TIVP050: Portfolio Review: Performance and New Positions w/ Daniel Mahncke & Shawn O’Malley

24:29To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. Yeah, those are shoes that I don't even find that ugly. I know that you find them very ugly. But yeah, I had Crocs on my radar ever since the Q2 earnings because it was a huge sell-off after they reported those. And it's obviously cheap. The metrics are kind of insane if you just look at them. There are few companies in the space that have a margin profile anywhere close to it.

25:07Lululemon, one of our other portfolio earnings, is actually one of the few companies in fashion retail that has those margins. And you're getting paid if you buy Crocs, basically the moment you enter the stock. I mean, it has an 18 % free cash flow yield and that's 18%. I think that's one of the highest that we ever looked for. And on top of that, they spend hundreds of millions on buybacks, which translate to a 16 % buyback yield at the time. So just by buying the sale, you're immediately getting paid for holding it. So on the surface, it really looks incredible. But I have one big problem. Actually, I have two big problems.

25:39The first would be that it's still a fashion retail business. And I really don't like investing in that industry. We've made two exceptions with Lululemon and with Nike, but those companies are obviously far more established than Crocs is. And another issue with Crocs is that their sales are actually declining. And I'm generally not a fan, as most of you can imagine, of investing in businesses where the top line is just moving in the wrong direction. And I love cheap valuations, but the best opportunities are usually those where you have a strong business, but a weak stock. And Crocs is actually struggling.

26:12I mean, it's been hit harder than many other brands, which suggests, at least to me, that this isn't just a weaker consumer environment. And that does give me some pause. And it's actually the reason why I did not immediately enter a position after the Q2 earnings drop, because I still felt like we should probably wait a bit and see how it plays out. However, and this makes me a bit more optimistic, that is 6 % revenue decline last quarter. and that was mostly driven by the Heydude brand. So there's Crocs and then there's the Heydude brand, which is a company that I acquired a couple of years ago.

26:43And that brand is not doing well. It was down about 20%. And while that's not great, obviously, I would still much rather have weakness coming from Heydude than from the core Crocs brand. I mean, the strength of the business is still the core brand itself. And if that part remains much more stable, I'm pretty happy with that. So even if Heydude never returns to meaningful growth, crocs can still be a pretty good investment as long as the quail band grows, even at, let's say, a low single-digit rate. And actually, it might help to just quickly walk through the variation model I built back then for the episode.

27:16I mean, if I would now assume that, hey, dude, keeps declining by, let's say, 10 % a year, and the crocs band grows at just 2 % in North America, which, by the way, it grew 17%, or at a cag of 17 % over the last five years. And then we're at maybe 9 % for international growth, where once again, they actually grew closer to a 25 % CAGR over the last five years internationally. But then you end up with a fair value of about$78 per share. And that's pretty much where the stock is currently trading. And remind you, that's if HeyDude basically gets cut in half over the next five years. So obviously, this still assumes some growth.

27:52So if Quark just keeps declining and it's not growing at all, this will not be a good investment. But the market is just not expecting a lot from this company right now. It really feels like Crocs is already priced for a worst case scenario. And you see that a lot with these kind of unloved stocks where sentiments just totally beat down. And clearly anything even slightly better than that worst case should lead to pretty solid returns, you would think. And so in our episode on them, I think the big question we want to answer was whether Crocs are just a fad or whether it's this more enduring brand that's here to stay.

28:26And immediately my gut instinct is, I remember seeing Crocs in the playground as a kid. So calling them a fad, I don't know. Maybe there's some cyclicality and some trendiness that comes and goes with the business, but it has endured for a while. And so I get that those kind of declining sales are not a good look for the company or for us wanting to feel confident about the brand we'd be investing in. But like you said, it's also not actually really the Crocs brand that's struggling. And volumes for them actually keep increasing steadily. And so the main pullback is spending on promotions to defend their margin profile, kind of in this weaker environment of consumer demand, and then also really because of the Hey Dudes brand being so weak.

29:10Yeah, that's one of the big things. When they saw that the consumer is getting weaker, they said, let's actually pull back on all the promotional activity that we do. So that might hurt the top line, but we still defend our margins, which is what, for example, finances the buybacks, which is obviously a huge part of the thesis. And that's kind of one of the other big risks that you potentially have in this stock. And that's management ending up repeating, making the same mistakes and goes out to acquire yet another company after hopefully getting Hey Dude back on track. And the buybacks do offer some natural protection against that because if you spend money on buying back your own shares, you should obviously have less money to then go and acquire another company.

29:50And they already had two failed attempts at diversifying. So I don't know, trying for a third time just doesn't sound to me like it's the best idea, but I'm not fully convinced that the management's incentives and the shareholders incentives are actually perfectly aligned because shareholders obviously, especially right now, want buybacks and as much capital return to them as possible over the next few years at least. And the management is probably thinking about the long-term health of the company. And over the long run, it's just usually very hard to survive on just one product in fashion retail.

30:21So I don't know, it makes a lot of sense for them to eventually decide that they want to buy another company yet again. Just, I mean, technically, Hey Dude could work out and they are a diversified company, but it doesn't really look like that's going to happen anytime soon. That said, I think it's a pretty encouraging sign that insiders have been buying shares in the open market recently. They have done that at prices around or in the mid to high 70s. That's where the stock is currently trading. And at the time of recording now, it's at$73. So technically even the low 70s. And to me, that's definitely a positive sign.

30:51And also the CEO actually said in an interview that part of the reason for the Hey Dude acquisition was that investors wanted the brand to be more diversified. And I know it's kind of the opposite of what I just said before, but we should also keep in mind that this was at a time where the investors will, when the stock was basically pretty much way further up than it is today. And Crocs are still a growth story. Now, if we think about investing in it, it is basically a value play. But back then you thought, okay, well, the Crocs brand is doing perfectly fine. Why not get another brand into the ecosystem and scale that up as well.

