How to Earn Stock Market Returns With Half the Risk

25:01And that assumes with zero R &D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at$64? Do you realize how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking? And so we know how that ended. And I think a lot of people have been making the analog for the last 10 years, since 2015, when we coined FANG, about that period of time. You guys have somehow managed, because you lived through it and you made a lot of money through it. But you have somehow managed to more or less keep pace for the last three and five years, despite having a cash allocation, a bond allocation.

25:46It's almost like a miraculous. And a value discipline. Yeah, like how did you survive? Because nobody else did. Well, we were, look, I'm not going to, luck does play a role. Sometimes you just get it right, you know, for periods of time. And certainly that's part of it. But, you know, look, being thoughtful about what businesses are going to be better businesses in five to 10 years, or at least as good, if not better. And that is to say those businesses that are going to throw off more cash flow than they throw off today. And what are you paying for that cash flow in the future today? So if you just look at that and think about like a bond, if you just were to invert every investment you were to make from a PE basis and look at it on an earnings yield basis, better yet, look at it on a pre-tax-free cash flow basis.

26:28is take the company's cash flow before taxes and before interest expense and look at it on an unlevered basis, you know, that's a numerator, and divide that by your denominator, your enterprise value, and kind of compare it to a bond and look and see how much you're going to get for that, like a treasury inflation protected note that'll give you some kind of growth in the future. So what do you want to pay for that growth is what we always come back to. And some things just get to be too expensive and so we back away. So we bought, we tend to lean into businesses when people don't like them. We still think that there's a few good puffs left in those cigars, if not more.

27:03We make a lot of money if they really end up being something better. So Microsoft's a good example of that. We bought Google in 2011 when people were really, really quite fearful of the global economic landscape. We bought Meta, which was Facebook at the time during the Cambridge Analytica scandal. People were going to, streaming was dead during COVID, so Netflix traded down. So we bought Netflix, which we don't own in Crescent anymore. But when you can find these businesses you think are going to be better in five and ten years, and you have a variant view as to that perspective, there is often money to be made.

27:36Would you rather own a company that you think the prospects are going to be better even if it were more expensive versus a company that's already expensive but you agree the business is going to be great and the market is right? What's more important to you, the outlook for the company or the valuation? it's if you could they're they're they're connected it's a balance well it also i mean i'm not going to pay a hundred times earnings for a company you know that it doesn't make any sense i'm asking if i gave you nvidia's last 12 quarters and i came to you three years ago and i said here's here's the next 12 quarters you have to pay 50 times earnings for this company you would though right sure if you know that company's going to grow earnings none of us do but right so it's all Okay, it's all a function of your conviction of what the growth rate and earnings stream is going to be prospectively.

28:25The greater the conviction, the more likely we're willing to pay up for something. I asked you that question because I think unfairly, a lot of people think of value investing as this PE is lower than that PE, therefore press the buy button on this one. And I mean, I did see some of that with like Intel versus NVIDIA a few years ago. AMD, definitely. Yeah, so there does exist that mentality, but that's not actual value investing. That's just looking at publicly available numbers and being as unthoughtful as possible about it. There's a lot more that goes into figuring out, is this truly a great business and worthy of a premium multiple?

29:02But you bring up an important point because value investing historically was really about the protection of the balance sheet as it was historically practiced and written about, starting with Graham and Dot. It was about the protection of the balance sheet, buying a company below book value. Better yet, buying it below its net networking capital. Good luck doing that now. Yeah, exactly. Right. But, and that's the way we started out and, you know, and really thought about, you know, protecting capital. But then we realized over time that so many of those businesses were businesses that were more likely to be disintermediated and disrupted by technological innovation, you know, better competition, et cetera.

29:39So we really wanted to say, we really sat back and said, all right, we have to really consider what the value of the business, what the enterprise is, how good is that business and own these better businesses and pay a good price. So is still a B. It's just not the balance sheet, it's the business. And so there's more volatility that comes with that. Valuing a piece of real estate doesn't move around as much as valuing a business. If I had a stock that I was very certain was going to deliver a minimum of 20 % earnings growth next year, and it was currently selling at 16 times earnings because there was some idea out there in the market that it was about to be disrupted by automation, would that be the type of stock that you would say, all right, we got to take a second look at this?

30:25If it's going to be disrupted, we wouldn't look at it at all. But you don't know that it's going to be disrupted. Oh, I thought your premise was that it would be disrupted. I can't tell you that it will. I could tell you the reason it's 16 times earnings in a 22 times earnings market is because that's the concern around it. 100%. That's the kind of business we'll look at. So that's Uber. That's$200 billion market,$250 billion market cap, 23 % earnings growth expected for next year. So cheap, they're buying back shares, which is not a thing that you would normally see a company like this doing, but how could they resist?

