TIVP035: Ferrari (RACE): High-Speed Compounder w/ Shawn O’Malley & Daniel Mahncke

28:33And then when you add to that, that the cultural cachet created by popular movies devoted to Ferrari's history, like the one that came out in 2023. It just feels like Ferrari is as famous and as relevant as maybe it has ever been. The other thing that I've seen that Ferrari is going on are these lifestyle products that lean into the brand as opposed to actually being related to vehicles. So they sell clothing, perfume, and gadgets that are all Ferrari branded and they even license the brand out to theme parks like Ferrari Land in Spain and museums. So they've created a number of bigger and smaller touch points to further perpetuate the brand's cultural relevance.

29:18Even if Ferrari t-shirt sales do very little to directly boost the borderline. And then there's something like 30 Ferrari stores worldwide where each one is sort of like a temple to the brand. I've visited one in Milan once and it looked pretty cool. Although I must say, I always found it a bit weird seeing people walk around in Ferrari shirts that don't drive a Ferrari. So personally, I feel like it kind of dilutes the brand a little and without a real benefit as they don't make much money with it or need that, I don't know, form of extra promotion. I felt similarly. I remember seeing the Ferrari store in Miami, but it is a pretty cool place.

29:59And at Ferrari's current scale, this kind of brand licensing that, as you said, doesn't really move the needle a ton. But I do think it does amplify the company's reach. And what's been fascinating for me with this show has been to with every company we study, for the most part, we get a better and better appreciation for how much branding matters. There's no single thing you can point to and say, okay, this captures everything you need to know about Ferrari. Like any brand, the Ferrari brand is a story. And truthfully, it is one of the best stories ever told. That's why there are so many movies about it and why it continues to captivate people's fantasies.

30:41When you have 18-year-olds across the country hanging Ferrari posters in their college dorm rooms, that tells you a lot about how the brand is perceived and will continue to be perceived by the next generation. And that's how I get very comfortable with the staying power of this brand. But you can also see this in the numbers, too. They have an order backlog that extends well into 2026. And 80 % of Ferrari's new vehicle sales last year were made to people who already own or have previously owned a Ferrari. And so just to say that again, because it's so absurd, four-fifths of their new sales are made to repeat customers.

31:25I have never seen anything like that before. And if you contrast that, even with Lamborghini, only about 30 % of their sales are to repeat customers. And so a couple weeks ago, we talked about Lululemon's industry leading rates for repeat customers. But it's a totally different thing when half your repeat customers are spending$100 or$200 on apparel. and when your repeat customers are making three, four, or$500 ,000 vehicle purchases. So the customer loyalty at Ferrari is astounding. And that's why we use that word quality. I mean, that is quality. Ferrari ownership is a special club that so many want to be in.

32:08And once you're in it, by all evidence, people keep coming back. It's interesting because sometimes you feel like you already know a brand or at least how big it is. But going through this episode right now, I just realized how big and important the Ferrari brand actually is, especially compared to all these competitors like Lamborghini, where you would think they're kind of on the same level, but apparently they're not. And something that's also interesting and we should talk about here beyond vehicle sales, merch, parts, and customizations is the financing division. This is a pretty common thing about automobile manufacturers, but there's a lending business built into the company and that can sometimes, I would say, make the story even more complicated.

32:53For Ferrari, this division revenue seemed to be far less consequential than for, I don't know, a company like Mercedes. But still, I would love to hear a bit more about it and whether it moves the needle, makes the investing case more complex, everything you know. So Ferrari Financial Services helps facilitate the purchase of all types of Ferraris. So those currently in production, pre-owned vehicles and classic models too. And then for those who have been proven Ferrari customers for some time, Ferrari will sometimes reward them with these special financing options. And it's just one more way for the brand to reward loyalty.

33:29In certain cases with limited edition vehicles in particular, Ferrari will sell cars directly to customers and the financial services division will help finance those purchases. But also Ferrari sells its cars through 180 independent dealers worldwide. So Ferrari may also offer those dealers wholesale financing options. So they have actually started to phase it out in the last few years. And really the vast majority of Ferrari's debt is actually just these lending liabilities. And to your point, Ferrari's nominal operating profit is about one sixth of Mercedes. But Mercedes net debt is 58 times bigger than Ferrari's.