31:23So I think investors probably have changed their view on what's best for the company. And honestly, I mean, if management is saying that investors wanted this and that's why they're doing it, you can see that in a positive or a negative light. It would suggest that we will not see another diversification attempt anytime soon, which is obviously good. But it also makes me question whether management ever believed that the HeyDude acquisition was even a good decision in the first place or whether they just thought, you know, this is what investors want. let's give it to them and if that's the case it sounds to me like a pretty weak management which was you know ready to spend billions on a deal they never really believed in in the first place I think it's a questionable approach to doing an acquisition and that's for sure but significant buybacks along with some instead of buying I mean those are good signs that offset some of the acquisition concerns I guess and so if it's up to me I would feel comfortable adding a position here and I think we are in pretty good alignment that it's almost more of a trade based on intrinsic value than like truly a quality compounder that we would want to hold for many, many years.

32:31And therefore it's one of the riskier bets in the portfolio. And that would probably be an argument against going into it altogether. But if we can kind of size it as a two to 3 % bet and know that, yeah, this is, I don't want to say rolling the dice on, but this is almost like a strategic gamble in a way of like, we feel like over the short to intermediate term, the risk reward is in our favor. But yeah, let me ask you, I mean, how do you think about it? I totally agree. I mean, at$73, I think it's just a pretty asymmetric opportunity. And of course, we do not want to have a lot of trading positions in our portfolio in the long term.

33:10But I think oftentimes when you buy a stock that's pretty, pretty hurt, pretty low down and you got to have to just look at the situation and then assume, okay, is this an asymmetrical opportunity where I'm willing to take this as a trade? And then if it works out, if both brands stabilize, I could totally see how this is a phenomenal company in 10 years time. And if that's the case, we're never forced to sell out of our position just because the price increases. We can definitely hold it longer if we think that makes sense. But as you said right now, I think it just makes a lot of sense to see it as a trade and then say, make it a 2.5 % position.

33:43So it's kind of reasonable considering the risk that the investment thesis still has. And just to be clear, for some investors who might know Norbert Lu and look at his portfolio, I want to make clear that we are not cloning his portfolio. I know he has PayPal and Crocs in his fund and they actually make up about 30 % of his portfolio, but we were sooner on PayPal. We pitched it here on the show first. We bought into it and then we also pitched Crocs. Now we didn't decide yet to buy it, but we actually just waited for a better entry. So no, jokes aside, let's maybe talk about one of our current portfolio companies next.

34:15Before recording this episode, we had a bit of a discussion whether we should add to Nubank. And it's still a relatively small position at, just like Quark's will be, 2.5%. And it delivered just another great quarter recently. So for us, I think Nubank is currently up about 30 % since we bought it. But I think our conviction has gone up, not only because of the stock price, but mostly because of the fundamentals of the company. So how do we currently think about it? So I actually talked to one of our community members about NewBank recently, and he works in banking and has spent a lot of time in South America.

34:47And he raised concerns about making such a concentrated bet on the Brazilian consumer and really the risks that come with that. And so at the same time, Nubank has just repeatedly shown that it can grow incredibly fast without taking on meaningfully more risk than the kind of diversified legacy banks of Brazil. And so we walked through the numbers in detail during the Nubank episode we did. But for anyone watching on YouTube or Spotify, we're showing a table on screen right now that compares Nubank's risk metrics to those of Brazil's traditional banks. And yes, Nubanks are a little bit higher, but really nothing that stands out as being very material.

35:31And so when you look at NPL, which stands for their non-performing loans, these are loans where the borrower is seriously behind on payments or unlikely to repay at all. And so typically you would look at these after the 15 day and 90 day marks of being late. And so new banks, NPLs are a little higher than competitors. But again, when you put that in the context of having four times the growth rate of these legacy banks, they're just doing a very impressive job, in my opinion, of balancing growth with risk. I've really never seen anyone do it as well as they have. And so at the same time, Nubank has been quickly diversifying into more secured, safer forms of lending while also expanding quickly in higher income markets that could be even more profitable for them.

36:16And so in Mexico, for example, a quarter of the entire banked population is already a Nubank customer after entering the Mexican market in 2019. And so, I mean, that's just incredible. And another kind of exciting thing for them that's been on the radar recently is they applied for a bank charter in the U.S. You might be thinking, wait, that's ambitious, right? How are they going to run this? Should they be focusing on running this playbook across Latin America? And what are they doing entering a very mature banking market like the US? And how could they even think they could try and compete there?

36:47And I think that's a reasonable instinct to have. But I do think the opportunity they probably see is in addressing the Latin population in the US, especially amongst folks who have family in Mexico, Colombia, and Brazil still. And so there is a massive market for these first and second generation immigrants to the U.S. that want to remit money back to family in these countries. And well, if the family you're sending money to uses new bank and you're able to use new bank in the U.S., I'm no payments expert or banking expert, but I would imagine that would streamline a lot of things by cutting out different middlemen.

37:22So I think that is really the value add of how they think they might be able to carve out a niche in the US, which is, of course, a much more valuable market collectively than any of these single smaller markets that they've quickly come to dominate. Right. It would be interesting to see what's their main objective going into that market. If it actually is just remittances, which definitely is not a small market, but at the same time, NewBank is already quite a significantly large company by now. So perhaps they're actually going just to be the number one bank for people that are Spanish speaking and in the US.

37:57I think we generally shouldn't judge NewBank's management's decision making. I mean, whenever they expanded, they were highly successful. So I do think they have a good plan for what they want to do and achieve in the US. And when we added Nubank to the portfolio, I mean, we sized it at about 2 % because we really like the metrics and the growth that the company brings. But we were also, I would say, fully aware that it sits outside of our circle of competency. And I still think it's totally fair to have it in the portfolio. And if you ask me, the odds are much higher that this will be a significantly larger company 10 years from now than it is today.

