MI304: Evolving The Value Investing Mold w/ Adam Seessel

26:25But as a business like Meta has shown us in the past, the market can react negatively for a time to massive spending in these areas if they don't see value in it. How do you go about looking at a business's R &D and marketing history to ensure that they're spending that money wisely and that it's returning some form of value? I mean, it's pretty common sense, Kyle. I don't know if I've ever used TurboTax, but I know people who use TurboTax. It's great. I've never used QuickBooks, but I know people who use QuickBooks. It's great. There's a demonstrated need for that product. Whereas something like Meta, Meta bet the ranch a couple of years ago, changed their name and said, we're going to invest, I think it was$10 billion a year in virtual reality.

27:09Well, that just strikes me as highly speculative. I'm not a venture capital investor. I'm not going to invest in unproven stuff that might work. I'm going to invest in stuff that while early in its life cycle has proof of concept that it's going to work. So QuickBooks has one, 2 % market share of its ultimately addressable market of small business software, helping small businesses keep track of their bills and invoices and so forth. Meta has 0 % of the virtual reality market because there is no virtual reality market. So, you know, it's common sense. It's like, I just thought, I'm not doing it.

27:47Amazon retail sales, North American retail sales, e-commerce is about 15 % of North American retail sales. Like, that's just not a very high number. So it's already established and yet it has a lot of room to grow. Progressive Insurance, which is really a tech company. It's an auto insurance company, but it's really a tech company. It uses tech to gain its advantage. It has 15 % market share. That number is almost surely going to go up. And meanwhile, the auto insurance market grows. So once you find a company with a fairly small share of a large pie and the pie itself is growing, good things are going to happen over time.

28:29So there's a quote in your book on value investing that I really loved, which was, the essence of value investing is to buy a stock when the market is voting on it, and then wait until the market weighs it. This made me think that a lot of value investors tend to stay away from optically high-priced tech names like we've been talking about. But if you know the value of a stock, regardless of its price to earnings ratio, all you need to do is wait for that stock until it is either not loved by the market and that drops the price of it or is not loved as much as it should be, which you use your BMP system to do, and then just wait for the market to weigh it properly.

29:06So would that be kind of your advice to value investors who tend to avoid tech stocks based purely on price? No. My advice to value investors who avoid tech stocks on price is to sort of join me in a contemplation of what's changed in the world and to join me in a contemplation of how gap accounting doesn't capture what's going on in terms of tech company value creation and sort of, you know, you have to change your mindset in the sense of tech is where the future is, number one. Like, ask yourself rhetorically, Mr. Value Investor, you know, where is most of the economic value going to be created in the next generation?

29:43You know, I'll give you four choices. A, healthcare. B, financials. C, industrials. D, tech. tech? It's obvious to a 12-year-old that the answer is D. So most of the growth in the economy is going to come from tech, number one. And then number two, how is the value of tech not captured fairly? Because as I say in the book, Kyle, Google and Amazon and all these other tech stocks, all of Adobe, Ansys, Salesforce, Autodesk, all these companies, large and small, have always looked expensive from the time they IPO'd to now, but they've gone up tremendously. So either it's a binary, the answer to why, why have they gone up even though they've looked expensive is binary.

30:31Either it's a huge shell game that's been going on for 25 years now, and it's getting ready to break, and it's going to make the dot-com bus look like a tea party, and Amazon and Microsoft and Google are going to go down 90 % because it's just been air, or the way we're measuring value has just been wrong. It's outdated. The answer is pretty clear that the second explanation is true. So you've got to really reorient yourself both philosophically and numerically if you're going to capture the value creation that the tech is generating. Benjamin Graham is often referred to by Horne Buffett and other value investors in reverential terms.

31:14Do you think the fact that he's held on such a high pedestal actually does harm to newer investors who get stuck on his asset-based evaluation methods? I do, actually. And I think it's a very insightful point you make. Look, I revere Graham as much as the next guy. I mean, he invented value investing. Before Graham, as I say in the book, the stock market was a casino, and there was no systematic way to figure out how to invest and beat the market. and one of his early jobs was taking bets. He worked at a New York Stock Exchange registered broker, but it was legal back then 100 years ago to take bets on the presidential election.