30:59And I look at something like that and I say, okay, I believe in automation, but then I also believe this company is going to figure out their own automated taxis. How hard could that be? There's going to be millions of automated cars. Well, they're going to have to figure out by licensing somebody else's technology. Yeah, they won't build it. Or they get acquired. Maybe Google ends up acquiring them. I mean, that's not a call. Just be really clear. Understood. I'm just saying that anything's possible. Well, I guess my point is, even in this moment with the S &P selling at a high multiple relative to history, there are lots of those types of companies right now.

31:34Adobe's another great example. Salesforce. Salesforce. There are businesses right now that people are very convinced AI slash automation is going to be the end of those companies' franchises. In some cases, it'll be true to your point. In some cases, it won't. So it's our job to sit back and understand whether or not how likely it is to be true. And by the way, just because it will be true, if a company can generate a ton of cash flow along the way and return that cash flow to its investors, it may not be a bad investment. Right. You said, so I guess I'm just, I'm very impressed. A lot of people that were around back then, especially in their formative years, and maybe it wasn't formative for you, although sort of early in your career, they got stuck.

32:17When I was younger, as you pointed out. Yeah, when you were younger. Before I got old, is what you said. But a lot of these people got stuck and said, like, I've seen this movie before. We know how this ends. We know that value and small value and whatever will have its day. And you have to evolve with the times. These businesses are fundamentally different. The operating margins, which was one of the big points in 2015, is like, these are unsustainable. Competition comes in. You wrote in 2015, buying a company at 20 times earnings, hoping for growth in earnings in a future P of 2022, 22 times, excuse me, is not a recipe for good risk-adjusted returns.

32:53Kind of is now a little bit. I mean, for the time being, yeah. And by the way, things change. Things change. And you've evolved, obviously. Is that one of the hardest parts is to throw things away that maybe you believe in, but you recognize that if the rest of the world doesn't believe in something and never will again, it might not be important anymore. It's one of the things that I've learned. And we're also, well, buying a business, when we buy something, we want to have a clear view as to what the future looks like. I mean, we want to have a clear view. It doesn't mean it's going to unfold that way.

33:25I guarantee you it won't unfold differently. And so what we have to, we always lay out what our KPIs, our key performance indicators are to watch and monitor that business along the way, because we're going to be wrong. And we, look, one of the biggest mistakes we made was not buying Amazon earlier on, at least in the financial crisis. We didn't buy it. Everyone's biggest mistake. Right. And, well, not everyone's. A lot of people out there don't have made a ton of money. But sadly, it was one of ours. And so, you know, I read the Everything Store book. And after I read that, I'm like, oh, I was so sad.

33:56You know, because I didn't, I'd spent the time, I didn't spend the time really enough on the web hosting business and what they were doing. And I spent the time. AWS. Yeah. And I also was less willing back then to pay for, you know, I'm so concerned about the here and now and what was obvious about the future as opposed to like, well, they can always change pricing and charge more money for X or Y to create greater profitability in the future. I was less willing to do that. But it really depends on the management team and what they're communicating that they're likely to do. It makes you feel any better.

34:25That was the biggest miss, according to Warren and Charlie. That was their biggest miss. They knew it was going to work and they just couldn't bring themselves to do it because it looked so different from every other retailer they had ever invested money in. Misery indeed. Very good company. Can we talk about the modern market, today's market? Yeah. Okay. Dying to get your thoughts on this. Michael, you have a couple of charts that are worth scrolling through just to set the table. So we are in a period of time where not everything, a lot of things are working really well. And it's the things that you want to see working.

34:56And there's, of course, a lot of bullshit. But for the most part, the market is acting very well. So we've got the NASDAQ 100 has closed above its 50-day moving average for 102 straight days. And there have been longer periods of time where it's done this, but they're few and far between. You've got the NASDAQ 100, as I just mentioned, the S &P, as well as the Dow and the Russell 2000, all making all-time highs. and you're seeing it in the sectors, the leadership sectors, financials, tech, communication services. And then you're seeing it in terms of like the equal weight, equal weight tech versus equal weight S &P.

35:36It's everywhere and it's not just in price. It is being driven, thank God, by fundamentals. So when you're looking at earnings estimates for the S &P, for the NASDAQ, as well as the Dow, all up and to the right, you're seeing everything you want to see. I guess the question that Josh and I were talking about earlier in the week is— Let's put up the Equal Weight Act really quickly. We did that. We got that one? Is the market too good right now? Does it feel too easy? And do you automatically get concerned when Michael shows you charts everything at an all-time high, like every major index, or not necessarily?

36:08No, that's my DNA. Okay. It's a concern, but that doesn't mean there aren't opportunities. Of course. So when you look back, we look back, and let me just start with making it analogous to the internet bubbles. We were talking about the dot-com bust back in 2000. And when you look back then, 25 % on the capitalization-weighted basis, 25 % of the S &P was trading at greater than 10 times sales. Today, it's 35%. So, yeah, that raises our hackles. and we get, that doesn't mean there aren't opportunities out there. We, you know, despite, you know, those nice charts you say and upward to the right, there are companies that are less important to those indices.