34:12And so I say that to emphasize that even though Mercedes is a bigger business overall in terms of sales and also profits generated, its debt load is so much disproportionately larger because they have to rely on financing much more heavily to drive sales. With the difference being Ferrari's buyers are among the wealthiest people in the world. and financing might be offered for convenience purposes, but Ferrari buyers also don't necessarily need financing support in the same way that the average car buyer does. And in the US, for example, Ferrari's lending is spread across just 4 ,800 customers.

34:49And ultimately, these loans are backed by the value of Ferraris, which have very minimal depreciation, if any, and actually tend to appreciate over time. So the lending profile is totally different from making a loan to John Smith, who makes an average salary and wants to buy a Toyota Camry, which we know will depreciate dramatically with a few thousand miles of driving. Ferrari is lending to more creditworthy borrowers and the loans are backed by higher quality assets. So I don't have a lot of concern about the lending division. And Ferrari, as we know, isn't playing a volume game either. And you need a volume game in lending typically for the business to be a profit center.

35:27So the financing business sort of just exists in the margins and it makes up less than two percent of revenues. When I look at the competition for Ferrari, it's interesting how much Ferrari stands out in the world of ultra luxury and supercars. VW, for example, owns Bentley, Bugatti and Lamborghini, but the overall business is still just barely profitable. I mean, VW has three percent net income margins. It's not a perfect comparison, of course, because VW mostly sells regular types of cars, but you would think that Bentley, Bugatti, and Lamborghini would help their margins a bit more. So Ferrari is special, but still, this is a stock trading at nearly 50 times earnings with a 90 billion plus market valuation.

36:17And Ferrari is as close to perfect as it gets, but ultimately, in my opinion, perfection doesn't exist. So buying a company priced for perfection always makes me a bit nervous. Aston Martin's market cap, for example, is about$1 billion or a bit less. And so my question is, is the Ferrari brand really 90 times better than the Aston Martin brand or worth 90 times more? It's kind of a simplistic framework, of course, but seriously, how can Ferrari be worth so much more than its peers, which also have luxury pricing, they're widely recognized brands, and they have rich histories of excellence. There's this great video where Guy Spear talks about exactly this, and we can link to it in the show notes, but basically his argument is that Aston Martin and Ferrari may not actually be the same thing as much as you might think.

37:09And for example, subtle differences in branding can show up as a big difference in the business's economics. Ferrari customers are so fiercely loyal to the brand, they don't mind going to the edge of town to buy one. Whereas Bentley and Rolls-Royce have to pay for very expensive showrooms in the center of town to reach their target customers. And that results in much higher costs of distribution. That's the difference between being able to truly pull your customers to you versus chasing after your customers. And I would not say that Ferrari is anything close to chasing its customer. If anything, it's doing the opposite.

37:47And as a result, Aston Martin is a business with negative operating profit margins. While, as we talked about earlier, Ferrari has almost software-like margins. So even if Ferrari and Aston Martin appear to be similar and selling very few but very expensive vehicles, again, Ferrari just is in a league of its own. And just looking at some of those other peers you mentioned, Ferrari sold nearly 14 ,000 vehicles at an average price of$570 ,000. Lamborghini sold 3 ,000 fewer vehicles, but it sold them at an average price of$340 ,000. And Bentley sold the same number as Lamborghini, but at an even lower average price, just below$300 ,000.

38:28So clearly the supply and demand dynamics are such that Ferrari can sell more vehicles and yet do so at a 70 to 90 percent average price premium to these great brands like Bentley and Lamborghini. And that shows exactly why I think there's something special about Ferrari and why the economics for them can be so superior. almost 600k is ridiculous i would have guessed it's about 300 to 400k but it really just shows that a lot of the sales are not the quote-unquote average ferrari if something like that even exists but special editions selling for these far higher prices and how about because that's so interesting we kind of double click on ferrari sales volumes and customer cohorts and you tell us What does that look like?

39:19And who is buying these cars? Who has that money to spend on a car? You might be surprised to hear that total sales volume has nearly doubled over the last decade. But the number of vehicles sold per model per year on average has remained around 1 ,000. And the way they classify their customer base is into three groups. Future Ferraristes, current Ferraristes, and collectors. And Fioristi, for context, is the term people use to describe the most passionate enthusiasts of the Ferrari brand. And the first two categories only have access to Ferrari's higher volume range models, but may find themselves waiting up to two years to actually buy one.

