MI345: A Decade Outperforming The NASDAQ w/ Brian Stoffel

26:36Yeah. So continuing on with this line of thought about antifragility, I noticed one thing in your analysis videos is that you apply a score on a scale, I think it was 1 to 15, and So I'm interested in knowing how do you quantify anti-fragility in the businesses that you analyze? Yeah, it's not perfect. It's not perfect at all. But the things that I look at is, believe it or not, I actually think a mission statement is pretty important because I think that it can guide when those five or six things happen, the companies that have a good mission statement with most people don't pay any attention to, they actually have a compass to try and help them through that period of time.

27:12But then I look at the moat and I look at optionality. those are the most important things. And I apply a certain number of scores. So I look at the different types of moats. And to me, there's five different types of moats. There's switching costs. There's network effects. There's low cost production, which is very similar to economies of scale. There's intangibles like patents, like government licenses, like brand value. And then there's counter positioning where the competition would have to hurt themselves in order to adopt your business model. Basically, what happened to Blockbuster when Netflix came on the scene?

27:49And then what I do is I try and say, okay, is this the kind of moat where I could... Basically, what I asked myself, the question is, is if someone gave me$10 billion and 10 years to take on a company, a leader in an industry, which ones would I not touch just because either the switching costs, the network effects, whatever those moats are, I just feel like I couldn't surmount that. And so for each moat that a company has, if I'm like, yeah, I couldn't do that, I give them two points. And if I'm like, I think I couldn't do that, but maybe I could do that, I'll give them one point. And as I said, it's very subjective.

28:31And I'm okay with that because here's the thing, Kyle. To me, if I make all of my decisions just based on objective numbers, I'm probably just going to get market matching results because that's what everybody else is basing it off of. If I have some subjective measures in there and there's got to be a balance, well, yes, then I could underperform the market, but that's the risk I have to take if I want to see if I can outperform the market. So I'm interested in knowing, you might not have done this and gone back, but have you ever gone back and just looked at the performance of businesses that scored high for you on the anti-fragility score?

29:09So it's a bit unfair for me to tell you the numbers that I have, because the last time I ran through them was 2021, which was kind of like a high watermark. But what I can tell you is at that point in time, any company that scored a 12 or above had market smashing results. And companies could score lower and have great results. But in general, over a long enough time frame to that point, and this is something I should go back and do, but to that point, the framework did a great job of giving me true positives. So there was never a false positive. I never had a company that scored really great on the framework and turned out to be a terrible investment.

29:53But I did have a lot of companies that scored poorly on the framework and ended up being a great investment. And I'm okay with that because I still have a smaller sandbox to play in where the percentages were higher that the companies I was picking were going to do well. Let's discuss some more details about your portfolio construction. So I looked back at X from the end of 2023 and saw that you had a post that showed you owned about 19 stocks, maybe it's changed since then. So I'm interested in knowing... I also looked back at other years prior to that and it seemed like you were in that high teens, low 20s number where that's the amount of positions you had.

30:30So I'm interested in knowing how you arrived at this number and why does it fit into your investing strategy? I wish I could tell you that there was a certain way that I arrived at that. I think part of it It might just be that naturally your brain can only follow a certain number of companies and feel comfortable with that. That might be part of it. I don't know if that's a human thing or just a me thing. But if you think about it, if I'm saying that 5 % is going to be the max of where I put my allocation into it, somewhere between 16 and 24 stocks is probably where it's going to land if that's the case.

31:06And unless it's a small cap stock, it doesn't really make much sense for me to put a small amount into a large cap stock unless I think it really has the potential to grow. So I actually have done that with Tesla because I think the range of outcomes for Tesla is enormous, much more so than say the range of outcomes are for Microsoft. So I tend to put those smaller cap stocks there. And that's why it can get over 20 sometimes. So one interesting point about being a relatively concentrated investor like yourself is how high you can allow a position to get before you start getting nervous. So my question for you is what level of concentration do you start losing sleep at?