36:51They're smaller cap that are trading less expensively, both domestically and abroad. So we have a large component, about 40%, you know, of companies domiciled outside the United States. We also have a number of companies that are more cyclical, you know, And those companies are less interesting to the masses and are not hitting new highs. We've got certain healthcare-related companies, not to dive into specific names, and healthcare is too broad a term, that we're finding as opportunities. But a lot of these companies, along with those small and mid-cap companies, are just trading below the radar.

37:26But what's interesting is there is this table I'll send you guys that really shows from from the October 22nd market low, how have things done through June 30? And large cap growth is appreciated 108%. Large cap value is only at 51%. But to help make my point, small cap growth is up a lot less than large cap growth at just 41%. But it's also up less than large cap value. So there is more opportunity. Now, look, again, we're talking at an index level and they're comprised of lots of different types of companies. It doesn't mean every company's cheap, obviously. You need a catalyst, though, when you're buying, let's say, a healthcare company that has sat out this entire rally.

38:08Let's say it's selling at a huge discount to the overall markets multiple. Is the fact that it's cheap and that the business is a good business, is that enough for you? Or do you also want to know why it might someday attract the attention of other investors who will buy it higher? If you have the right management team allocating capital well. You know, good things happen to cheap stocks. Okay. So you believe like, it's not important why it will go up. It's just important that this business is throwing off a lot of cash flow. It's defense. It's got some moat. And we think this is going to be a good business for the next few years.

38:43Therefore, it's a good investment. And someday someone else will agree with us and buy it higher. We do think about what catalyzes it. It's not that we don't think about it. We do. We just don't always have an answer. Okay. I mean, if you think about our position sizing, this kind of gets into that. But the greater conviction you have in the company, this business, and its mode, and its growth rate, and its management team to allocate capital well and understand what the catalyst might be in the future, all of those things, you check the boxes, come back rosy, then you end up at a larger position.

39:13I'm sure when you look back over your career, you think about how nonlinear businesses are in terms of the path that they travel, ups and downs. Like Netflix has had a million different hiccups along the way. So how important is getting the industry group right versus getting the winners and the business? Like we're talking about fundamentals and value investing and, you know, ratios. But like these, at the end of the day, these are, you have to be a business analyst. Right. A hundred percent. I mean, I'm more partial to the idea of having tailwinds. I don't mean like gale force tailwinds to push my America's Cup yacht, you know, across the finish line.

39:47I just mean that the fact that the, why do I want to buy a business a la SQL where it's, it's, it's deteriorating. And we'll fight a prevailing trend. Yeah. And then, and then, and then sometimes along the way, it's like, will a company that's fighting that prevailing trend to use your, your phraseology, you know, is some companies will fight it successfully. The others won't. Why was, you know, why has Walmart been successful and Target successful, but Sears not. Yeah. Right. So we just, you know, we're always mindful about what the management teams are doing. It's not, when you analyze the business, you got to understand the management.

40:18So this is a business that's in secular decline, a stock that I tried to bottom fish and I didn't, I sold it. Western Union, for example, if you were to just look at the fundamentals, just like the strip away the business, they pay their dividend every year. I don't think they've ever cut or not paid, at least in a long time. It's a 10 % yield. It's cheap, but obviously it is being disrupted. It is under a massive amount of pressure. not specific to that, but a company like that reinventing itself. Is that interesting to you? I don't know Western Union well enough, but just, and this might be way off base, but superficially what I know of Western Union in terms of, you know, delivering money from point A to point B and, you know, somebody here who's might be a migrant worker sending it back to their home, you know, in a province of Mexico, you know, is a way, you know, to, you know, you know, get money back to them and help their families, you know, you can Venmo.

41:13I mean, the digital banking system is there. So I don't see, again, I don't know what else, I don't know what else there is, you know, out there in their Western Union business, again, as I haven't studied it, but if it's just, that's what it is, that's not, doesn't hold any interest for me to want to look at. One of the things I wanted to ask you about was just this idea that there are some value investors who will, I mean, they don't last long. Their careers don't last long, but there are some value investors who will become personally invested, almost like a defiance. Like I'm not wrong. The market is wrong.

41:48You'll see, you'll see. And I saw people ride Sears to zero and I'm sure you did too. And JC Penney. And look, number one, I'll just stipulate. It's really hard to know when doubling down? Like sometimes it might actually work out well. And then you have the coal industry where every company in the industry goes to zero. The steel industry, I think we were left with one and now Japan owns it. Like we've seen entire industries disappear. So how do you guard against making that type of error where everything you believe might be true and yet that prevailing wind that's in your face, just it never goes away until these companies just entirely disappear.