40:02Clearly, Ferrari's intentions is always for demand to exceed supply. And then with the third group, collectors, well, they have access to or can be invited to purchase the rarer special edition and supercar models that Ferrari sells. So there is very much a customer hierarchy that exists. And I find that really fascinating. Just because you're super rich doesn't mean you're entitled to buy whatever Ferrari you want. And you can probably guess that turning down these types of people who are not used to hearing no personally or professionally, that only makes them want a Ferrari more. And having the broad portfolio of vehicles that Ferrari now has also supports repeat purchases by creating different Ferraris for different driving occasions.

40:46For context, Ferrari segments its customer base into people who are pilots. And those are people who are looking for a high performance extreme sports car for challenging roads. And then for sports car drivers who really want a more versatile luxury sports car driving experience. And they try to appeal to both with different models. And naturally, a big part of the moat here is the brand's intangible value. And I was actually surprised to learn this. But Ferrari has ranked as one of the strongest brands globally in three of the last seven years, placing it among this really elite group of companies that consistently score AAA plus ratings from a third party group called Brand Finance.

41:30And those other top brands include WeChat, Google, Coca-Cola, YouTube, Netflix, Rolex, Marina Bay Sands, and Deloitte. It is only one of two car brands to fall within the top 25 of those rankings, with Toyota being the other. So that is such a testament to Enzo Ferrari and the tradition that his successors have carried on in building one of the greatest brands really ever. It is very impressive, though I know sometimes branding can be so abstract that people don't feel like it's really an actionable insight to have. What do you actually do with that information? I mean, there are so many different brands, so many different industries, it's kind of hard to categorize that.

42:17But where this does become more tangible, in my opinion, is the fact that selling Ferraris has been pretty easy historically, and the sense that they are typically sold new at a price below what the same car can sell for on the secondary market. And that's called residual value. And it's actually part of what many luxury companies do. Why that matters is because what it makes it easier to sell the new cars new, but also it creates goodwill with customers who can rationalize that they are actually making an investment instead of just spending their money, which implies that Ferrari is such a good brand, it pays to own a piece of it.

42:55I think you have some compelling stats for us on Ferraris with actual value, right? I definitely do. I've been pretty excited for you to ask me that because, I mean, this is good. So a total of 74 cars have ever been sold for more than$10 million. And now I'll put you on the spot and ask you, how many of those do you think are Ferraris? I mean I feel like you're gonna say something crazy like almost all of them but when I think about all the ultra high-end brands out there and the different types of classic cars I would think only a handful could be from Ferrari your gut feeling was was right Ferrari makes up more than half of that list.

43:41So more than half of the most expensive cars ever sold are Ferraris. And if we zoom in on the top 10, Ferrari has eight of the most expensive cars ever auctioned. So that is just absolute dominance. And while the decision to purchase a luxury item is driven by emotion and a symbol of status, the total cost of ownership is a consideration too, particularly among these longstanding collectors where residual values increase, the cost of ownership is reduced. And as you said, that promotes customer loyalty in these repeat purchases. So now maybe it makes more sense how unlike really any of their peers, Ferrari can have 80 % of its sales coming from recurring customers.

44:33And there's this really cool index I came across, and it kind of looks like a stock index. It's called the K500 Classic Cars Index. And it monitors changes in the classic car market using tens of thousands of these verifiable auction sales results and then charting that index over time. And yeah, Ferraris of really any vintage do pretty well, and they tend to rise faster than the overall index on average. And while the index has actually quintupled since 1994. So that's a 5.5 % CAGR over 30 years. And it's not bad. I mean, you would have been better off owning the S &P 500, but it is kind of crazy that just buying classic cars over 30 years might have done better than investments in bonds or holding cash in a high-yield savings account.

45:22And according to Morningstar, and they cited a study by a car enthusiast group called Hagerty. They also confirm that Ferraris generally fare better than their peers in terms of the rate of depreciation in a car's early years. And for example, when comparing Apex Coupes, the value of a Ferrari 488 Pista rose approximately 5 % one year after being sold and declined less than 10 % three years after being sold. And McLaren 720S, on the other hand, loses around 12 % of its value one year after being sold. And then by three years later, it's lost over 20 % of its value. And a Lamborghini Aventador doesn't really fare any better either.