31:52Boy, it depends on what stock is there. Because when Shopify was there, basically, I've had three or four different stocks that have been there. Amazon, which I originally bought in at a split adjusted$7 a share. Shopify, which I was lucky to get in at$4 a share. Mercado Libre and CrowdStrike. Amazon, I got nervous because at the time, it was a very volatile stock. It got up to about 15 % of my portfolio. Shopify, I've already told you about. With MercadoLibre, I'm less nervous about that just because I see its valuation as not egregious. CrowdStrike makes me a little bit more nervous. As of just yesterday, which would have been Valentine's Day, actually bumped up to my number one position for a short period of time.

32:48I just, when I say that, what I mean is that that's one that I could see, it's the type that could fall 30 % or 40 % in a day. I'm not saying it's going to happen, but it certainly, it could happen. I don't see that same dynamic with MercadoLibre. And I guess, Kyle, the other thing I would say about that is, is the more a company deals in the real world with things that you can touch, the less worried I am. So if Tesla grew to be that size, I'd be less worried. Mercado Libre, I'm in Costa Rica right now. They have physical operations throughout Latin America. I'm less worried about Mercado Libre.

33:27Even though Mercado Pago, a digital asset, is a huge part of their business, they've got stuff that you can touch. Amazon, I was not as worried because I see those vans and I see those fulfillment centers. I drive past them. They're not going anywhere. And if they're getting disrupted, I'm going to see that with my own eyes. CrowdStrike, well, that's a different story. Shopify, well, that's a different story. I don't see customers leaving CrowdStrike and Shopify in my daily life. I don't take my dog on a walk and I'm like, oh, there's some customers leaving CrowdStrike, but I can take my dog on a walk here in Costa Rica and be like, oh, MercadoLibre or at home and be like, oh, Amazon.

34:08So I don't at least sloop over those things. So I guess I never really thought about it this way until you asked. It's the ability to actually see it in the real world. If I can't, well, then I might lose some sleep over it. Obviously, you just kind of brought up a quote in one of the previous questions I asked where you said something along the lines that evaluation plays zero role in a company making into your portfolio, but now as of 2022, it's going to play a larger role in the allocation once it's in your portfolio. I'm interested in understanding a little more about how you manage risk using that strategy.

34:42The biggest thing that I do with that is I'm usually investing in companies that are still trying to maximize their profit margins. And so it can be really, really difficult to figure out, well, how much can earnings grow moving forward? If you're looking at the company and you're like, okay, so they could grow sales by about 15 % per year for the next 10 years? How much does that mean that earnings could grow? Well, I don't know because earnings are probably going to grow a lot faster than sales can grow. And so it becomes this really tough guessing game. And so what I try and do is I try and look around and say, what is that free cash flow margin that this company could have by 2034?

35:31And I look at it and I'll just give you an example. So CrowdStrike is one where I start looking at it these days and I'm like, if they don't run into any huge problems, they could have anywhere between 35 % and 40 % free cashflow margin. They've released information saying they believe it can reach 38%. And so what I do, Kyle, to try and manage the risk in that valuation, because there's two types of risk. One type of risk is that I'm significantly overpaying for it, which is basically every day that you wake up and you don't sell a stock, you're basically buying it, which I think is a really important idea that a lot of people miss.

36:12They're like, well, yeah, you got in at Shopify at$4 a share, but what should I do today? And I'm like, look, I'm not selling. So that's the same as buying to me. And the first risk is that you overpay. And that's what happened with Shopify for me. Even though I wasn't paying, I was paying. The other risk is that I look at a company and I say, well, it's got a PE of 200, I got to sell. And then it just continues to go up and up and up and up. And the reason for that is that people don't understand what happens to profits or free cash flows when you're going through operating leverage. I try and assume, say when I'm looking at CrowdStrike, I try and assume that today they've reached that free cashflow margin.

36:58So I don't have the numbers in front of me, but let's say they've got$10 billion in sales and they've got a 38 % free cashflow margin. Then I say, okay, I'm going to put myself in a world where they have$3.8 billion in free cashflow, 38 % margin. How much does that have to grow to justify today's stock price in a reverse discounted cashflow model. And that, I don't know if this is just giving me false comfort, but that's how I try and manage because you have to balance about selling because of some multiples that aren't really appropriate to be applying versus, hey, this is a really expensive stock.