42:32Sometimes what's inexpensive is there because of, you know, ephemeral headwinds. So it's our job as analysts, business analysts, to your point, you know, to understand what is ephemeral. Is it is that going to change if it's just a cyclical business or is it or is it something that's secular that's happening negative? Now, we might get it wrong. And there was an example. We didn't buy Amazon, but we did sell our entire portfolio of retail stocks. Last one standing was Walmart, and then we'd sold that. And then we bought back, because we had owned it previously, we bought back PetSmart. And for a minute, just a starting position, then we ended up selling it quickly because we realized we were wrong.

43:11So you have to have the intellectual integrity to question yourself. Yeah. You just can't rest your lows. And defiance doesn't get you anywhere. One of the problems and one of the origins of that defiance is when you go out publicly and you, quote, defend the stock or you plant your flag or I know you don't do this stuff. You go on Twitter and you say, this stock that I just bought a 20 that now is 10, I'll bet my life it's going to make a comeback because people don't like to be publicly wrong. So maybe not talking about your biggest positions in such a public way or putting your life on the line for a stock is like a really great way to avoid that, that issue.

43:54And it's also like what your DNA is and how willing are you to admit you're wrong. And, you know, and, you know, a lot of that's just formed by your DNA and some of it's formed by your environment. I've got, I live with five women, my wife and four daughters, and they regularly tell me I'm wrong. I told you, I knew it. I was right. I didn't say I was just kidding. So, okay. So in, in the context of your life, you're somebody that's comfortable being wrong. 100 % and then not putting yourself in position where you have to like defend something to the death we'll take our mea culpa we'll say we were wrong and why we were wrong that's you know what people get really attracted to high conviction type of people who come out and say the 10 year is going to 6 % and you're going to wish you listened to me that stuff gets a lot of attention in the short term you can't survive 20 years doing that because you're going to be wrong and you have to have positions that you're comfortable backing off on publicly So, yeah, I mean, look, the world can change.

44:52The world does change. Companies can change, as you pointed out. You know, I think it was Michael who said it, you know, and you have to be on top of that. So if you go out there and speak with great conviction about a certain company, then you're going to come out and after you've sold it and say, okay, here's why we sold it. I mean, it's just too much noise. We don't want to be in that business. Yeah, I don't blame you. We want the number. The first slide that you showed, you know, shows upward to the right. We want that to be our slide over the next 20, 30 years. Right. We get things right.

45:20We get things wrong. But the sum total of all of that effort is this. Right. And our portfolio moves in and out of different asset classes and different sectors based upon where that fear is. And so our energy exposure was a lot higher in the early part of the – in the early – that shows our whole exposure. Okay. So the bluest stocks. The bluest stock. You see that moves around. The green is bonds. And the bonds that we own are not high-grade. We buy – we'd rather accept credit risk rather than interest rate risk. We think we can understand that better. We don't know what direction, you know, the 10-year is going, you know, over the next five years.

45:59And you're not – when you do that – so, like, I see these periods of time where you're heavily invested in bonds. You're not just flipping it into HYG. Like, you're actually looking at each individual credit. Yeah. Okay. Yeah, our high-yield exposure today is just 1%, a little less. And that 1 % is, you know, high yield does not, isn't that interesting today. Today, we're talking about tighter than average spreads, lower than average yields, and worse than average covenants. Yeah, sounds great. So high yield spreads are 300 basis points, you know, over treasuries. It's 200 basis points less than the 500 basis point, you know, average of the last, you know, 20 years.

46:31The yield is 7.1%, which is about a point less than the average of the last 20 years. And covenants, as I said, are as poor as they've ever been. And so, so much and so in favor of the borrower, you don't even have, you know, the confidence, you can get the keys to the kingdom back in the event of default. Now, on the positive side, I'm looking at the HYG, for example. I think, you know, I've read that, you know, I haven't parsed it, you know, individually myself, but I've read, you know, something about it that suggests that the HYG, the high yield index has more EBITDA per average company in there than at any point in time.

47:06It's higher quality than a tech event. Higher quality businesses. is with less. So lower sports makes sense. Right. So yeah, but a lot of that risk has shifted over to the private credit market. What is this net risk exposure, this red line? Well, because we end up with some shorts at periods of time. Okay. So like if you go looking at the financial crisis. So you'll have shorts in the portfolio. Is there a max limit? Well, not a max limit. I think it's, I'm not sure if there's actually a maximum in our charter. We've never seen a proportion. I think most we've ever had was like 11%. I'm seeing some shorts.

47:34A little bit. I'm seeing a few. I can talk about them. You want to wait for a better pitch. You have the ability to go into different areas of the market, de-risk, up-risk. But the pitches seem to be happening so much faster these days. It's like they're 175 miles an hour. When you finally have a chance to swing, it's like, what just happened? And I'm talking about the V bottoms. No, really a great point. You have to be prepared in advance for when it does happen because the world has had a tendency, you know, since the financial crisis, to rebound very, very quickly. Everything's faster now. Why wouldn't the market react faster?