31:54So he took bets from customers on the 1916 presidential election. That's how crazy Wall Street was back then. You think it's crazy now. You can bet on the... They were bookies essentially. So he created a system, you know, what am I paying? What am I getting? Don't overpay. All these things are huge gifts that he gave to the investment community. At the same time, he was way too conservative because he came of age precisely in a very speculative era. He lived through the depression in the 30s, so paid to be conservative. And so Buffett went beyond him and started paying higher prices for better businesses.

32:36And I think that we need to keep going and even, quote, higher optical prices, even though they're really not higher prices for shares in tech companies. So yes, I do think that to put him as sort of a, he's a saint, he belongs in the value investing canon, but times change, life moves on, and our attitudes have to move on too. So speaking of Benjamin Graham, in your book, you discuss the evolution of value investing, starting with value 1.0, which was inspired by Benjamin Graham's asset value approach. Then in value 2.0, you discuss Warren Buffett and his brand TV ecosystem. And then you present your BNP checklist for value 3.0.

33:18So as entire industries change, the way we evaluate must change as well. But what are some of the timeless investing concepts that continue to thrive from value 1.0 through to value 3.0? Well, let me just set the stage for your listeners by saying, you know, value 1.0, Ben Graham was assets, as you say, and not just assets, but what could they be liquidated for? I own a company, a stock that has inventory of X dollars and cash of Y dollars and no liabilities, and the net assets are worth$100 a share, and I can buy the stock for$60 a share. I can buy it for 60 % of liquidation value. Beautiful.

34:00Because the theory is that the$60 a share will inevitably go to$100 to reflect at least asset value. That's a very good construct. David Buffett said, well, that is a good construct, but I live after World War II. The US is in a very stable place. The economy of the US is growing. I want to buy great businesses. So I'm not going to look at assets so much as I am going to look at earnings. I'm going to look at their earnings, and I'm going to be willing to pay it up. As I show in the book, there's a chart. It shows he was paying higher and higher multiples as time went on because his conviction that a great business would grow and would sort of outgrow the high multiple, the conviction that he had was increasing.

34:44All I'm saying is we need to move on to the 3.0, where we don't focus on earnings, current earnings so much as earnings power, the latent ability of a company to earn money. As I said, when I compared the 30 PE multiple versus the 15 PE multiple, the 30 PE multiple company is much less expensive than it would optically appear because it's reinvesting to grow its future earnings. Those are the three constructs. But look, paying a fair price, that concept will never die. Being rational, that concept will never die. Getting good managers, that concept will never die. So there's a lot of good still in investing.

35:28That's why I saw the subtitle of the book is Value Investing for the Digital Age. We just need to modify. We just need to modify. It's not a revolution. It's an evolution. Let's take a quick break and hear from today's sponsors. Hey, it's Sean O'Malley, just popping in with a quick message. If you like this podcast, well, I've got great news for you. We've got a handful of other shows for you to explore, from learning about Bitcoin to embracing a richer, wiser, happier lifestyle. Just go into your podcast app and type in We Study Billionaires to find our collection of shows. We Study Billionaires is our flagship podcast, and we've made a name for ourselves over the years by interviewing the best investors in the world, including Ray Dalio, Howard Marks, Joel Greenblatt, and many, many more.

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38:55That's theinvestorspodcast.com slash tip-finance. All right, back to the show. So in the price portion of BNP, you are looking for a price to earnings of less than 20, implying a 5 % or greater earnings yield. What is the significance of this earnings yield number? The way I look at it is the multiple, of course, is the price over the earning. But the earnings yield is the earnings over the price, E over P. So if I'm buying something that is earning$5 and the price is$100, the PE is 20 and my earnings yield is five. So the way I look at it, Kyle, is, well, theoretically, if I own the whole business, I could take out that 5%.

39:41I would get a 5 % dividend yield on that business day one. Now, in practice, companies retain the earnings to grow or they buy back shares. So it's not all dividend out to you, but it's a good theoretical construct that day one, I'm getting 5%. Well, even in the rising rate environment, that's still higher than a government bond, right? Which is anywhere from 4 % to 5%. So I'm getting paid more than the government would pay me. But in contrast to a bond, my coupon will grow. 5 % coupon, if it grows 20%, next year will be a 6 % coupon. And if it grows 15%, 20%, the next year, it'll be a 7 % coupon.