37:36Everything needs to go perfect in order for it to justify this price. That's a fragile stock. Even if it's an anti-fragile business, if a stock needs everything to be just so, it's just like that teacup sitting on the countertop in San Francisco. So you have to account for that. So I liked how you use probability-weighted valuations when you analyze a business. You speak about this a lot in your videos. And in my opinion, the hardest part of doing this is figuring out how do you weight each scenario. So I'd love to know your framework for how you weight each scenario and how you try to improve accuracy on that.

38:14In the end, what I really think it is, Kyle, is... So I do this more with what I call stage one, stage two companies. Those are companies that aren't even profitable yet, where at that point, you're just looking at what's the addressable market? What percent of that market could they get? What kind of free cash flow margin could they get? And then you build your base case, your bear case, your bull case. And like you said, you assign probabilities. And what I would say, Kyle, is that instead of just picking one, but when I go on X, I have to pick one because I can't sit there and play with this tool for an hour.

38:50No one's going to watch that. And it's not going to do anyone that much good. But you know what I do, Kyle? I sit there and I play with it for like an hour because that's what you actually have to do. You literally just have to sit down and play with it and be like, huh. And it's so interesting because sometimes I can have a 5 % chance of the bull case and it looks like a great investment. And I pull that down to say like a 3 % chance of the bull case. And all of a sudden it looks like a terrible investment. And that makes me sit back and say like, huh, the dynamics at play here are really saying that this company has to do really well to be worth it.

39:31On the flip side, there's some times where it's like, well, the difference between the bull case and the base case that I have, it doesn't make that much of a difference. So it really comes down to playing with those probabilities and saying, let's make it. And I will say, I always make the bear case the biggest, always. And then the base and the bull case, you just kind of have to play around with. That's how I arrive at it. And I'm just kind of, I kind of sit there, I play with it. And honestly, Kyle, then I'll wait like two or three days and I'll come back to it and I'll be like, okay, what seems like the most reasonable way to look at this?

40:10And I'll say just, I'll give you an example of where this played out well for me is with Transmedics, a company that basically is helping organs make it to donees healthier than just putting them on a bag of ice. I did that and And no matter how much I weighted things towards the bear case back in, I think it was November, maybe, before the stock just, it was up like 60 % the next day. And I remember I just got lucky. This is not skill. That was luck. And I bought it the day before that happened. But that's what led me to is I just sat there and I played with it and I played with it and I was like, they just have to not do terrible.

40:48And this looks like it'd be a pretty good investment. 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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44:10That's theinvestorspodcast.com slash tip-finance. All right, back to the show. You brought up moats, obviously, in a previous answer that I asked, and you're talking about how you kind of look at five general moats. So I know that you're a fan of Hamilton Helmer and his seven powers, and I got a chance to interview him and talk about all of his moats, but I'm interested in knowing more about how you assign moats to different businesses. And also, what are your favorite moats to look for in a business? I think switching costs are probably my favorite. And the reason that switching costs are my favorite is because they're the most plainly obvious in my own life.

44:51I bank with Wells Fargo because I went to college in rural Iowa and I knew I wasn't going to stay in rural Iowa. I knew I was going to go be a teacher. I was a middle school teacher in Washington, D.C. after college, and I knew there was Wells Fargo's there. So I signed up with Wells Fargo because that just made the most sense to do. There are few banks that kind of have disappointed me the most than Wells Fargo. And guess what, Kyle? I still bank with Wells Fargo. Why? One, it's a pain in the butt to switch. But two, I am deathly afraid that I'm going to forget about one of the critical accounts that's linked to my bank and I'm going to miss a payment, mortgage, credit card, what have you.

45:36And I know I could sit down and take care of that. I just don't want to. Now, that's just me with the bank. Imagine a hospital that has Intuitive Surgical's DaVinci robot that they've put down$1.5 million for. And they've got three doctors that have spent most of the last five years training on that machine, you cannot have a comparable product and get anyone to switch to you. You have to have a product that is leaps and bounds better than anything else and at a better price to get them to give up what they've already devoted that money to. And then, Kyle, the other thing I love about switching costs is what most people ignore is that there are a lot of companies out there that have what I call sneaky switching costs.