48:09I'm not faster. I'm 62. I'm much slower. But every aspect of our life has gotten faster. So why wouldn't we expect stock market reactions to be faster? There will be a point in time, I would argue, that things will go down and stay down for a period. I just don't know. 22, they did for 22 for 18 months. Yeah, but I don't know when that's going to be or what next is going to happen that's going to create that opportunity. But we have to do the work first. You just have to be ready to go and hit those pitches. you know because you know they're coming at a point so for example i did a ton of work on embarrassingly you know giving them nothing to show for it you know on on deer because i said that pitch when that comes because you know i did this about a year and a half ago and i said deer is like is the is the best ag equipment manufacturer in the world you know case new all in and ag co pale by comparison and earnings are going to be down because the ag complex is up in value so much commodity prices are up so much.

49:04And, you know, when people are making, farmers are making more money, they buy more equipment. And so business is good. So business is going to be bad again in the future. It's a cyclical business still. And so we'll be able to buy it. Stock hit a new high. And so it's like, so that was work was for nothing. So again, being prepared. And then, but this idea - Well, Deer turned the tractors into iPhones that have to update software and everyone's got to pay monthly. And they made it, it made it the best business in the world. Well, yeah, it's the technology, they lead in technology by far. It's It's pretty great business.

49:32But, you know, across the firm, we have this sensitivity to losing money and trying to be prepared. That's why our fixed income team, led by Avi Patwaddon, you know, is one of the reasons why it's done as well as it has as well. Oh, wow. I noticed there's no gold in that allocation, but can you go there if you feel like it? Yeah, I mean, I just don't feel that people are paying us to make a gold decision. Because if you were to go and buy gold, you're going to have 5 % and you'll see people have it, or even 10%. If gold were to, you know, double from here. Yeah. What does that mean about the rest of the market?

50:05What have you really done for your portfolio? And it's, I just don't know that we're adding the value on our team that offers some kind of variant view to, it doesn't mean, that does not suggest for a moment that gold isn't worthwhile owning. I'm not saying that. Well, Eviar did that. So First Eagle Global famously would combine stocks, bonds, and gold. But I mean, even then, his gold position, how big did it get at its peak? Well, probably the gold miner position was the proxy for gold in that case, maybe. Yeah, so I just don't – I'm including gold miners, junior gold miners, gold ETFs, or even just owning the bullion, all in the same bucket.

50:37I want to put up a couple of your slides. John, can I have chart 13, please? This is from your deck, fund objective met since inception. So congratulations. Congratulations, but walk us through these three different charts and why these are the ones that you want investors to pay attention to when they look at your fund. Yeah, we have to show this one from Inceptions. It shows the S &P 500, but the MSCI Acqui has been our benchmark since 2011. And you definitely beat that, right? Yeah, we've beaten that. And so, as international has not done as well as the U.S., it helps explain why our equity-like rates of return are 40 basis points behind the S &P 500 in part.

51:15But we've done that with averaging 30 % or so in cash along the way. It's really incredible. A lot less risk. When I look at this, I say this is incredible. Our goal is to deliver equity rates to return and avoid permanent payments of capital. Permanent impairment of capital means losing money, monetizing, realizing that loss rather. And whereas volatility is just – things are going up and down. And so you can look at the drawdown, and the drawdown is half of the markets. So for the people that aren't watching or listening, I want to say this out loud, okay? Okay, since annualized total return since inception, and guys, picture every disclaimer you've ever read in your life, okay?

51:50That's what's on the bottom of the slide, okay? You guys are neck and neck with the S &P at 10 % and change, but then the largest drawdown in the S &P 500 since the inception of your fund, as we all know, is 55 and a quarter percent, which I'm guessing that's great financial crisis. Yeah. Okay, and your largest drawdown is 27%. 0.87%. So that's the objective of the fund. The reason you're going anywhere is because sometimes you don't want to be fully invested in the stock market. Right. Okay. And a third less volatility. That's a byproduct. I'm going to be very clear. A third less volatility, you know, and just speaking, you know, for what the chart shows, for those of you who can't see it, we, our volatility has been 10.89.

52:32The S &P 500 is 14.96 since our, since our inception. But volatility is a byproduct of our process. We don't target. What is that, rolling 30-day? What is the volatility? Or is that just standard deviation? Standard deviation. That's it. Standard deviation. But we just don't, we don't target it. It's just, you know, if you're a value investor, if you're thoughtful about, if you believe price matters, you're thoughtful about the businesses you own, and, you know, you're seeking to protect capital, you're inherently going to have lower volatility. The mutual fund industry, I mean, there's been a million slides showing index flows up and to the right.