38:31But at the same time, we're on the same page about this being a riskier bet simply because we don't have the expertise in the banking sector, especially not in banks that operate primarily still in South America. I mean, if we talk about risk, it can mean so many things. I don't think that NewBank is remotely as risky as maybe Crocs is right now. The risk is more so that we do not fully understand the business model to the same extent that you can understand a fashion retail company. And we just wouldn't be the first ones to spot warning signs if things start to deteriorate in Brazil, for example, or the consumer is weaker than banks are counting on it.

39:08There's just a real chance we would actually end up holding the bag longer than we should if that happens. And that's exactly why this remains, maybe we should call it a learning position for us in the portfolio and why we're keeping the size of it unchanged for now, even though it's definitely performing even better than we hoped for. I like that framing of it. And not every position has to be a core holding. I think we're in agreement with that. And we do see these asymmetric opportunities in stocks that maybe don't have the right margin of safety or a big enough margin of safety to be a comfortable core holding for us where we're not losing sleep at night worrying about it.

39:43Then yeah, I don't have any issue with having these smaller positions and just kind of letting them cruise and saying, you know, the upside here more than offsets the downside, even if the downside is going all the way to zero, right? That's why you're capping the position. So it can only do so much damage to your portfolio. And I mean, Reddit was a perfect example of that. When you're talking about a stock that has doubled or tripled, the net effect is very positive. And yet at the same time, our portfolio would not be just totally destroyed if Reddit went to zero. Obviously, we don't think that's very plausible at all.

40:17But just in terms of thinking about kind of the range of outcomes on the extremes. Yeah, I mean, speaking about core holdings in our portfolio, a company where we should discuss doubling down on is probably Uber. I mean, I feel like we talk about the company so often. There's probably no company that we talk about more often than Uber. We were invited to give a speech recently at an investing conference in Lisbon. A couple of weeks ago it was, and then we pitched Uber as a stock when we were on stage. When we were at the TAP summit in Big Sky, Montana, a couple of months ago, So we pitched it again.

40:50And also our members in the intrinsic value community are likely by now tired of us speaking about it too, because we pitched it in one, maybe even two of our calls there as well. So it's a company we just spend a lot of time on. And given how much we talk about it, 4.8%, which is where the position currently sits at in our portfolio, may not even be adequate. I mean, originally we bought into Uber in the 60s and we've already added once. So our average price right now is closer to, let's say,$75, which puts us at roughly a 20 % return today. So it's not like the stock has run away at that point, at least not to our average buy-in price.

41:25So adding might not be unreasonable, especially when we are still, I would say, early in the broader thesis that Uber will become the main aggregator of AV demand. And even if you look at the evaluation, it seems very reasonable. I mean, the forward price for cash flow is around 18 times and the forward PE is about 27, which is slightly higher. But then again, if we talk about the average market company right now in the S &P, it's even slightly lower than that. And by the way, if you're looking at the numbers yourself, maybe on Fiscal AI or wherever, you will notice the current PE sits at just 11 times.

41:55That's just because Uber booked a huge tax benefit that inflated earnings by almost, I think it's$5 billion in the last quarter. So the reported earnings are overstated. The actual PE is closer to 27. But then again, I mean, what matters to us is mostly cashflow. And if you trade at 18 times free cashflow, and the company is growing 20 plus percent, it's not even not expensive. It's actually cheap, if you would ask me. And maybe the most important part of the story is that Uber has become a genuine cashflow machine and just keeps on getting better. Margins keep improving. And the business is finally showing the kind of operating leverage that investors have been waiting for many years.

42:30I mean, currently on the screen, we show a chart that I sent to Sean on Slack earlier, which is maybe one of the most beautiful charts of operating leverage I've ever seen. Basically starting from the bottom left and they're losing a ton of money. And then in almost a linear straight line to the upright, you just see how they make more and more money each year. I don't think there's much more I can add to that. I mean, that perfectly encapsulates it. And if you can watch what we're talking about right now, I mean, that chart is really very illustrative of the point. And so I would love to buy Uber at an even cheaper price, of course.

43:03but we are actually at about the price where we have previously added to Uber. And so I think there's a reasonable argument that we still see the company as being undervalued. It's a long-term bet we feel comfortable making. We've only gotten more comfortable with that bet over time. So why not increase the position to 6 % or 7 % today? And if we get a serious sell-off in the shares, I mean, that would be an opportunity to take it to maybe even a 9 % or 10 % position where we're just averaging down and taking advantage of the whims of Mr. Market. But yeah. Absolutely. I totally agree. I mean, maybe simply because we talk about making it a core holding, and also because whenever we hold or held a presentation on Uber, we split it into a bull and bear case.

43:45And for reasons of consistency, ours took the bear case. And maybe because of that, I'm kind of prone to also give that argument. And maybe it's interesting for listeners who haven't heard us talk about Uber yet. And since we're discussing making it a core portfolio holding, maybe we should quickly summarize the bear case once again. And very briefly, I mean, mainly there are two risks that we see for Uber. And the first one is pretty, pretty easy. It's basically a fast expansion of way more and to some extent also Tesla, if they can expand fast enough to aggregate demand in their own apps for AVs and just ride hailing in general, that obviously would be a huge hit to the Uber thesis.

44:20But honestly, I think once multiple AV companies are out there with functioning cars and they choose to plug into Uber's ecosystem. I think Waymo and also Tesla would simply be forced to do the same and all the cities they operate in just plug into Uber as the aggregator. So basically that is a race between Tesla, Waymo that need to be fast enough to not only create AVs but also create the scaling effects that you need to aggregate a mart in your app before other AVs are on the road and just basically partner with Uber, which is what most AV companies have done and still are doing in the case of Uber anyway.