46:27And the number one example of this to me is Netflix. I used to think Netflix doesn't have switching costs. That's ridiculous. It takes me two seconds to cancel my subscription. And unlike Wells Fargo, I'm not going to suffer any negative consequences by doing that. I can always just go back and sign up again. And that was one of the reasons I didn't invest in Netflix for a long time. And then I did and I'm not anymore. That's another story. But then I sat back and I thought about it and I was like, when is the last time that I watch Netflix. And at that point in time, it had been like three months.

46:55And I was like, huh, it's just something I don't even think about. It's connected to my credit card. At that point in time, it was like 12 bucks a month. So what? Going out and getting two beers with a friend? It's sneaky switching costs because it happens and I don't even think about it. And there's a lot of companies out there that are the same way in that respect as well. So I know that you're a big fan of using the reverse discounted cashflow analysis, which you've already referred to multiple times. So just for people in my audience who might not even understand what that is, and hopefully you can describe it over audio format, but would you be able to describe what that is and also how you use that and fit it into your investing strategy?

47:36I think first we should talk about the one that's more popular with people who really like to get into valuation, which is the discounted cashflow analysis. And so with the discounted cashflow analysis, what you're doing is, is you're putting in the current price, you're putting in a growth rate that the company will have over, let's say, the next 10 years. You're putting in a terminal growth rate. So you're making all these assumptions about how much a company will grow, and then you're giving it a discount rate. And for those, don't be turned off by discount rate. What a discount rate just means is you're saying, I want this stock to go up by X percent every year.

48:16So if you want it to match the market, the S &P 500, about 10%. The S &P 500 goes up by about 10 % every year. So you put in today's stock price, you put in the growth rates, you put in a discount rate, and it spits out a price for today. And the problem that I have with that is that the output, a price for today, that it's so clean, it's so clean, it's sexy. It's like, oh yeah, I got it. It says it's$130. It's trading for 140. I'm just going to wait till it gets to 130. I'm no fool. But guess what? You're forgetting about the assumptions that you made. We always forget about the assumptions that we make.

49:00It's like the COVID thing I was talking about. We can look to the past and say, oh yeah, those things happened, but I knew about them. And we forget to look forward and be like, no, there's going to be a lot of surprising things coming up as well. What a reverse discounted cashflow model does is you still put in today's stock price, which is, that's something that's real. You put a discount rate in, which is just saying, hey, here's how much I would like to get per year. And what it spits out is not some future stock price that it needs. What it spits out is how much, whatever your profit metric is, I like to use free cash flow, tells you how much does that need to grow over the next 10 years.

49:48And so now it's not sexy. It's not easy. It's not, but it makes you think. The problem with the DCF is people can use it and then they think that they don't have to think. The great thing about a reverse DCF is it makes you feel uncomfortable. And that discomfort is where its power lies because you have to think for yourself, how confident am I that free cashflow can actually grow by this amount moving forward? Or I take it one step further and I say, I'm going to assume that today it's already got that free cashflow margin that I'm expecting in the future. Because look, Kyle, if it doesn't reach that, at least I know where the error was in my process.

50:31My error was that I thought it could reach a 38 % free cash flow margin. And in reality, it was just 20%. There it is. That's where my error was. Whereas if you just spit out a price, you don't even really know where the error was. So I don't know if that answered your question, but the real thing is, is that with a DCF, you're left with the question, is the stock trading for less than this today? And if so, buy it. With reverse DCF, what you're left with is, here's the growth rate it needs in free cash flow in my case. How reasonable does that seem? And then you make your valuation determination based on that.

51:13So one thing I noticed in your analysis videos is that you use a lot of analyst estimates. So Warren Buffett once said, quote, forecast may tell you a great deal about the forecaster, they tell you nothing about the future." So I'm just interested in understanding more about how you use analyst estimates to augment your own investing. Robert Leonard Not much. So the videos that you're referring to are videos that Brian Froldi and I put out there. And typically these days, because we've got a lot of things going on, our YouTube content is really focused on dissecting earnings of a company. And a lot of people come to those videos and they want to know why a stock is moving so much today, which isn't that big of a concern for us as long-term stock investors, but we also want to meet people where they're at.