40:29and then an 8 % coupon and a 9 % coupon. That's why one of Buffett's many brilliant insights was to say that stocks are bonds, but they have expanding coupons. You know, the 10-year treasury is not going to pay me more than 4 % or 4.5%. It's not going to grow. It just sits there. But a dynamic business grows. It goes into new markets. It introduces new products. It raises prices. It innovates this. It innovates that. It cuts costs. It buy back stock, which raises my per share earnings value. The coupons grow. If I'm buying a great business, which B is the first part of the analysis. If I've decided that the business is great, it earns money the right way, not the blood sucking way, it's got a huge long runway, it's got a small market share of a large market, it's got competitive advantages, it's got reasons why it can continue to grow, then And I'm confident that that 5 % coupon can go 6, 7, 8, 9, 10.

41:28And in 10 years, it'll be the price will have been dwarfed by the earnings that are out there in 10 years. So 5 % seems like a good rough bogey to me. There's nothing magical about it. So given the prevalence of monetization of data and attention these days, do you feel network effect modes are going to be an ever growing area of competitive advantage in the digital age? Yes. Yes. I think that's a good insight. I mean, you see it now with AI, right? AI is all the rage, but the only companies that can really do it at scale are the big companies, Microsoft, Alphabet, chief among them, because they have the cash flow to reinvest.

42:12And I think it's pretty widely acknowledged that Google has 75 % of the top AI research talent. That network effect grows there. It's not just data, it's resources. And, you know, an AI researcher, you know, like three good Google AI researchers could go off on their own and do a startup. But they wouldn't have cash, they wouldn't have the resources, they wouldn't have the computing power, they wouldn't have the market to sell into whatever application they created. So I think network effects and the mega caps are very much benefited. And as long as they continue to execute on innovating, they will do well.

42:54Outside of businesses such as Meta, Amazon, and Alphabet, are there any other businesses that you think are worth researching more to understand network effects? Or can you just get away with studying kind of those major guys? You kind of know a network effect business when you see it. Here again, it's important not to get too caught up in the theory and just sort of be practical about it. Like Airbnb, they started with their apartment. And it's called Airbnb because they blew up a mattress and put it on an air mattress on their floor of their living room. So, you know, start out with one host and then one guest and then two hosts and two guests and then four and then 16 and network effects.

43:34And the more hosts, the more guests and the more guests, the more hosts like that. If you keep that in mind, you can see immediately whether a business has network effects, you know, one begets the other. Virtuous circle, however you want to say it. Flywheel, There are a lot of business terms to describe it, but you kind of know it when you see it. Facebook social network, people are on there. That means more people come on there, which means more people come on there because it's a social network. They're not hard to spot. So you had a really good breakdown of the contrasts of a financial or stock analyst versus a business analyst in your book.

44:12You said, and I quote, a financial analyst believes that the numbers drive performance, but a business analyst knows that the numbers, the ratios, and the stock's performance all derive from one thing, business quality. For listeners who are accustomed to looking at investing through the lens of a stock analyst, what would be their first steps into evolving into a business analyst? Well, it's one of the favorite points in my book and one of the really more profound realizations I've come to. I used to be a classic value investor, price first, numbers first, quantitative, quantitative, quantitative.

44:47And I just understood that business quality not only dwarfs the numbers, but it drives the numbers. That's where the numbers come from. Good businesses are going to generate good numbers. Bad businesses are going to generate bad numbers. So General Motors sure looks cheap, but what kind of numbers is it going to be producing going forward? I would encourage people to just sort of think that way. I don't know, People have to come to their own conclusions. But for me, I got tired of buying into businesses that look cheap and just kept going down. Business quality rules. It's sort of, if we don't have enough evidence of it by now, I don't know what more evidence we can have.

45:27So you just need to deeply think about, okay, I own businesses X, Y, and Z, and they're cheap optically, but what is their quality? What is their future? Sure. And what numbers are they going to be producing in five years, three years time? Whereas if I bought business ABC, okay, it's optically more expensive, but what's it going to look like in three or five years time? Quality wins. So a new investment that you have just made is in Texas Instruments. Could you go through the business and management part of your BMP framework on the business with me to help the audience understand it a little bit better?