53:03Mutual fund flows going the exact opposite direction. You, and a lot of that is, listen, And even the ones that do outperform, luck versus skill, how do you untangle all of that? This is evidence that this is skill because being able to keep track with the S &P with a third less volatility, that's not luck. You've done this for three decades. So pat yourself on the back. Pretty good. John, can we have chart 15, please? I found this one interesting. This is the FPA Crescent Fund's net equity exposure. Whoa, whoa, whoa. Why are you so bearish? Well, stop. So this is you versus the MSCI ACWI. What's the right way to explain this?

53:41Like the percentage of your portfolio that's currently in equities on a net basis versus the performance of the index itself, the ACWI in this case. And this – look, there's a lot of noise in this chart. But you're just – you're trending lower since 2022. Right. That's – like if I were to draw a trend line, you are growing increasingly bearish as the market rallies. Well, I don't – bearish presupposes a view to the future. We're just not seeing in the present the attractive risk rewards. So what if I also drew a line that said forward earnings multiple? Like it would probably – it would trap the market.

54:20That would be a better chart than this. Well, this is your slide. I know. We have other slides too. You just picked this one. Okay. We've got lots of slides. Right. But this just shows you this slide. One can expect that as the markets are rising, you know, that especially rising quickly, because you can see that dip as it rises, you know, that you, you know, that we are going to be get more exposed or less exposed, less exposed as the market rises and, and get more exposed as a decline. So you can see, look at the, look at Q125. So we had pulled our evaluations. 56 % net equity exposure. Right.

54:52And so, and, but then Liberation Day happens. We found out more opportunities, you know, as a result of our, our president's actions. The pitch came. Yeah. And so then we started getting more invested, but unfortunately it gave us only a couple of days. Again, to your point about the 175 mile an hour fastball you got to hit. I would assume that you're surprised, uh, again, having read your 2015 letter this morning, cause I'm surprised that it's, that it's been, we're 10 years later. And at the time, it's not like things felt cheap or exciting at the time. Amazon was$200 billion. And I remember thinking, holy shit, that's a lot of money, like a$200 billion market.

55:25Oh my God. And it's 10 years later. And of course, there's been pullbacks and corrections and bear markets along the way. But these businesses have never been fundamentally stronger. Is it conceivable that this is just a sort of— He wants you to say it's different this time. No, no, no. No, obviously, it was different this time. I mean, clearly it was. Yeah, yeah. Well, some companies are going to last longer than others and perform better for longer periods. I mean, you mentioned at the top of the hour, you were talking about Cisco. Cisco has far underperformed Microsoft, but did we actually know that was going to be the case?

56:00Of course not. In February of 2000 when the market was speaking. So look, we have a portfolio of stocks. Some we're going to be more right on than others. And we're going to be surprised on the upside and the downside by different companies in our portfolio. So you're very much focused, bottom up, looking at these securities themselves. How much do you think about the state of the economy and macro stuff? Does that enter into the process sort of like working backwards because the companies are talking about these things? Or do you pay attention to these things from a top-down perspective at all?

56:33When we look at companies, we build models. And there's this false precision to the models. I mean, because you just plug in certain assumptions and you end up with this very precise earnings per share result or precise free cash flow result. And the truth of the matter is is that it's just a function of our assumptions and we're not anchored to that type of precision. We build our models. We don't look to see what is likely to happen over the next quarter, six months, year. We build a low base high, looking out of the next two, three years or longer, to try and say, okay, what can happen if the company really executes?

57:12And recognizing that they could stumble and maybe not execute, that would be the low case. Maybe the industry goes through a downturn that could contribute to the low case. And in the high case, everything happens terrifically. And so that's how we really think about the macro backdrop. That's all set against the macro backdrop, what could happen in a weaker economy. What happens if rates rise? If it's a more levered company, they have to refinance their debt at a higher level. What happens in the event of a recession and unit volume gets hurt? What happens as a result of tariffs where a company has to either raise their prices in order to maintain margins or do they not maintain their margins because they're going to, you know, basically eat it for their customer to make sure the unit volume stays there.

57:55Those are all the questions we're always trying to anticipate up front when we build our models. And then we constantly fine tune them as we gather new information. So this is on a case by case basis, each investment, not a, I think the Fed's going to cut next week. Therefore, we should own 10 % more financial stock. Like that's not the way that you're thinking about the macro picture. Correct. Okay. So one of the things that traditional value investors that are not bottom-up have gotten wrong over the last decade has been things like the CAPE ratio and margins and their mean reverting nature that they never mean reverting.

58:30And a lot of the reason is because the index is primarily at this point, the large tech companies, their margins have a much different profile than the 493. As you look out with your portfolio, do you expect to see margin expansion as a result of this hopefully productivity wave that we see coming as a result of the AI spend? Do you think that's going to happen? No, I think that it depends on the industry. So I don't want to make a too broad a statement, you know, about that. So the AI, a lot of the, there's a large language models and the big AI that's out there. How that unfolds and who's the winner from that and what the margins would be, I'm not, I just don't have a point of view.