52:01And especially if you're a beginning stock investor, you want to know why is the stock moving so much today? And for the 24 hours immediately following a company's earnings, where that stock is moving is almost entirely based on what the company said versus what Wall Street was expecting. Over time, it's meaningless. And so Warren Buffett is right. And I agree with Warren Buffett in that if you're a long-term investor. Because look, my biggest positions I've owned for more than 10 years. I guess CrowdStrike could be an example. I got that right after its IPO. But most of the others I've owned for more than 10 years.

52:36So I agree with Warren Buffett. We throw those in there because it does help explain why a stock is moving in a certain direction in the 24 hours after it comes out with its earnings. You spoke with Brian Feraldi about how narrative follows price. I really liked it. And this was one of your major lessons I think you learned back in 2022. So one thing I wanted to highlight was how you mentioned that it works both ways as a good narrative and a bad narrative. So when the narrative is negative, it usually means that the stock price is also in the dumps, just like when the narrative is positive, that usually means that the price is sky high.

53:10So looking at the language that investors use to describe a narrative obviously is super important because it helps you identify where investor sentiment and perception is of that stock at a particular point in time. So I'm interested in knowing how do you use narrative to help you improve your decision-making and investing? What I try and do is I try and remember that narrative, and by narrative, we're talking about stories, really. Stories, some people say that the greatest instruments that humans have ever invented are like the Hubble telescope or nuclear power or AI. And I think that's completely wrong.

53:46The greatest tool that humans have ever invented by an order of magnitude are stories. We think in stories, we're convinced by stories. And stories are not good or all bad. Stories are just powerful. And so they can be powerful for good or powerful for bad. And you can't escape stories. Nobody can escape stories. We have to make sense of the world somehow. But you have to be aware of how influenced you can be by the story that's out there in the world about a stock that you own. The best way that I know how to make sure that you're trying to inoculate yourself a little bit, as much as you can from the stories surrounding a stock is to go to the company's financial releases.

54:39What I do is I try and take once every six to 12 months, review my portfolio. And what I'll do is I'll read over the annual report. I'll read over the quarterly reports. I'll read over the presentations. I'll look through the presentations, but I won't look at what anyone else thinks about it at all. Just last night, HubSpot came out their earnings and I made sure that I read through all of it. And I came up with what my initial opinion was before I went to see what the stock had done after hours, before I went to the message boards of the Motley Fool or the community that Brian Froldy and Brian Withers and I have.

55:24It's kind of like, Kyle, I don't know if you're familiar with this, but if you're in a meeting with a lot of other people, it's a lot better to have everybody write down their idea. If they say, what's the best thing we can do over the next year? Have them write their idea down on a sticky pad, give it to someone and someone reads them out. Because if instead, you just go based on the first person that raises her hand or the first person that speaks up, we are all naturally inclined because stories are the most powerful thing humans have ever invented. We are naturally inclined to bend our own opinions toward that story because now that story has the floor.

56:01And reality doesn't give two you-know-whats about the story, but we humans do. And so that's why writing it down is such a much better idea for teams because then you've got all the options out there and you can sit there and actually think about all of these options. That's why I think it's so important that investors sit with the financial statements, sit with the, say, interviews with the CEO before you see what anyone else, including the market, thinks about what's happening with the stock, and then start to calibrate yourself. So write down what you thought after Alphabet reported their earnings.

56:37Write down what you think. Then go around and see what everyone else thought, notice any differences, and then check back on that a year later. Because if you really start to get a feel for the companies you own, you'll notice when you had a feeling that ran contrary to the narrative out there, and you were right, and how sometimes you were wrong. And that can be really, really valuable. So one thing that I didn't even know about Brian until I got him onto this interview was that he actually lives in Costa Rica for six months of the year. So I know I've seen photos of you in what look like beautiful, sunny areas, and I just kind of assume that you like traveling a lot.