46:03And then I want to go over the price in a bit. Sure. Yeah, happy to. BMP analysis for Texas Instruments, a good case study. Texas Instruments is involved almost 100 % in a tech market segment called analog semiconductors. And I learned about this five or six years ago, and it was a real eye-opener for me. I always thought that semiconductors were the chips that went into memory and storage, Intel, and so on and so forth. And that's a much bigger industry. That's digital chips. That's zeros and ones. That's digital semiconductors are ones that just manipulate digital data. And that's a huge, it's a very difficult business, actually, digital semiconductors.

46:47It requires scale, enormous fabs costing billions of dollars. Product cycles change every couple of years. So you see now that NVIDIA is the darling because of their AI chips, and Intel is in the doghouse because they missed the transition. So I don't like that business. It's capital intensive, product cycles change every couple of years, scale matters, and the risk of missing a product cycle and becoming a laggard is just well-documented. I mean, Andy Grove, the best CEO in the semiconductor industry maybe ever, you know what the title of his autobiography was? Only the Paranoids Survive. Only the Paranoids Survive.

47:30Like, do you want to be in an industry where only the paranoids survive? I don't. Like, that's hard. I'd rather be in an industry where like a lazy guy can do okay. Like that would be good. But so I don't like the digital semiconductor industry terribly much. I mean, those who bought NVIDIA because they saw something, I mean, hats off to them. But NVIDIA has to be paranoid now because another product cycle will come. Texas Instruments is not in that segment. They're in the analog segment, which is much smaller segment. It's maybe a fifth of the size of the digital segment. Analog means anything that has to do with non-binary, non-digital, non-zeros and one.

48:10Analog semiconductors basically help get real-world phenomena into the digital ecosystem so that NVIDIA's and Intel's chips can analyze the data, manipulate the data, store the data. So driverless cars is a great example. There's a lot of digital chips in there to tell the car what to do. But for those digital chips to work, they have to have sensors outside of the car, noise, temperature, movement. Those are all analog signals that move in waves, sound waves, power moves in waves. Analog semiconductors capture all the non-digital phenomena in the world, all the real world phenomena, temperature, sound, noise.

48:56And those can't be shrunk. Those semiconductors can't be shrunk because they'll lose their fidelity beyond a certain amount. So Moore's law does not apply. So the ruthless economics, only the paranoid survive economics do not apply to analog. So that's great. The other thing that's great about analog is you can't have one chip for 100 applications. The analog chip that regulates the power in the iPhone is different than the analog chip that hears your voice, which is different than the analog chip that monitors the temperature. which is different than the analog chip that helps when you swipe your phone.

49:32They're all little niche industries. They're all little niche. I think I can't remember the numbers exactly, but I think Intel has maybe 50 SKUs, different units, and Texas Instruments has over 100 ,000, like all little bespoke things. And it's not an industry where only the paranoid survive because once you get a good power regulator or once you get a good sound conductor, It's probably good enough for five or 10 years. So you don't have to keep iterating. And the product cycles aren't rapid, which allows an analyst, business analyst to understand the long future. And yet, at the same time, they're exposed to all the tech tailwinds, right?

50:11They're exposed to digital driverless cars, Internet of Things, anything that needs human or real world phenomena to be translated into the digital world needs analog semiconductors. And of course, we know that that number is just going to keep going up. So I love the analog semiconductor business. Texas Instruments is the market leader, but they only have 15 % share. So it's still pretty fragmented market, but they're the market leader. The market grows, I don't know, 7%, 8%, 9 % a year, which is much better than the underlying economy of 2 % to 3%. And Texas Instruments grows a little faster than that because they're always taking share because of their scale.

50:49Well, the top line for Texas Instruments is going to grow 10 % a year. And then the other thing I love about Texas Instruments as a specific analog business is they're the only one that own their own factories. Everybody else has outsourced their factories, are fabless. So they do a lot of work with Taiwan Semiconductor, which is a great company. But Texas Instruments gains a lot of manufacturing advantages from owning their own factories because they don't have to pay a middleman. They're vertically integrated. So that gives them a cost advantage. So not only do they have the broadest product portfolio, and because of the market share leader, they can invest most in R &D in terms of absolute dollars, but they also have a cost advantage.