44:58So I think that's a risk where I would say this is the least likely to actually materialize. I mean, right now we are talking about Waymo and they are planning on add another five cities where they will be exclusively on the Waymo app. And these cities are Miami, Dallas, Houston, San Antonio, and Orlando. And while I am surprised and also to some extent proud of Google is still one of our portfolio holdings and what they can do with Waymo and the speed at which they do scale their offering, I don't think this pace is enough. I mean, especially considering that we are only talking about cities in the US right now and then only about certain parts of the cities because all of them are still geo-fenced.

45:34I don't think that's enough to actually hurt Uber. And the second potential risk that we talked about in Portugal as well is a potential takeover of Lyft, the biggest competitor that Uber currently has in the ride-hailing space. And companies that aren't questioned to do that are probably the big tech companies and perhaps the best positioned one is Amazon. I mean, Lyft's market cap right now is about$8 to$9 billion, which is a joke for any company in the big tech, but especially for Amazon, especially if you see that they would get 25 % of the US ride hailing market just like that. And Amazon could plug Lyft into, let's say its prime membership and monetize it from basically day one.

46:08And what makes this even more compelling, at least in my mind, is that they could also use these Lyft cars and then plug them into their delivery system. So think of Amazon's AVs, which they're also building, bringing the packages to just the nearest Amazon warehouse in the city. And then drivers, basically Lyft drivers, pick them up, take over, and take charge of the last mile delivery. I think that's kind of a short summary of what potential bear cases look like. I think it all sounds good on paper. And if Amazon should really get serious about this, and it's definitely worth monitoring closely.

46:43However, I think about this kind of in a framework that is often maybe overlooked, in my opinion. And if you look at the past ventures of Mag 7 companies, they have actually failed quite often. They're not the kind of unstoppable titans in all instances in the way that we build them up to be. And so, for example, Apple wanted to build a car. Failed. Even Uber wanted to build an autonomous vehicle and eventually shut down that project. Facebook wanted to build a second Snapchat and failed. Amazon wanted to get into the smartphone market and failed. So while it seems like big tech just kind of ubiquitously dominates every market they enter, that is actually not the case historically.

47:24And so they're very successful in breaking into more fragmented markets and dominating them. And so Google went into a fragmented information search market when it started. Amazon did the same for e-commerce and Apple for smartphones. They actually even really kind of pioneered a new category. and many of their future ventures that were successful would kind of come about the same way but what most of their failures have in common is that they tried to gain share in a market that was already dominated by one major player and so if apple had put all its resources into dominating the podcasting and music streaming market for example i have no doubt that they could have done it.

48:07But doing so would mean neglecting the core business and their other cash cows. And so there would be a huge opportunity cost. And so to me, going up against this very capable competitor like Spotify that is singularly focused on this one niche, as opposed to trying to do dozens of different things like these Mag7 companies, well, that's how they're able to compete and win against the likes of the Apples of the world. And I say all that just because I'd find it really hard to imagine that Amazon could make a ride-hailing app its top priority, even if it acquired Lyft and successfully do so. And if they don't, they just simply won't really be able to disrupt Uber, in my opinion.

48:46They won't have the distribution to be able to do so. And so the ride-hailing business is much more complex than it seems from the outside. And Uber has mastered overseeing and facilitating it thanks to decades of experience, data, and billion-dollar investments. Sounds to me, and that shouldn't come as a surprise, like we are in agreement about adding to the position. And considering our cash position and compared to our other core portfolio holdings, what do you think about making it 7 % for now? It really feels like that would be a more appropriate allocation given our bullishness on the thesis for Uber.

49:26So I'm on board. Sounds good. Okay, I believe there are two other companies on our watch list that could be attractive right now. But before we discuss them, let's quickly go over some positions we already own and whether we consider selling them or at least want to give some updates on them. How about we start with a company that has been one of our earliest additions, and that's Nike. Nike is a company that has actually been one of our biggest winners at some point. Unfortunately, we didn't sell the stock back then. And in hindsight, you know, always we're talking about hindsight. It was a mistake we simply made because the stock appreciated so quickly.

50:00We bought Nike at$56 and the stock quickly went up to about$80, which would have been a nice 40 % gain. But I think at the beginning, we were even more inclined to view our holdings only as long-term plays. And obviously most of them are, but Nike was bought also as a trade around the tariff times, mostly just because that's where the timing for our episode landed. and we should have treated it as such too. By now Nike has come down again, although it's still up about 10 % from my entry price. And the turnaround will definitely take some quarters and we knew that from the beginning. However, I think we are both in agreement that if we should see$80 again, without materially improved fundamentals, we take our gain and sell the stock.

50:43And I know that might sound a bit arbitrary, like why exactly$80? And honestly, I don't have a great answer for you, but part of it might simply be us being victims to the anchoring bias. But it's also within the range that I deemed attractive when I first looked at Nike. And again, I knew this would be a turn-on story that would take a couple of quarters and potentially even years and also depend on the broader macroeconomic environment. And if I see Nike outperforming my expectations for the turn-on, I will happily hold the stock well beyond$80 too. I'm pretty happy with the price we paid for Nike.

51:18I think it's not cheap if you look at it from a PE standpoint, just due to the fact that earnings are so depressed and have been really revised down. But just judged by really how we feel about how sound the brand is, at around a mid-50s price, it feels like a pretty good margin of safety to bet that Nike can kind of turn the ship around. And as that turnaround makes progress and we see margins start to trend closer to historical levels of profitability, then those valuation metrics should, as they say, mean revert, right? Appreciate to much more attractive levels. It'd be sort of a tailwind on the investment.

52:01So, I mean, it's a small position. And I think we agree, really, we're not sure whether there's any need to sell it at this point. And so we're kind of just happy to hold it at the moment. That's right. I think there's no updates that we have to give on in terms of adding or setting the position. And when we're always trying to hit this, what I would say, tricky balance between updating people on our holdings, because at the end we do this publicly and we get tons of opinions and inputs, which we truly appreciate, by the way, while still investing with a long-term mindset. And we need to walk through our positions and we have to give proper updates, both here on the show and also in our free weekly newsletter.