57:16So So can you talk a little bit about your experience of kind of how you got to this point of living in Costa Rica for six months out of the year? Yeah. Well, I will say it used to be six months. These days, because I have kids that are in school, it's more like two months, but I'll still take it because I live in Wisconsin for the other 10 months and it can get cold there. But my wife and I were middle school teachers in Washington, D.C. We worked at schools that were charter schools. They had a little bit, they had different rules. For instance, the school that I taught at, the kids were in school from 7.30 to 5 every day.

57:48There was school on Saturday. There was school during the summer. It was great. We accomplished what we wanted to with those students, but it also wasn't sustainable for me. So, after five years, we both looked at each other and we said, it's time for something different. We said, well, what do we do? And neither one of us knew what we wanted to do. So, we said, well, what the hell do we do with that? And my wife said, we've been saving. We live in this tiny little apartment in Washington, DC, and we work so much, we don't spend that much. We can do nothing, no mandatory job for a year. And we said, well, we can't do that in Washington, DC.

58:24Where can we do that? And we landed on Costa Rica. We found a place to live there based off of Craigslist because Airbnb didn't even exist at the time. We got picked up at the airport by a random person who brought us to the house, and we were in this mountain town with very few expats that were anywhere close to our age. And it was pretty weird at first. Then that's when I kind of started going crazy. My wife handled it very well. I did not. And I needed something to work on. We had to roll over our 403Bs. And I was a writing teacher. I'd never taken an econ or a finance class in my life. Well, I took one my senior year of high school.

59:08That was it. But the more and more I looked at what we could do with our money and importantly, what the company had done with our money that our school had used, the more and more I was like, well, this doesn't make sense. And I had all the time in the world to spend on it. So I just started learning about it. And I started writing on the Motley Fool's boards and they contacted me and they said, hey, you can do this and we'll actually pay you for it. And I was like, well, that's crazy. I don't have a background in this. And they said, yes, we can tell, but you're a good writer because that's what I was a writing teacher.

59:45And they said, you come, we'll train you. You've got the writing. We'll give you the finance stuff. And then we can go from there and you can work from wherever. And I said, okay, that's great. And so 14 years later, we live on a coffee farm in the mountains of Costa Rica, not our farm, but a family that has become family for us. And we live on the farm for two months. Our kids run around and play. It's great. I know that you don't take evaluation in as much of an account, but obviously, I think there's probably a business out there that maybe you wish you could own, but you just can't wrap your head around the price, or maybe you don't understand it as well as you think you need to.

1:00:23What would be that business? I mean, I'll go with can't understand it as well as I think I need to. NVIDIA would be that business. I would buy it. The valuation wouldn't bother me because you can always buy 1%. Anyone can buy these days, you buy$10 worth of NVIDIA if you use some trading brokerages. But for me, I am not technical enough to truly understand how wide the moat is that NVIDIA has. And there are a lot of people out there who are smarter than me who do understand that and who have made a killing on that. And I say the more power to them. But if I don't understand what the moat is, it's not going to work for me.

1:01:09That's why Axon is my favorite example of the widest moat business I can think of. Another person that works with Brian and I, his name is Matt Cochran. He's actually a police detective in Florida. And I'm just like, Matt, what would it take for a police department to switch away from Axon at this point, given that you've got the stun guns, you've got the body cameras, and forget about those. You've got the software that stores all this information. And he's like, an act of God, basically, is what it would take. I can understand that. And especially being a teacher working in the public service, I know how hard it is to switch from a grading platform for a middle school.

1:01:50So I can get that, super processors and GPUs, that's too hard for me. And I'm okay staying on the sidelines there. So Brian, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about your newsletter and your investing course? Sure. So Kyle, a couple of places that they can go, obviously Twitter, I'm Brian underscore Stoffel underscore. If you go to longtermindset.co, we just launched the webpage this week. You can go there, sign up for our newsletter, and you can see the courses that Brian Faroli, Brian Withers, and I offer there.

1:02:26And then one other thing that I do, I've partnered with Savvy Trader lately to show my portfolio in real time for anyone to see. You can subscribe to see that there. I do not encourage you to copy what I'm doing. But when I was a teacher, Kyle, the best way to teach my students how to write was to literally sit at the overhead and to think out loud and write. And that, more than any lesson that I could come up with, improved my students' writing the most. That's what this partnership with Savvy Trader is.