46:06It loses around 8 % after one year and then 17 % after three years of being sold. So I'm throwing a lot of numbers around. With the simple takeaway being that many Ferrari models don't depreciate within 12 months of being sold, which is uncommon in the industry. And they tend to depreciate less over several years than anyone else. And that was the study's findings in a nutshell. But there's just a lot of variance across make, model, and year. And this is going to sound like kind of a loony thing to say, but I actually see a similarity here with what Ferrari has cultivated among their customers and with Berkshire Hathaway.

46:48They've both created this culture of long-termism. and it reminds me a lot of the culture Buffett has created among shareholders of Berkshire and we got to see that firsthand at this year's shareholder meeting in Omaha in May and the types of people who invest in Berkshire and go out to the shareholder meeting they're not your average retail investor they are people who follow Buffett and have learned to think particularly long-term to an extent that is abnormal compared to the average investor. And not only is the average Ferrari purchaser not your typical car customer, they're not even really the typical car customer of other luxury vehicle brands.

47:30It's more like this cult-like following that deeply cherishes all things Ferrari. And that is what makes the brand unique. You can really see that long-term culture at Berkshire literally in the fact that Berkshire's trading volume turns over much less than other S &P 500 companies. And with Ferrari, you see it in, as you mentioned, the higher rates of repeat customers and through vehicles that comparatively hold their value better than the rest. One thing I wanted to add, which will be pretty interesting to see, we will see how Berkshire's culture or how strong it actually is next year when we once again visit the shareholder meeting.

48:09and we will see how many people show up after it was now Buffett's last year at the meeting. Right, and part of how they've done that is they foster this proud long-term ownership culture through offering a very comprehensive, long-tenured maintenance program. In other words, there is a support system designed for every stage of a Ferrari's life. and that is pretty unique among luxury car brands and for example it is the only luxury car brand to offer a seven-year complete service plan which is automatically included with every car purchase and that sort of stuff implicitly conditions people to treasure their Ferraris beyond the fact that they spend a massive amount of money on them and to view them as these lifelong commitments in some cases.

49:04And that is fanaticism. And it's just not something you see with really many other products, let alone car brands. And after that seventh year, assuming your Ferrari is in excellent condition, which it should be given the warranty program that's included, then your car will likely qualify for extended coverage through its 15th year. And that extension also applies to pre-owned cars and can be transferred between owners at any point during the plan. And between the 15th and 20th year of the vehicle's life, Ferrari offers specific maintenance kits over and above the regular service plan to then preserve car performance and safety systems longer term.

49:48And if customers follow those maintenance plans for 20 years, then their vehicle will automatically receive a certification that makes it more valuable to collectors ultimately. So there is an incentive to follow the guidance that Ferrari so thoughtfully lays out. And so when I say Ferrari has built a long-term ownership culture, sort of like the approach Berkshire has taken with its portfolio companies and shareholders, I'm not giving you a song and a dance. This is very real and it pays dividends for the brands by making it easier to sell Ferraris. at consistently high and rising prices over time.

50:25And that, again, is why they can sell 80 % of new vehicles to repeat customers. Such a great system where even stuff like maintenance programs, which are usually just seen as a necessary service that is part of the product offering, but honestly just an extra cost for the car manufacturer, is turned into something that both increases retention and seriously adds to the culture of the brand and the lifetime value of a customer. I said it before, but your pitch today really gives me a new degree of appreciation for Ferrari. But at the same time, since we're considering making an investment, before we get too excited about the story, how about we linger a bit on the risks?

51:07What are some of the headwinds that Ferrari is facing? Like all other auto manufacturers, it is in the process of dealing with what seems to be an irreversible trend. And as many people who came of driving age as teenagers back in the 70s, 80s, and 90s will know, preparing for and earning your driver's license was really a rite of passage. And it was typical that on your birthday when you turn 16, the first thing you do is head to the DMV and get that glorious driver's test and secure an ID that really in many ways would authorize you to not just drive an automobile, but really gave you a sense of freedom.

51:44And yet there has been a consistently growing percentage of young women and men between 16 and 25 who neither have a license, nor do they really seem like they want to get one that urgently. Since 1983, the percentage of 18-year-olds with a driver's license has fallen from 80 % to 59%. I mean, I didn't even know that was going on, but that's astounding. And with driving services like Uber and Lyft really being ubiquitous in the US, even in these small cities, the number of drivers just continues to shrink relatively. And consequently, so does automobile ownership. So that is the real challenge.

