inventory sales at levels are down. I can't think of a single thing they could do with this result, though, that would change my five-year outlook. Now, I might, after a couple in a row, and this is where I'm going to eat to my own words a little bit. After a couple in a row, I might say, this thesis seems broken. I expected unbroken levels of growth, sequential growth year on year on year on year. They haven't done it. It's been two years since they grew. Actually, this business feels like it's done.

1:13:06And so there might be an earnings period where I say, this is their last chance, unless they rectify something, I'm out. So that's always possible. Or the trajectory is okay, but I paid X or the share price assumes Y. I don't think it's possible anymore, so I'm out. So those things are possible based on you know some sort of series of data i just can't remember any time where i've gone i really like i really like it really like it oh no that sucks i'm out i've often gone okay this one's on a bit of a watch i need to see some evidence that that they say it is going to play out at some point eventually my patience is is one thing not because i'm impatient just because i've given them enough time and they haven't been able to deliver so i'm not going to say i never obviously at some point i have to use earnings to make a decision so i'm not saying i ignore it altogether um i just want to make that point that for me, it's a little bit of somewhere in between where I say, you know, one quarter, one half, genuinely don't care, don't have a view specifically of what I think they will do.

1:14:00I might say they haven't grown for the past year and a half. You know, I'm kind of running out of, the thesis feels broken. This earnings might confirm that's true, but it's almost a negative screen rather than a positive screen for me. And I genuinely, I don't know about you, mate, I don't have a, I've probably got 20 companies in my portfolio. I don't have a sense to what I expect any of them to do this off. Yeah, I guess it's a question of how specific you want to be. So I'll stick with Ava only in the sense that they need to have some pretty strong growth from here. Right, okay. Just to be very real about the situation.

1:14:37They have sort of said that they have aspirational targets of up to$100 million in sales in the coming years. So it's not that it needed to be a certain number, but, you know, if it was 8 % growth, like every, you know, the bigger, the slower the growth in the current quarter, current year, the heavier the lift is for subsequent years. And the harder that target is to achieve. So while it's not a specific, I'm kind of glad that you're kind of broadly in line with what you told me to expect, notwithstanding that you probably shouldn't have given me any kind of balance at all. Yeah, exactly. you know but but but you have and you've so like oh you know nasty if that had come in that was like below their lower end of the range it's like well that's it doesn't break the thesis but it's like gosh what's going on here you were sort of indicating this before um uh so there's there's a there's a um they're generally right as opposed to specifically wrong kind of angle pardon me to all of that kind of stuff yeah um but yeah yeah i mean this is this is this is um this is the difficulty with all of it because you are taking set periods in time and trying to extrapolate that many years into the future yeah and it's hard it's really hard to do um but this is why this is why this idea of um which we often talk about is margin of safety is so important Yeah.

1:16:05Whereas you want something where you don't have to hit, you don't have to have perfection to do well. You know, I just want to, if I'm directionally correct on this thing, overall, I'm probably likely to do pretty decently. You know, is it a Ferrari for me next month? Probably not. And if you're investing in that fashion, you're not investing, you're speculating. But if more or less, again, I always like to think of it, really dumb it down here. If I just don't, forget the share market, this is my business, right? And am I still happy to own this business? like well still profitable sales still growing this area could have been done a bit better overall the aspirational target still seems achievable reason i'm happy i'm happy guys keep doing it keep doing what you're doing yeah exactly exactly um whether the share market's down two percent or up three percent or five percent today is irrelevant to me and in fact let's say let's say for the sake of argument in this example that i looked at this result and shares were up 15 today which can happen on these very illiquid stocks maybe maybe someone put through a ten $10 ,000 market order popped up.

1:17:03Yeah, that's right. Doesn't take much. Well, that's fantastic. I'm going to sell. I was like, yeah, it feels good. But really, if things are still on track, you're going to lock in a 15 % profit? Like 15 %? When this thing should be a multi-bag or over a... Again, I'm going to be very careful the language I use it. If, if, if, if, if they manage to sort of... But equally, mate, if your entire thesis rests on a 15 % gain between the price you're buying and your sell price, and the average market return is say 9 % or 10%. You've got to be right two times out of three with that gain just to get even with the market.

1:17:39And that's already a very, very tall order. And again, I'm not saying people shouldn't. If you buy a dollar for 85 cents, go for it. There's your 15 % gain. Oh, it's not quite 15. I've worked backwards, but you know what I mean. Take the money and run. Go for it for sure. But on an uncertain return, paying 85 cents that you might possibly get the maximum of a dollar, That is a remarkably, remarkably difficult strategy to pursue and successfully beat the market at any length of time. I've talked about it so many times, but I'll repeat it again. You know, it's the things that keep me awake at night aren't the stocks that haven't performed well.

1:18:14And there's plenty of them. It's the ones where I was too clever by half. We talked about zero before. Man, I bought a bunch of that. I bought a bunch, a lot. I think it was$8 at one and then I got another at$12. I sold out at like 20 or something. I'm thinking I was a genius. What an idiot. What an idiot was I, right? Like that is, and I've done it with CSL. I've done it with Cochlear. I've done it with a bunch of things where it's sort of like, they're the things that haunt me because I know that if I hadn't done that, if I just got out of my own way, my situation right now would be very, very, very, very different.