52:37But we also don't want that constant flow of information to push us into making too many buy or sell decisions. And that sounds easy in theory, but I can tell you that at least for me, I look at my portfolio and the market news daily since we started this show. And before that, there were at some point months when I didn't look at my portfolio. And while I listened to all the earnings calls and the updates, I consumed far less news and also commentary on my companies. And if you own stocks that are especially more controversial and perhaps contrarian, this makes things a lot easier. I mean, one such stock that we currently own is Lululemon.

53:13It's been, I think, our worst performer currently, down 20 % from my entry price of$200. So it's fair to say that we have been a bit early. However, and that might just be the value investor in me, I don't see myself panicking about it at all. I was more skeptical about it than you were at first, but the valuation is just so attractive. And it obviously became even more attractive now. Just looking at the numbers, we have a brand growing by almost 30 % in China and over 20 % in other international markets. And the US business has definitely slowed down a bit, growing only 2 % right now. But at a forward price to free cash flow of 15, it is definitely on the cheaper side.

53:51And fashion is cyclical. There will always be collections that resonate more and others that don't resonate that well, but that's just part of the game in the industry. And a small side note, Sean gifted me a Lula sweater when we were at the TAP Summit in Montana. And boy, that sweater definitely has a very convincing quality and it quickly turned into one of my favorites. That was my goal of the trip was to finally convince you of just how high quality the Lulu products are. And so as you might have guessed, yeah, my thesis has not changed either. Competition has definitely increased over the last few years, but that is just the reality of capitalism.

54:29If you make a lot of money, competitors are going to show up and try to eat your lunch. And so one of the reasons you liked Nike, despite not really loving the retail industry generally, is because they dominate the biggest sports on the planet. I mean, Nike is still the go-to brand in basketball, 30 years after Jordan, American football, and soccer too. And they completely reshaped sneaker culture. Before Nike pushed athletic shoes into the mainstream, nobody was wearing basketball shoes casually on the street, or at least not in the same way that I can think of. And so I think it's just totally fair to say Lululemon did something similar for athleisure and normalizing it.

55:05Nobody thought it was normal to wear yoga leggings outside of the gym. And Lulu made that mainstream, right? Now you see people at the coffee shop and the grocery store wearing leggings. And so today, Lululemon is kind of the embodiment of the athleisure movement as a brand. And I don't think that trend is disappearing anytime soon. It's persisted for a while. And we've really only seen society lean more into do casual, comfortable clothing. And so it's hard to say whether I think Lulu will be a great compounder for maybe the next decade just because of how brutal competition in retail can be.

55:38But even in a scenario where they're not growing as quickly, you're still left with what I think is a very strong global brand that is gaining traction internationally. And it's trading really at the lowest valuation it's ever had by far. I mean, we're approaching a PE of nearly 10 times earnings. And so that's a 10 % earnings yield with a company that probably has, if they manage the brand correctly, does have a long runway ahead and is continuing to repurchase shares and has industry leading customer loyalty rates and profitability. So even if it is not this long-term compounder that we want to find these companies where we don't have to do a lot of additional work, they're just so great to invest in that they take care of things themselves, they keep reinvesting of their business.

56:24And we just get to passively watch from the sidelines as it continues to generate wealth for us. That's the ideal scenario. We're always looking for those. There's only so many of those bets to go around. So sometimes you have to make more of these kind of value plays where you're thinking, can I buy a dollar for 80 cents, for 90 cents? That is probably closer to what we think the situation with Lululemon here is. Let's say it's like 70 % value play and maybe 20 or 30 percent, we really believe that the brand can continue to compound from here longer term. I mean, to the point I just made a minute ago, when you buy into companies that need to prove themselves again before the market is willing to give them the benefit of a doubt, it just takes time.

57:11And that waiting period isn't always pleasant because the progress is never linear, actually. I mean, that's simply part of the process. And of course, if the situation works out in Quark's situation, but even more so with Lululemon, they still can turn into compounders. But of course, before that, it's just an advantage, I think, if you look at them for what they are currently, which is kind of a turnaround, kind of a value play. And then you can see where they're actually heading. I mean, PayPal is in a very similar situation in a lot of ways. Speaking of PayPal or PainPal, as you have remarked to me before, that was one of your pitches that has not aged as well, just like mine with Lululemon.

57:54So are there any updates worth mentioning? Do you see any cause for concern or do you feel like the company is very undervalued? Well, the earnings reports since our pitch have been pretty good and actually a bit better than I expected. And there are new partnerships announced every single week. PayPal is now live on perplexity, making it this week, actually, the first opportunity for a gentle commerce. So you go on perplexity, you look for a product and you can immediately pay with PayPal. And a similar partnership exists with OpenAI and Google, although they will start a bit later. And in part, that's why the stock had actually had a rally after its last earnings report.

58:28It was up about 18%. And for a quick moment, it looked like, you know, we have a quick 20 % gain and a good start into the pitch. Unfortunately, it couldn't hold on to the gains and actually started early into the other direction immediately afterwards. So the sentiment of the stock is just really in the gutter. I think it's, for us now, close to 17 % or 80 % down. So similar to Lululemon. I didn't think much of it. And if PayPal wouldn't already be a 5 % position, I think there would be a case to make that you should or could double down at these prices. And while I did do that in my personal portfolio, I wouldn't recommend it doing for the intrinsic value portfolio simply because we have many positions, many opportunities that we can play at.

59:08And it's always about the opportunity cost of adding to one position, which means there's no more capital to add to another position. And there are signs that PayPal's turnaround will take a bit longer than we first anticipated. I mean, PayPal's CEO, Alex Chris, recently gave an interview at a Citibank conference. And it was, let's say, not the most exciting talk that he has ever given. One thing that he repeated is that consumers are showing signs of weakness, especially the low to mid-income consumers. So it was mostly about the macro environment, but he also mentioned how the turnaround takes time.