52:30If the future is self-driving cars and maybe not even car ownership, because it's just so easy to jump into a nearby robo-taxi, does that mean that no one will know how to drive? 40 years from now? Would people have to learn how to drive just to own a Ferrari or would Ferraris have to be self-driving? I mean, in that case, there's a concern that maybe car driving would almost be, would kind of go the way of horseback riding. It was a skill that was very common, then it quickly became outdated. And now it's kind of stereotypically a hobby for the rich. wow okay i mean that's a narrative you can call me short-sighted or naive but that bear case seems like too much of a stretch to me i mean the underlying trend might be right fewer young people get driver's licenses and with more and more avs and ride-sharing alternatives not everybody needs a car but when we talk about high performance cars people just love to drive them and it's that freedom that you talked about and i'm not even yet talking about ferrari but more about Mercedes or BMW.

53:36And like we so often said today, Ferrari is on a whole nother level. But I guess you can argue that this might be a very distant risk weighing on the terminal value of the company. And clearly not yet. I mean, people are willing to pay a PE of 50, but perhaps in the future. And since we talk about terminal value often, it might make sense to explain what that even is. So what we mean by that is the value of a company beyond what we can model with some level of confidence in the valuation. I like to only model out five years. Some other investors choose to model out 10 years. And thinking about the terminal value kind of means thinking about what could threaten this business even after all that time.

54:17What could cause it to transition from a mature company to a declining one? And for Google, the anxiety is that AI chatbots or vertical search tools could kill its search and therefore also its high margin ad business. For a company like Uber, it's uncertainty around how AVs will change the mobility sector. Do we need an aggregate of demand in the future or not? Even with these two companies, I think those fears are overblown. But in Ferrari's case, I really don't see it at all. The first two are fears that we also already see materialize, at least to some extent. The Ferrari bear case is almost certainly decades away if that ever happens.

54:58You're right. I mean, it's a really long-term bearish argument against Ferrari. And it maybe resonates with me a little bit. I do tend to generally think it could be directionally true, but people really overestimate, I would think, how quickly these society-wide changes like that can happen. And if we're talking about a risk that is, realistically speaking, 30, 40, or 50 years out, or is maybe just a complete sci-fi fantasy, then to your point, in our terminal value, how seriously do we take that today? The market doesn't seem to be taking it that seriously. And if the biggest argument against Ferrari's continued success is that the world will eventually run out of people who know how to drive, well, I'm pretty happy to take the other side of that bet for the foreseeable future.

55:43And maybe listeners think I'm making a straw man argument here because it really doesn't sound like a great argument, but I'm actually basically quoting an argument that was made by a few different professional investors on the Value Investors Club forum in a post a few years ago. And this gentleman in particular was making a case for shorting Ferrari. And the point being, this is a real consideration on Wall Street and for the bears. But if we were to own Ferrari, I would not be losing any sleep over this risk for the foreseeable future either. And as a more tangible risk, though, I would point out that the company, because of how sophisticated and unique Ferraris are, it does still rely on just a handful of these single source suppliers, where that supplier is really the only option and there's no backup plan.

56:34And the counter argument there is, well, you know, they survived COVID and the disruptions from the invasion of Ukraine. But still, there is a fragility there. Their supply chain is not going to be nearly as robust as other automobile manufacturers. And that poses some risks. And so fortunately, so far, Ferrari has not seen any significant changes in orders or cancellation following the implementation of import tariffs in the US. Plus, not only does Ferrari have pricing power, but tariffs could actually benefit them by boosting the residual value of Ferraris in the secondhand market. So that is kind of a wonky thing to think about.

57:11But it does kind of I feel like no matter what happens, Ferrari wins. It feels like luxury brands overall always find a way to win, even if tariffs can be good for the business. Something else that has stood out to me is that since its IPO in 2015, Ferrari has pursued something which you might call a horizontal growth strategy by offering the widest product portfolio among luxury supercar manufacturers. is it seems that Ferrari has been able to increase total volume while maintaining its air of exclusivity. You mentioned this earlier when you talked about how total sales volumes have doubled and the average sales per vehicle model have stayed the same.