1:18:47And there are the gains, the real gains, the real, not, you know, the nice, oh, that was a nice little return. I'm talking about the wealth creation opportunities, like the life. No, I don't want to say life-changing. I'm not talking about yachts and private jets. I'm just about, you know. Who does yachts and private jets anymore? I'm buying spaces. I just mean like the freedom to have a much more, much more options in life. You know, it's just like, I'd be pretty close to retiring right now if I had just got out of my own damn way on a whole bunch of decisions on that. And I'm not. not even close right because which we're pleased about but you probably not so much well again it's just it's sort of it's this this idea and at the time god i felt great about those trades like i really did you know i knew it i knew it was cheap and oh 50 i did that in a year look at me i'm the next warren buffett no i wasn't i was a stupid idiot and and it's and and if if i had my time again and i and i try not to repeat these things although i'm sure i am to to some measure is is to remember that that is what i am in this for i am in this my edge really i think and this is one of the few remaining edges for the private investor is one of a longer time horizon and and if that's my edge i need to exploit it and i'm never going to be able to exploit it if i take any profit as soon as it appears and it's probably just appeared because of some short-term volatility nothing other than you know and it's just uh you know don't don't be me is what i'm saying to our be smart and what and what and it's not just the case of hindsight harry there because in those in those situations although the share price was reacting very favorably in the short term we actually saw the thesis playing out i.e that the the client acquisition rate was growing churn was saying super low um the zero was was was um just kicking like strategically long-term legitimate gains were being made and reinvested and and you know the flywheel was in effect and i took the easy money and so don't make that mistake on the other hand things aren't going well uh regardless up down whatever get the hell out take the money and and whatever's left whether it's a profit or what get the hell out of the way but that this is this is really the answer to your question is is the long-term thesis in on track and if it is 100 and that's and even The only I will say is OnTrack can be a bumpy track.

1:21:10Oh, no, not can be. Will be. Will be a bumpy track. So, I mean, not to bang on about Kogan. We haven't talked about it for a while. So, you know, my thesis on Kogan is it is much, much, much larger sales-wise in five or ten years. So, the question isn't, you know, you mentioned$700-something million in sales. I don't even know the average sales number. I've got no idea. So, let's shoot at$700 million. If it goes to$500 million in the meantime, that's going to suck. If it ends up still at, you know,$4 billion, that's the only thing that matters, truly the only thing that matters. Now, as you say, I can't pretend as it goes from seven to six to five to four to, you know, it's obviously, yeah, but it might get to$4 billion and then I'll be rich.

1:21:45You've got to draw it at some point. Again, I just wanted to make the point just to add some nuance to it. OnTrack is directionally on track, roughly, you know, with the puts and takes of, in this case, retail, right? There's going to be tougher and better times for retail. COVID was a pain trying to work out some sort of, I pay for a lot of reasons, but as an investor trying to find a straight line through the stuff, I get no idea. Now, in three years time, if it's not over a billion dollars, I've got problems. So directionally, absolutely. And there are other businesses, by the way, that should keep growing year on year because they're not that sort of business, right?

1:22:20So, you know, you've got to be mindful of that. But that's the one thing I just keep making the point that on track directionally over the long term is where I'm focused within a bumpy path. It's the same as the share price thing we started talking about with the zero way back, as you said, at the beginning of the podcast. It was way back too, by the way. I think it's tomorrow by now. But yeah, that's the key. That's the key for me is making sure that directionally it's going to get to where I want it to get to, not that it is getting there on a straight line. A straight line is great, by the way.

1:22:51I'll take them, but they don't need to be the case. Yep. Probably should make this a final point because we're so insanely over time. But the other thing I would say, and I know it's a repeat, is don't beat yourself up when the thesis doesn't play out. Statistically, it's not. Not just once or twice, like a lot, probably four, maybe five times out of ten if you're good, right? It's not. I thought this, and look, I can tolerate a little bit of uncertainty and a little bit of a bad period here, but this thing is clearly not working. Yes, exactly. I cop it on the chin, walk away, walk away. And again, not because the share price has gone down, but because the business is not performing in line with what your expectations were.

1:23:35There is no more money has been lost over time by investors by putting their head in the sand and going, la la la la, no, it's fine, it's fine. Oh, now it's cheaper. You know, again, speaking from experience here, I'll average down so the loss doesn't look as bad. You know, it's gonna happen, guaranteed to happen, not just occasionally a lot. And so that's another great skill to have is that lack of ego where you can go, huh, turns out I was wrong on that. Oh, well, dust yourself off and go look for another opportunity. It's fine. It's absolutely fine. And so too often, I see it particularly with new investors, and it's just luck of the draw when you start a lot of the time.

1:24:16I just happen to have started in this period. Imagine if you started in small cap investing 18 months ago. Yeah, that's right. This sucks. It's the worst thing in the world. What am I doing? I am out, you know? And it's just like you've learned the wrong lesson when the lesson should really be as like, no, this is normal, right? There's nothing unusual about you making a bunch of mistakes. And even where you're right, where the market not recognizing it for quite a while, this is 100 % the way. So endurance is probably the number one sort of skill to have. So just recognize that, I mean, it sucks.

1:24:52I get it. but don't beat yourself up too bad when it happens and move on. And the real trick is that you'll get better at it, like with anything over time. And just the fact that you're there will make sure that as the years roll on, you'll end up doing really well. Right back to the beginning of the pod, we're talking about even a 7 % annual return on average is going to really move the needle for you, for your family's wealth over the decades. and you're just not going to do it if you have a bad one or two years and give up. You're just guaranteed not to happen. So keep yourself in the game, learn from your mistakes, chin up and carry on.

1:25:33And another thing, no, I'm kidding. We are well and truly done. We are done. Put a fork in us. We are done. Follow us on the socials. Listen on Sunday. We have some mailbag questions. That's all we have time for. 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. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under Financial Services Licence 400691.