59:41And while macro is not under PayPal's control, obviously, it's not a promising sign for Q4 and the market reacted like that too. I mean, while Venmo and Buy Now Pay Later are growing very fast and scaling very successfully, They reached the goals that are supposed to be reached in 2027 already this year. Bennett Checkout, which is probably the metric that matters most to Wall Street, will likely be below last quarter's growth rates. Do you think they will increase their buybacks, considering how depressed the share price is? Or how do you think about that? I hope so. I hope they will increase them.

1:00:16I mean, they're already buying back a lot of stock, but they recently took on a short-term borrowing facility of about$5 billion. That does not mean that PayPal has immediately borrowed$5 billion, but it has access to it when it chooses to use it. And many companies use these programs to finance buybacks. And at current prices, I would like to see that. I mean, the company is fundamentally much stronger than at any point in recent years, and it's trading close to its April lows. And April was a time where many people believed we would see a global recession. At the current rate, so even without assuming the use of debt, that PayPal will buy back about 10 % of the entire company just this year.

1:00:54Another thing that I just love to see, we often talk about it, and I think it's underappreciated in PayPal's journey, is how effective Alex Chris has reduced PayPal's stock-based compensation. Ever since he took over, SBC is, as a percentage of revenue, or has come down as a percentage of revenue from over 5 % to just 3%. So all of that is making the buybacks just a lot more meaningful and effective. we might have to wait a bit longer until paypal does return to double-digit growth but in the meantime we're getting compensated with these massive buybacks and so until then and since last quarter also a dividend too which has another one percent to the total shareholder yield this is one of those situations where i'm happy to patiently wait for things to hopefully play out in our favor as we see it patience is one of the most important things for investors like us and I still hope that there's a positive surprise on the purpose of the macro side and we see much stronger 2026 than 2025.

1:01:52But as you said, until then, we are getting paid through buybacks and dividends. Another company you've covered recently that might have become even more interesting due to declining share prices and also maybe some new information that has come out is Salesforce. So why don't you tell us about that? Yep. On that note, many thanks to our listeners and the community because I got a lot of feedback after the Salesforce episode. And if I had to summarize briefly, it seems that people who work with Salesforce daily don't think that I will actually go and eat their lunch anytime soon. I get messages from people who have worked with half a dozen CRM tools and they told me Salesforce is by far the best.

1:02:30And some even worked on some AI projects and they still said that AI tools are still far from replacing tools like Salesforce and especially Salesforce. So I think those are some really helpful insights. And I know the folks we spoke to in our community gave us similar insights. Perhaps this also means that Agent Force isn't yet the game changer that Mark Benioff promises. But honestly, I'm okay with that. If it means that Salesforce won't get disrupted by AI yet either. So then Agent Force can be seen as maybe more so a growth accelerator for Salesforce and maybe a defense mechanism for AI tools rather than an attempt to prevent the unavoidable.

1:03:09And with that backdrop, Salesforce has become even more attractive in my eyes, mostly due to valuation. The only thing we have to consider at this point is, once again, opportunity costs. It's funny to say this since we've tried to decrease our cash pile for most part of the year, but at the same time not dilute the quality of businesses that we own or to diversify basically just for the sake of it. And it seems like we now get to the stage in building our portfolio where we have to weigh one position against the other, which is a new challenge. But it's also exactly why we want to bring people on the journey of building such a portfolio to show how the challenges change over time.

1:03:48So yeah, let me throw it back over to you. What are your thoughts on Salesforce? We said this quite a few times in that Salesforce episode we did, but the company really does remind me of Adobe in some ways. In both cases, you have this AI narrative that's weighing on the stock really materially. And then in both cases, you're looking at still these very well-positioned market leaders that could arguably actually benefit more from AI than they're disrupted by it. And so Adobe, just in a kind of very simple valuation terms, does appear cheaper on paper than Salesforce right now. But still, Salesforce might be similarly hard to disrupt, right?

1:04:27They're very deeply embedded in corporate America. And the switching costs of, okay, what does switching cost mean? How long it would actually take to retrain your entire office on a new software and get those workflows integrated through a new system. I mean, there are real frictions from moving an entire company off of Slack and Salesforce into some kind of alternative, Microsoft Teams or whatever it is. And so that stickiness, that switching costs, I mean, that does provide legitimate margin of safety and kind of moat around the business that you don't always get in software, right? Sometimes it is easier to switch.

1:05:06If I want to switch from Spotify to Apple Music, maybe it's annoying, maybe it's a hassle, but there's not really any reason I couldn't do it. if I wanted to take the last five years of my files and projects and workflow and messages distributed across my team and the entire company and migrate that into a new platform, that's a headache. And so that really, not to say that Salesforce doesn't create a lot of value on its own and isn't innovative, but when we talk about a margin of safety, something that makes it harder for this business to lose, that is kind of what we're talking about. And so at a forward PE of 20 and afford price-to-free cash flow per share of 15, Salesforce does look very intriguing.

1:05:49Those are significant discounts to the valuation of the S &P 500 for a business that we think is probably of higher quality than the median S &P 500 company. So if they can deliver on some of their longer-term targets that they've recently set, which includes hitting$60 billion in revenue by 2030, the stock should be off to the races as far as I'm concerned. That was actually, I wouldn't say a shock, but a surprise to many that they just gave this target of$60 billion in 2030. And I model it out in terms of what would that mean for the stock. I was basically using my base case assumptions on margins and on free cash flow conversion.

1:06:28And even at$60 billion in top line in 2030, the fair value would quote unquote only be $280 and then you apply our typical 10 % margin of safety and you're closer to$250. And at that point you get close to the 12 % that we usually use as our hurdle rate, but you're not fully there. And what might be interesting is that I think it was in 2022 at their dream force, Salesforce actually put out a price target for 2026 of$50 billion. We're at$40 billion now. So that's a whopping$10 billion miss. And to be fair, Salesforce had an activist coming in in the meantime and focused much more on profitability after the activist took control over the company, at least to some extent, which is something that I believe was generally a good thing for the company.