57:55How sustainable is it though for them to try and make more and more types of Ferraris so they can increase sales volume without diluting the status of any single model just by producing too much of it. It's hard for me to think that they could go another decade of that without throwing overall supply and demand for Ferrari's out of balance. I think the success of the strategy to broaden its portfolio is really only possible because of Ferrari's reputation for industry-leading innovation. Each model they launch has revealed some advance in design, technology or performance despite a rate of 15 model launches per every four-year period basically starting in 2018.

58:39So I wouldn't bet on their R &D budget falling too much as a percentage of sales because it just remains so structurally important to their growth strategy. And then you're right, they're testing the limits of how much they can meaningfully innovate. And there's a risk that those innovations go stale. And we've seen this with Apple. Launching a new iPhone every year or has turned iPhone release days from these breaking news events that would promise to reimagine how we all use our phones and interact with the digital world now being these sort of boring incremental improvements. I don't get that excited about them anymore.

59:14I mean, it hasn't been fatal to Apple yet, but I'm sure they wish they could command more hype from their launches. It's just so hard to meaningfully innovate long-term at a certain pace. And so to your point, Ferrari could be setting itself up for something similar down the road. But the paradigm change for Ferrari has been from the very strong adoption of their hybrid vehicles. So that helped a lot to support volume growth over the last five years since hybrids were truly something fundamentally different. And maybe the new types of EVs that they come out with can carry the torch and give them more room, more runway over the next couple of years to continue to excite people.

59:57But again, at some point that it starts to go stale. The sixth different EV model is not quite as exciting as the first or second. That is just the reality. And so more practically, things like personalization and collector car launches, I think, will continue to drive the business forward longer term. Though new releases will always be a big part of the sales strategy and the hype that they generate. You mentioned this to me before we started recording, but I have to mention it because I found it so interesting. 40 % of executives' long-term incentives are based on total shareholder return relative to a peer group dominated by luxury firms whose business models also rely on branding and pricing power.

1:00:46And in my pitch for PayPal, I talked about how much I like the management incentives there, where management was judged against the total return of the S &P 500 over a multi-year period. And yet Ferrari's comp structure might actually be a bit better than that. I love the idea of challenging them to really outcompete other top luxury brands that are publicly traded companies. I agree. It is not a bad incentive structure at all. But it does puzzle me that they haven't done a better job of executing buybacks at more attractive prices. They've had this high-class problem of always having such an expensive stock that it hurts their ability to do buybacks effectively.

1:01:29But maybe we talk about more when we get to the valuation section. Let's just get right to it. I'm sure there's more to dwell on, but I'm curious to see where you landed with this stock and also talking about buybacks. So I'm ready to talk valuation if you are. Okay. All right. Well, as I started working on my model, I couldn't help but think that the predictability of Ferrari's business is pretty compelling. They know pretty much exactly how many vehicles they're going to sell several years out into the future because it basically increases by 1 % to 2 % a year. And then if they raise prices by an average of 5 % each year, you've got baked in 6 % to 7 % top line growth.

1:02:09and it also helps that they have an order backlog with deposits that can span more than a year out into the future too. So again, you just have a lot of demand certainty and maybe they can't raise prices by 5 % a year for forever, but there is probably a pretty long runway for them to keep raising prices, especially with all the pent up demand from people just waiting to buy a Ferrari. I mean, what is the difference between spending$500 ,000 and$525 ,000 on a Ferrari to someone who maybe has a$50 million net worth. I mean, it's probably not a big one, especially if this is someone who is a true believer in the Ferrari brand.

1:02:47For the long-term trend, it might bear mentioning that income equality has gotten way worse since the great financial crisis, meaning that in most places, the rich have gotten richer faster than the overall economy has grown. And the top 1 % have done very well over the last 15 years. Just look at how the stock market has done over that time. So Ferrari buyers, I would guess, probably have as much disposable income, if not more, as they ever had. It certainly bodes well for their continued pricing power. You're not wrong. And that is why I think Ferrari can continue to raise prices for many years to come, while also gradually pushing sales volumes higher too.

1:03:29As repeat customers make more purchases, and as the population of ultra-wealthy people globally increases generally, that just creates many more possible customers for Ferrari. And I also think there is some operational leverage to be gained on what I would assume are these relatively fixed costs for R &D and administrative overhead. And for example here, since 2019, Ferrari has been investing$200 million more every year into R &D. Yet, R &D as a percentage of sales has fallen from 20 % to 13 % as the business has grown. So for anyone who's not familiar with this concept of operating leverage, that is a pretty good depiction of it.