51:29So I'm starting to tick off, market leader, spend the most in R &D, cost advantage in this great niche industry. So I'm loving Texas Instruments. I'm kind of going back through my research as I learn all this stuff. So it's a great business. I think it'll probably, over time, it'll grow revenues 10%. The margins will increase a little bit as they gain scale and leverage, and then they'll buy back stock. So I think the earnings growth for them per share is probably in the mid-teens forever. Forever is a long time, but for at least 10 years. So a company that can grow earnings 15 % for 10 years' time and has sustainable competitive advantages in this great little niche industry is a wonderful business.

52:15The multiple, so that's the business. The management is great. They don't own a lot of stock, but they'll quote Buffett. They'll quote Graham. You go on their website, they have a whole dedicated slideshow to capital allocation. They understand what drives value. They understand return on capital. They make all their investments based on return on capital. They are interested in getting to the station fastest with the least amount of fuel. They do not want to build a big fancy train. So the management definitely gets it. And you just spend a little time on the website and you listen to their investor calls and you'll see that they are shareholder friendly and investment savvy.

52:54So, okay, so my B's checked, my M's checked. And then the price, this is a good example of sort of a more ordinary earnings adjustment, but optically, like this year, they're going to earn$7 and change and the stock's 160. So let's call it a low 20s multiple. So it doesn't pass my test of 20 and under, right? But study the market, which I have now for five or six years, you'll understand that they're in a lull. See, what happens is customers like automakers and auto and industrial is most of their markets now, auto and industrial. And those guys will order a lot of chips and demand will grow a lot.

53:34And then they'll say, oh, we're overstocked. And so they'll cut back on their orders. and then they'll run their inventories down and then they'll overorder. Then they underorder, they overorder, under. So it's lumpy, cyclical a little bit. And we're right now in kind of getting toward the bottom of where the manufacturers have underordered. So the$7 and change earnings number is probably a false number. It's probably too low. Like if I just do my numbers and correct for the inventory adjustments, I think they're going to earn twice that in four years. They're going to earn$15 or so in 2027. That's kind of my estimate.

54:11Only thing I know is it's going to be wrong, but it's directionally accurate. So if you adjust the earnings to compensate for this inventory correction, it's trading well under 20 times. So all three boxes checked, great business, savvy management, good price. You have to watch out because China is a wild card now. There's all these trade tensions and Apple's phones are now not being allowed by some government employees. So there's going to be some stuff going on in here. But overall, what I've told you is undeniably true. Part of the reason the dot-com businesses didn't work out around the year 2000 was that the infrastructure wasn't in place to support those businesses.

54:56As you mentioned in your book, it was the same with cell phones. They became more ubiquitous as the technology got better and the prices came down. What industries or sectors are coming online today that you envision having long tail ones? Oh, there's so many. There's so many. I mean, AI is all the rage. I mean, I don't know exactly what's going to happen, but it's going to be big. As I said earlier, it'll probably be monetized by the big guys, Microsoft in its office suite, charging money to use AI in Word and Excel. Google, it'll help in their search business. I don't even really try to bother to count the ways the next big things.

55:38I just know they're going to be big things. I mean, this year it's AI and at some point driverless cars will hit, and then quantum computing is going to hit. I don't bother ticking off all the ways. Of course, I'm familiar with them, but I say to myself, what is going to be driving the incremental value of the economy for the next generation. As I said earlier, it's going to be tech. Adam, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about you and your book? Kyle, I enjoyed it. And you asked good questions and I hope it benefited your listeners.

56:13In terms of connecting with me, I mean, here's the book, all that stuff we've been talking about, you can just pick it up on Amazon or your local bookseller if you want to help support them. And then, you know, look, you can Google me. I'm on the web. I'm on LinkedIn. Happy to chat with anybody. And I've kind of figured out how to invest with discipline using some of the traditions of value investing, but also making accommodations for this new digital reality that we live in. So I'm happy to help others if they want to continue their journey as well. Okay, folks, that's it for today's episode.

56:49I hope you enjoyed the show and I'll see you back here very soon. Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by the Investors Podcast Network. Every Wednesday, we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.