1:07:16But still, if we assume Salesforce misses by$10 billion again, we would only get a fair value of around$200, assuming the same margin profile again. And I'm not saying this will happen. In fact, I think it's way more likely that Salesforce top line actually re-accelerates and then they do reach the$60 billion target. But it's still something that at least to me is worth keeping in mind when we compare Salesforce to other opportunities. And I mentioned this to you before when we discussed all of the insights and adding to some positions, I still feel like I need a larger margin of safety to compensate for my lack of personal experience with the product.

1:07:56It's not that you can't invest in something without being a consumer or a customer of the company. You definitely can. But actually using the product does help so much in understanding just the competitive dynamics and also the stickiness of the product. I totally get what you mean. I mean, it's no coincidence that most of the companies we own are either, as we like to joke, installed somewhere on our phones or have some sort of connection to our daily lives, either from our work professionally with Adobe, the clothes we wear with Lululemon and Nike, and so on there. So Peter Lynch talks about this concept of the consumer edge very frequently.

1:08:35And we talk about that a lot too, of wanting to use our insights as consumers as potentially valuable data points that at least guide us and orient us as investors. And so again, it's not a requirement for us to be customers of the companies we invest in, but gosh, it really does. When you've looked at a lot of businesses, it really helps with getting up to speed quicker and kind of having a barometer of the risk and reward going forward. If you are truly a consumer of the products and can say, oof, yeah, this is not working as well as it used to, or this use case is not as valuable to me anymore.

1:09:14Those are real insights that obviously they're anecdotes. You know, no scientist is going to say that this is a rigorous academic study. But at the same time, should you discount the fact that you're not using the products as much anymore? and question, okay, well, are other people feeling this way? It's just kind of more the impetus to look around and give you these like launch points that you really just would if you're just kind of observing the stock and the company from a distance, just would never really even think to question those kinds of things or have the same insights. So I think it's perfectly reasonable to demand a larger margin of safety for a product that you don't personally use every day or understand as intuitively.

1:09:57And that is really the case here with Salesforce. I know we Slack each other a lot. Daniel's probably sick of seeing me because we're between work calls together, between podcasting together, between seeing each other in person and messaging over Slack. We are very much in constant contact, it feels like. Last week, I know that we had three days. We were basically coming off one call, joining the next, and then joining yet another call, basically for four-hour meetings in a row. So it can get intense at some point, but I would never have too many meetings with you. So no, I'm actually happy you think about it that way because I know that it can feel like a cop out, but I'm just not yet excited enough about Salesforce to still go that step and say, even without being a consumer, without looking really into the product, I can make a bet here.

1:10:44And gosh, we cover a lot of companies today already. And I know we're not used to this pace. I mean, normally we spend 90 minutes on just a single business. today we're basically backing down our entire portfolio plus some watchlist companies. So it is a lot, but I would say we have two companies left. And I think it should be interesting and important that we cover them because one of them is getting sold off entirely. And the other one is about to become our, I think, third largest holding now. And attentive listeners might already know which companies we're talking about, which one is getting the upgrade, which one is leaving the portfolio.

1:11:19But yeah, I think it's important for us just to come. It's good. It's good to tee up. Yeah. So the company that's getting added or getting increased in the portfolio is the company we've brought up a few times today already and really consistently on the show over the last couple of months, and that's Adobe. And I just, I don't know if there's much to add. The thesis really has not changed since we first looked at the position back in May. Really the only thing that has happened is just the stock prices kept going down. It's down almost 30 % year to date amid these fears that AI will replace a need for creative tools like what Adobe provides in their ecosystem.

1:11:55And as we said earlier about Salesforce, the stories just overlap a lot. I mean, Adobe is this undisputed leader in the creative space. Every major corporation, film studio, marketing agency, big creative team are all heavily, heavily reliant on Adobe from creating designs and moving motion pictures to monitoring how their advertisements are performing. There's just this massive ecosystem. It's only getting bigger. At the time of recording, Adobe recently proposed an acquisition to offer to Simrush for$1.9 billion, which is only going to further kind of cement their value add in the marketing analytics space.

1:12:39And so I think a lot of people overestimate the competitive threats to Adobe, when in reality, there's just not any real competitors that are equal to them at the same scale, even though there are legitimate alternatives for smaller individual creators, but not really at the corporate level, right? You could look at Canva or Figma gaining traction and think that that means doom for Adobe. But the reality is that the vast majority of Adobe's revenue comes from corporate America and really the corporate world, right? Not just America. Film studios, agencies, and enterprise clients. This is not a business driven by people like Daniel and I, or even small to medium businesses.

1:13:23These customers need reliability, compliance, workflows, integrations, asset management assistance, the full ecosystem of corporate buzzwords. And that ecosystem really is Adobe, unlike any other company we've ever seen besides Salesforce. And so AI will absolutely transform the industry. There's no doubt about that. But most of that transformation we think will happen inside of Adobe's products, not outside of them to the detriment of Adobe. And so Canva and Figma might win the individual creator market and folks making videos for TikTok will love to use them. And maybe small businesses, local restaurants, and that's great for them.

1:14:03But we are interested in a much more valuable upstream pie that Adobe has continued to dominate. And that's really their core market. One thing that I learned from PayPal is, or Paypal, as you said it, is that when the stock is not performing, but the company still is, one thing that always helps is throwing around some numbers. So I will do the same now for Adobe. Adobe is trading at a forward PE and forward price to cash flow of less than 14, making it the fourth stock actually we discussed today that is trading at an all-time low relative to its own history. And whenever we cover growth stories, I feel like we lose our value investing touch a bit.