1:04:12And it directly translates to higher profit margins. So that trend can continue as the business keeps growing, especially if that growth comes mainly from higher prices rather than trying to sell more vehicles and more types of vehicles, which would require an increase in R &D. So that price-driven growth is really the most valuable in some ways because it provides the most incremental boost to margins. And I could really honestly see Ferrari's operating margins rising to 30 % or higher by 2029. And with the continued share buybacks that they've been doing, I don't see a reason why earnings per share couldn't easily compound at 10 % to maybe 15 % a year when you account for their top-line growth, both expansion and margins, and then this shrinking denominator from share repurchases that reduce the shares outstanding.

1:05:06And we look at a lot of companies, that's very healthy compounding, Daniel. And the question is, are we paying a reasonable multiple for that growth in the returns on capital that come with it? And so that's the trickier question. since inception at IPO, the market has always treated Ferrari as not just a luxury stock, but really as being one of the best of the best luxury stocks like Hermes. And that's a credit to the investment bankers who originally helped sell the IPO. And it explains how Ferrari's multiple can be about twice LVMHs. Its median PE over the last decade is 40 times. And even over the last five years, its median has been even higher at 48 times earnings.

1:05:51And so today, the stock is trading near that five-year median and actually toward the top of its longer-term valuation range. So it would be hard for me to come here and argue that the stock looks relatively cheap, but given the quality of the earnings here, you feel very confident that the company can into recessions, continue to raise prices over time, and continue to use F1 and its brand to drive sales on top of the very high returns on capital the company's historically generated, really relative to almost any other company. It's not surprising for Ferrari to have a much higher valuation multiple than the market average, but maybe not this high.

1:06:34I think a more reasonable price to earnings valuation for Ferrari would be in the low 30s. And so when I do some basic modeling and account for a pretty significant contraction in the exit multiple as the business continues to mature, I see the stock being fairly valued between call it$300 and$320 per share and pretty attractive to buy if you can get it at$270 or lower. And that is a substantial discount, I should say, to the current price at the time of recording of about$490. So even though I really want to own the company genuinely, it does have to be at the right price. And you know that. And right now we're not even close to it.

1:07:17So it's hard for me in good faith to say we got to add it today. One thing that you can look at just to understand how expensive the company is, is looking at the dividends, which should be way more consequential than they are since they spent a big chunk of their earnings on dividends. But actually, the price of the stock is so high that the dividend yield is like 0.7%. That doesn't move the needle at all, really. But at a lower entry price, that dividend yield would, of course, be much more meaningful. It's a really good point. 27 % of Ferrari's earnings go toward dividends, with another third toward CapEx.

1:07:53And then the rest goes toward share repurchases. Though the share repurchases, the same thing is true. They're also made at such a high price that it really doesn't have much of an effect on the overall share count. So I would actually probably prefer that they just distribute capital by way of dividends and try to more than double their dividend yield, make it a little more substantial, rather than just sinking a large chunk of earnings into these relatively unproductive share buybacks. And to put 40 % of your earnings into buybacks that only shrink your share count by half a percentage point a year or so, I mean, that just really does nothing.

1:08:32And if you contrast that with our portfolio holding Ulta, where they're allocating a higher percentage of earnings toward buybacks for sure, yet they're shrinking the share count by 5 % to 6 % a year. So they're maybe spending two and a half times as much on buybacks as a percentage of their net income, but they're shrinking their share count by 10 times as much. And that is the difference between buybacks at higher and lower valuations. And it just strikes me as very poor capital allocation by Ferrari, where they're treating share buybacks as this objectively good thing without considering the price they're done at.

1:09:10And whenever you're buying back stock well above the fair value for the shares, you're arguably destroying potential returns for shareholders going forward. So ironically, that poor return of capital strategy, to me, says to me that they should trade at a lower PE, which if that did ever meaningfully happen, would help them conduct more effective buybacks. A premium valuation is a blessing and a curse in many ways. If you're relying on stock-based comp to attract talent or want to use your stock as a currency to make acquisitions, then a premium valuation is great for managers. But if you're trying to maximize shareholder returns and return capital with share repurchases, paying a higher price tag reduces the number of shares.