59:10The applied AI and how it's used to help your business and whether to distill the SEC filings and look for certain things and to be able to pull from it using Grammarly for me to help write my shareholder letters so I don't look completely moronic making basic grammar mistakes. Then there's also AI that's going to be used in certain businesses that will really help these businesses and it's not going to get competed away. Companies like biotech companies, which we don't have any expertise in to be fair, But the lab, the bench strength in the labs because of AI is up exponentially. And that's good.

59:47That's good for the world. You can deliver hopefully over time. We expect, you know, drugs are going to come more frequently, new drugs at lower costs. And that shouldn't get competed away. What could happen, of course, is on a regulatory basis, you could end up with less margin allowed for these drug companies because there's more margin allowed in the US than elsewhere. So there's other risks to it. But some companies that are benefiting from AI, a lot of it, you know, some companies will have first mover advantage and they'll be able to reduce their cost. And then let's just take the, you know, let's look back in the 1970s and some of these vertically integrated apparel manufacturers with retail locations and they moved offshore, they're manufacturing.

1:00:26So they were able to manufacture at a much, much lower price point, bring it, you know, even despite the long lead time, therefore a higher financing cost, you know, as well as they've been paid to ship it to get to the United States, but they were able to bring it back and have this big pricing umbrella because their competitors didn't have that. So they had this excess margin. Well, all the other guys realized that and said, oh, well, I'm going to go overseas and do that. And that got competed away. So you're going to see some of that happen too. Yeah. I've heard from a lot of people, you ask like, all right, it's the AI era.

1:00:59Why would you be bullish on small caps? Why would you be bullish on healthcare? And all of these areas that have either nothing to do with the AI boom or are so disconnected that it's almost like we're having two different conversations. But I've always thought, and I've heard this from a lot of people, if the AI boom is not going to turn into a bust, the only way that happens is if all these other companies find a ton of value in using these tools and adopt them and pay for them. Otherwise, in other words, if you don't get an earnings growth benefit in the rest of the stock market, then by definition, all of this CapEx spending by the mega caps is going to look wasteful in hindsight.

1:01:42It has to work. You're going to have to. Well, first off, some AI companies are going to be incredibly successful. Yeah. Some aren't. Which ones will those be? It's for a different conversation. We'll all find out together. Yeah, exactly. But, I mean, look, there's no question that AI is a real benefit for IT services, for calling a tech support line or calling for a retailer if you want to return something, you could end up with these questions for a return that can all be handled by AI. So a lot of these phone centers that are located in other parts of the world that have a very, very low-cost labor pool are going to be disintermediated because of that.

1:02:21And everybody's going to migrate in that direction. Right. So I sort of feel like the secondary benefit of the AI boom has not been felt yet. And all of a sudden, And there are a lot of companies that are going to come out and start raising their earnings estimates. And the reason why is going to be productivity. I just – To the extent that isn't competed away, which would be business and industry specific. Yes. In some cases, it will be. That's a really great point. I wanted to ask you, with the two or three hours we have remaining, I wanted to ask you a couple of other hot-button items that are going on in the markets right now.

1:02:55So the independence of the Fed and just generally what you think of monetary policy given the unemployment rate versus inflation push-pull. Do you think that's something that is going to be very impactful on the markets or not really or to be determined? Well, I mean, TBD, it's not something I really can opine on. I have no idea. I do. I mean, we do have a Fed chair that has come out and said that security prices are rich. So I don't know why he had to do that. Well, by the way, I mean, you had Greenspan 96 who called for a rational exuberance. And then at the S &P 500 price level, even after the decline, after the dot-com bust, it was still higher than when he called it.

1:03:39You had Bernanke who said that in 2007 that the subprime crisis would not spread to the broader economy. And Yellen said in 21 that the inflation would be transitory. She admitted her mistake in that regard. So, I mean, you just, you know. Okay. You don't worry so much about the public pronouncement. We're really good at responding to pitches that are thrown to us. But what you're basically asking is what pitch is going to be thrown to us? We don't have any idea. Quarterly earnings reports versus, I don't know, annual. How important will this be to your process if all of a sudden 300 of the S &P 500 decide, oh, this is cool.

1:04:19We'll just, we'll talk to you every January. Look, I, well, first, they're talking about semi-annual and using, you know, the European model. The UK way. They'll talk to us twice a year. But they'll talk to us along the way. They just won't give us numbers in between. They'll talk to us along the way. Actually, they might be able to talk to us more because there'll be less quiet periods. So I'm actually, I'm completely in favor of it because - You like it. Businesses don't generally change much from quarter to quarter. I already, I've already laid out that we are looking longer term anyway. So I'd be fine with annual reporting.