1:14:41But when I realized this dad, that we talked about four companies that are currently at all-time lows for their valuation, all of them high-quality companies, I thought to myself, nope, we're still fine. We're still value investors. If you just make some basic updates to my fairly conservative model on Adobe with the current stock price, the implied expected annual returns, return per year over the next five years is 18%. That's a very ballpark estimate. And so to be fair, that does make some slightly optimistic assumptions about the exit multiple at 25 times. But for a company of this quality, that's still a discount to the overall market.

1:15:22And so it doesn't seem crazy optimistic, even if it is a little bit more on the optimistic side. But even with a more moderate assumption on the exit multiple, right? What we think that if we sold out of the stock in five years now, what is the valuation the company would be trading at down the road? And we typically think of it, we'll be at a discount to the overall market, we'll be in line with the overmarket, we'll be a premium to it. At 20 times earnings, we would still overcome our 12 % hurdle rate, right? So the implied returns would still be very good. if you assume pretty substantial compression in the valuation going forward, such that at least with how the S &P is currently valued, and maybe people think it's overvalued, at a 20 times exit multiple, you're really at two thirds of the S &P 500's price to earnings ratio.

1:16:12So these are not wildly aggressive assumptions where we're like, oh, well, yeah, you know, Adobe's valuation has to double for us to even get a decent expected return. It's just absolutely not the case really at all. If I can assume that I buy a high quality company, one of the highest quality companies out there, and I only have to pay 20 times multiple for it to overcome a 12 % hurdle rate, I think we're in total agreement that we should add to that company. And I think the first time we bought Adobe, or at least when we doubled down, it was an 8 % position for us. It's currently sitting below 7%.

1:16:43So how about we just bring it back to 8 %? That works for me. Easy enough. All right, sounds good. So it has been quite the journey, but we are close to the end. I still promise you all one company that will leave our portfolio and go back to the watch list. And that company is, as some people might have guessed, Ulta Beauty. It was one of the first, perhaps the first ever companies pitched on this show. And the thesis, I must say, worked out exactly like you laid it out back then. And the return has been great too, especially for just one year. So tell us about it. Well, it's one I feel like I got lucky with.

1:17:18I mean, it does feel a bit sentimental to let go of the very first company we ever added to our intrinsic value portfolio. But like you said, the thesis basically played out as we hoped, right? We held it for almost a year and ended up closing the position with around a 28 % return, which I think is very respectable. And so in my original pitch, I had mentioned that Berkshire actually owned Ulta for a brief moment in time and they initiated the position and then sold it just one quarter later, which I thought was a real shame. It did have me questioning whether I had made the wrong decision by continuing to bet on Ulta, but it has worked out for us.

1:17:54And so at the time, I just didn't really understand why they did that. It's the kind of business that you could really easily imagine having a booth at the Berkshire Hathaway annual shareholder meeting at the CHI Arena in Omaha, right? It's just very simple, very profitable, very well run, tied to the real world and kind of enduring trends of human consumption. Beauty is an industry that will always be around. It's not going to get wiped out by AI or the digitalization of the economy. And so we sold not because Ulta suddenly looks like a bad or worse company to us at all, far from it, but more because we believe that there are just better opportunities available for us at the current valuation for Ulta shares.

1:18:39And so, I mean, I have no doubt that Ulta could produce market-like returns or even maybe still market-beating returns from here, but it's just at really a different stage in its lifecycle now. And the valuation is not as generous as it was. I mean, it's still a great business, but now they've made some progress on the turnaround and the market has started to appreciate that. And so looking at it now, you see, well, you have harder comps, not as favorable valuation. The runway for growth is not going to be as easy as it was in the past. And so the brand is strong, but the setup is not as asymmetric today as it was when you first bought it.

1:19:19I pitched the company, I think,$400 a share on this podcast and on We Study Billionaires. went down to 350 continued to endorse it and buy it at the time we sold it when it was well north of 500 per share that's a pretty solid gain or you're pulling forward future returns if you expect a stock can do 12 to 14 a year over five years and then you suddenly jump up 30 well what that means is the returns you expect in the coming years are not going to be as good and therefore you should probably exit the position so that was the idea that maybe we could rotate that capital into something with a better risk reward and then a longer runway for the portfolio, as opposed to just not locking in the gains that we had already earned from that original thesis with Ulta.

1:20:07It's not always easy to explain why you hold on to some companies, sell others, and then double down on yet other companies. But I think it makes sense. If you look at the companies where we think it's a smaller position, but we do believe there's just a lot of growth ahead in the next 10 years, we like to take that bet and just let accrue. And there are some companies that, you know, we thought they could beat the market anyway, and then they just keep getting better and the valuation keeps going lower. So that's when we double down. Then there are some companies where just the thesis, as you just said, is playing out and maybe it's five years too early for the company to make those returns.

1:20:40And then you just, you know, sell the company, take your gain. And I think that's perfectly fine. And I hope this has delivered a pretty good overview of where our portfolio currently stands and how we think about our holdings and the companies on the watch list. Next week, though, we will get back to the usual format, you know, the show that you all know, a deep dive into one company that could potentially make it into our intrinsic value portfolio. And I guess, Sean, you will have some hints for us to figure out which company that would be. Yeah, it'll be a case study on what was, for a while, a very promising social media company that just never really cracked the code on monetization.

1:21:20So despite having nearly a billion monthly active users, which is just like insane, growing revenues 13X over the last seven years and creating a number of actually very innovative features that have since been cloned by companies like Meta on Facebook and Instagram. This is a company that's trading well below its IPO valuation still. So yeah, I want to see whether this is a company that deserves to be so disliked Or if maybe there's enough untouched earnings power for us to get excited about it at current prices. And with that, I would say it's time for me to close today's episode with a quote by today hedge fund billionaire John Paulson, who said, quote, The stock market goes up or down and you can't adjust your portfolio based on the whims of the market.

1:22:06So you have to have a strategy in a position and stay true to that strategy and not pay attention to noise that could surround any particular investment. and with that said I hope you all have a good weekend and we see you next Sunday