1:09:53you can actually retire for every dollar that goes toward buybacks. And in this case, Ferrari doesn't use stock-based comp all that much, and they don't make acquisitions in stock. So the really rich stock price isn't doing them any favors, honestly, in terms of buybacks and forward-looking returns for people who buy the stock today. And they destroy so much capital that it's hard to imagine where the growth should come from going forward. I think that's a pretty long way for us to say, operationally, Ferrari is great. but they really could further separate themselves by tweaking their buyback strategy and with all of that said I think it's safe to say we won't be adding Ferrari to the portfolio today but it it makes for one heck of a case study besides maybe the very first episode of this show when I went through the pitch for Madison Square Garden Sports Company this is arguably the coolest company I've covered I knew learning about Ferrari would be fun but I've really been pleasantly surprised how genuinely high quality the business is and how enjoyable the case study was to do.

1:10:56It's a real masterclass on branding and in supply and demand too. So who knows, Daniel, maybe one day we'll go from debating buying the stock and we'll actually be buying Ferraris ourselves. I would take that. I mean, unfortunately, we're at least 10 years late to finance that Ferrari by buying the stock in the company. Not to say that it's too late to make great returns on it or with it, but the risk reward has shifted. I think that's safe to say. If there's one mature company in the world where I would pay a PE of 50, it is Ferrari just for how of an insanely well-run company it is. But I don't like buying stocks that are priced for perfection.

1:11:38And as evaluation shows, if we assume a lower multiple, and let's be honest, a PE of 30 is still a premium multiple. The returns look really anything but promising. And as you said, another big problem with the valuation is just how inconsequential buybacks and dividends are at these prices. And if you just think about the billions of dollars they've already put into that, it's kind of sad to think about all the money which never really reinforced shareholder returns. And you know my bias for luxury companies and also strong brands. So if we should ever see it at a multiple around the low to mid 30s, I would want to revisit it ASAP.

1:12:17But you know the company better than I do from what you told me today. And I do see no compelling bear case for this company. I think the only actual concern here is valuation and the multiple that you have to pay for it. I agree. And I'm a little nervous about what it would take for the market to contract the multiple all the way down to 30. but as you said if it's not something that's too much of a serious long-term concern maybe it's a just a general market sell-off and panic that would be such a great opportunity to own what is an incredible business that really never goes on sale below 40 times earnings so we're being a little picky here but you have to give yourself that kind of margin of safety because the downside side becomes way too asymmetrical at such a high PE like that.

1:13:08The company is just not growing that fast. If they're growing twice as fast than they currently are, I could maybe get behind a 40 plus PE, but just not the case. Perhaps we get lucky with the EV start. I mean, I could see a future where perhaps the EVs don't sell as good as the market hopes. And that's why, I mean, I think we only need one or two quarters and a company that is valued at a P of 50 might go down to a PE of 30. And that's just because, you know, one EV comes out and it's not the biggest hit the market is expected. And perhaps we then get a chance to grab the storm. All right, well, maybe EVs will be our big opportunity with Ferrari, who knows?

1:13:48I think it's that time of the show where we move on to what's next. So how about we get a preview of next week's pitch? So care to give us a few hints, Daniel? The company I will pitch next is one that has been around for a long time, at least if you compare it to the lifespan of the overall industry. And when I think about it, I recall my old school days because its products dominated the computer labs back in the day. And nowadays, the story is a bit less about hardware and more about clouds and AI. However, despite the AI narrative, it couldn't yet match the performance of any of those high flyers such as NVIDIA.

1:14:30And that's why I think it might make a pretty interesting case right now. And I think these hints were pretty vague still, but I know we have some very intelligent people in our community. So I think that might be enough for some to get what company I'm talking about. Okay, yeah. Well, with that, we'll leave you with one last quote from none other than Enzo Ferrari, who tells us, I've yet to meet anyone quite so stubborn as myself and animated by this overpowering passion that leaves me no time for thought or anything else. I have, in fact, no interest in life outside racing cars. If only we could find that kind of passion from the founder of every company we look at, that would be great.

1:15:11I believe that spirit very much underpins Ferrari's continued success to this day as a company and with the stock. So with that, we will see you again back here next week for Daniel's Pitch.