1:04:48Maybe it separates the renters from the owners. And it looks at these companies. It lowers the reporting costs for these companies. It frees up the management time to focus on what's important. Does it potentially lead to increased volatility because there's a higher potential for surprises and some of those will be negative? I don't know that that's necessarily the case. I don't think if you look at the vol of the UK market versus, I'd have to go back and look. But you're not investing in disruptors. so well at times we are and we look we've we own some of them we've owned some of them over time I mean Netflix was a disruptor right or is you know as far as remember Hollywood Pictures and you know Blockbuster video and movie gallery we were actually we're short I think I owned I think I owned Blockbuster at one point yeah I didn't I mean I was short we were short Hollywood Pictures and movie gallery 24-7 stock market trading god I hope not well It's inevitable.

1:05:48I know. I like to sleep at night. I don't like it either. I don't like it because it's like money's on the line that we're ostensibly responsible for and we're sleeping. So I don't love it. Yeah, except for the fact that the news won't be coming out in the middle of the night. So that's really going to be the bigger driver. It's going to be at the end of the day, it's going to be noise, right? Because if your assumptions are correct and you look out into the future and you've got that longer term point of view, yeah, you can have more volatility along the way. But all we care about is the price.

1:06:18I say this as if I'm sleepable, which I don't. Is the day you buy something the day you sell something? Did you have trouble seeing the entire asset management industry make this really hard pivot into digital assets, considering that outside of staking, the majority of all of this activity, there's really no cash flow generation. Very difficult to value these things. They're mainly a function of supply and demand. making them look more like commodities or currencies than they look like stocks? Did you have trouble watching that play out? Give me an example of what you're talking about. Bitcoin, Ethereum, digital asset, treasuries.

1:06:59Look, I think that cryptocurrencies are real, right? But we don't own them because, at least speaking for myself and not my partners, I just don't know how to value them. Is Bitcoin worth$112 ,000? Is it worth$50 ,000? Is it worth$20 ,000? I just don't know how to value it. And if I can't ascribe a value to something and be able to articulate why I believe that's the value, I won't own it. What if somebody says the way to figure out the value is the network effect because effectively these are technologies? And so the more users, the more highly they should be valued or the more money coming through them.

1:07:31That's just direction. That's not value. That's just the direction of the value. That's not giving me a benchmark. Okay. um i wanted and and then then what happens with when quantum becomes a thing and you you can bust the rsa you know you know algorithms you know ostensibly at at a million cubits so that happens what happens to your you know digital wallet oh there's going to be so many lamborghinis for sale on the secondary market the day uh the day somebody comes out and says my quantum computing has just solved all these equations at once um has anybody ever or how many times i should say or how frequently do you get people asking you why you don't have an active ETF version of your extremely popular mutual fund?

1:08:13Well, we have an active ETF subset of our fund, right? The son of. So we have our FPA Global, symbols FPAG. Okay. And that is our larger capitalization companies that we're not worried about scaling. So if you have an ETF - Can that go anywhere or that's just the stocks? It's just stocks. It's really, it's delivered programmatically from our larger companies that we own. It doesn't own the debt, doesn't own these smaller companies, doesn't own any derivatives. So no liquidity problems. Right. So you don't have to worry. I mean, one of the problems with ETFs is they can become too big. So how do you do that with small cap?

1:08:47So we want to be always true to our investors. So this is something we can look at it with a look at our investor with a straight face and say, look, if you want a more fully invested version of what we do for the large cap carve out of what we do, then here we can hand you FBAG, run by my partners, Brian Selmo and Mark Landecker. Are you just generally speaking, are you hopeful for the investor class over the coming years? Not there won't be a bear market or there won't be a correction, but just generally speaking, you think it's going to be okay? I'm actually more hopeful because with these pod shops and all this trend towards passive, I think it gives people like us a greater potential opportunity.

1:09:29So I'm actually more excited today than I was 10 years ago. So valuation notwithstanding in the market at the moment, that can just be temporary. I love that. Thank you so much. This is the man, right? The man. All right, we're going to break for dinner, and then we'll come back and we'll do it. You good? You think we got it all? Yeah. Can we just eat dinner right here? Bring it in. This has been so awesome for us. Michael and I are obviously fans of what you do, and your track record speaks for itself, but also I think anyone that reads any of your stuff learns something every time. So thank you so much for that.

1:10:02We appreciate it. Steve, we always end the show by asking people what they are most looking forward to. What's something they have coming up out on the horizon that they're excited about? Why is there applause for us? That was a print of applause. The audience is anticipating this with great fervor. Professionally, I look forward to the next cycle to put capital to work. I mean, I look forward to that dip, buying something that's significant. It'll be 10 minutes long. Are you going to be ready? Well, we'll see. Well, I'll tell you after the fact. And then, you know, personally, I just kind of hope I have grandkids one day, but I'll need some son-in-laws for my daughters first.

1:10:42Steve. All right, dude, you're the man. Thank you so much for being here. We really appreciate it. I want to say to all the pounders out there listening, thank you guys so much for watching, leaving us waitings, leaving us reviews. We really appreciate it. Guys, great job this week. We're good? Yes? All right. Thanks so much. We'll talk to you soon.