TIP736: How the Best Investors Execute w/ Clay Finck

26:08The PE ratio of Meta went from around 8 to 37 in less than a year. That's over a 360 % increase in the share price just from multiple expansion. Unless you believe that Meta's business model was broken and in the midst of a permanent decline, then it likely wouldn't have been wise to sell shares in light of that decline. I think the case is clear that Meta's moat is pretty strong and they're able to at least sustain their existing business for a number of years, ignoring any potential for future growth. Being able to weather through drawdowns of great companies, I think is an essential skill set.

26:44it can be incredibly difficult to separate the signal from the noise and determine whether the business's long-term success is in jeopardy or not. I like to give a business some sort of leash for underperforming in terms of its fundamentals. Every stock is bound to eventually have a bad quarter. And let's say if a stock has, say, six underperforming quarters in a row, for example, then that might be time for me to consider moving on. And maybe the company simply wasn't as good as I initially assessed it to be. The other thing to realize is that it's totally normal for a stock to suffer through a decline.

27:18If we assume that investors value a company based on its future cash flows, you can play around with the DCF model and quickly see that you can get a 30 % to 50 % difference in the business's intrinsic value just by slightly tweaking some of your assumptions. So as the daily news flow comes through and the company releases their quarterly updates with some decent volatility in the results, you're going to see these occasional 20 % to 30 % declines in about any business. We just don't know exactly when they'll occur and how severe those declines will be. Having the ability to sit through drawdowns can give an investor an immense advantage.

27:55Peter Lynch once said the key to making money in stocks is not to get scared out of them. During Lynch's time running the Fidelity Magellan Fund, he delivered average annual returns of 29 % per year over 13 years and experienced three drawdowns of 20 % or more for his fund. The inevitability of drawdowns also highlights the importance of knowing what you own and having conviction in where a business is heading. When you know a company has a durable and competitive advantage, a strong balance sheet, and a proven track record of generating shareholder value, you're far more likely to stay the course when others are selling in fear.

28:30It's also empowering to know that volatility and drawdowns are the price of admission to earning superior returns. Many people simply can't stomach the volatility of the stock market, which presents an opportunity for those who know what they own and can effectively navigate through those drawdowns. This brings us to the discussion of the assassins and the art of killing losses. This chapter felt a bit more like taking a trader's approach to investing than that of a long-term value-oriented investor, but some of the principles can still apply, I think. The assassins did an excellent job of limiting their losses and not letting their emotions get the best of them by relying on a framework that drove their decisions.

29:13So this ties into the earlier point of having a plan in place once you enter a position. It can be easy to have a position going against you and to simply change your thesis on that investment. For example, perhaps you bought into a high-quality growth stock, all of a sudden, it's turned into a turnaround play with many underperforming segments. Another point he has here that I liked is one of the things that I think good investors do well is to only make big decisions when they're in a good emotional state. So if you're exhausted, overly stressed, or just not in a good state of mind, then it's probably best to avoid making big decisions because it's just much more difficult to think rationally.

29:54This is exactly when you're prone to be making a big mistake is when you're not feeling well and you're making these decisions based on your emotions. On the topic of drawdowns and reevaluating positions, I think it's also important to think about why the market is selling off a certain name. At times, there are these exogenous factors that essentially bring the entire market down. Think about March 2020 during COVID or the great financial crisis. Essentially, anything that was publicly traded was being sold off because of this liquidity shock and the tremendous amount of uncertainty that was in the market.

30:31During these times, I think it's especially important not to panic sell because history tells us that stocks have always recovered from such exogenous shocks. Now, when it isn't this type of shock, we need to take a real close look. So through mid-June 2025, the S &P 500 and NASDAQ are roughly flat on the air. So if you own a stock that's down, say, 30%, then it's likely due to the business itself or the industry they're in. One well-followed example is LVMH, which is currently down over 50 % from its high a couple years ago. I don't have a strong view personally on the company, but many believe that it's a well-run business with very good management.

31:10Growth has slowed after the boost they had post-COVID, and revenues even saw a decline in 2024. It appears that LVMH is suffering from softer demand in China, which represents around 30 % of their business. And they reported that sales in Asia, excluding Japan, dropped over 10%. So LVMH seems to be in this situation that they have a number of things simply not going their way. There's this weakness in China, the uncertainty around tariffs, and then investors just might be a bit concerned about the succession plans as Bernard Arnault is now 76 years old. According to Finchat, LVMH is at an EV to EBIT ratio of 13.

31:51That's the lowest that metric has been since 2016. And it's even lower than the drawdown in March 2020. And one caveat I'll add here is that the company's implemented some price increases. And I think this might put pressure on their growth that they're going to see in the future. So not all multiples are created equal. Just because this multiple is lower than March 2020 doesn't necessarily mean that today's price is a bargain. So if they overdid the price increases and earnings end up declining, then investors might find that the multiples you're seeing today could potentially be high. Again, I'm no expert on the luxury industry, but those are just my general thoughts.

32:28Freeman Shore, he shared some research on how investors behave after selling a loser. Research from Mike Thaler and Eric Johnson suggested that once a person has sold a losing investment, their behavior can potentially turn a bit risk-seeking, which they referred to as the break-even effect. Some professionals might feel that they need to turn their losing situation around or else they face potentially being fired. When you sell out of a losing position, you're really making two decisions. First is of course that that stock is no longer a good idea to have money in. And second, your money would earn a better return being invested elsewhere, which is referred to as your opportunity cost.

33:08But the lack of another compelling opportunity should not prevent us from exiting a poor investment, as we always have the choice of temporarily holding cash before we get it allocated elsewhere. Selling a position can really be a difficult experience for many, even if you feel like you know you should not be holding that business. Research from Kahneman and Tversky found that the pain experienced from losing$50 is far worse than the joy we experienced from winning$50. This means that we can find it easy and pleasurable to sell a winning stock, and difficult and painful to sell out of a losing stock.

33:44And the idea of the potential for regret if the stock rallies after we sold can really paralyze us into inaction and indecision. This brings us to discuss hunters, who are the investors that found themselves in losing situations, but instead of selling out of their position, they doubled down and bought more shares. As I alluded to earlier, once a stock has a big drawdown, statistically, it doesn't have a great chance of recovering and making new highs, so it's a bold decision to double down on a stock that's down, say, 30 % or 50%. These types of moves are typical of a contrarian value investor.

34:20They see a future that the market largely disagrees with, and they're able to find these market inefficiencies. In taking this approach to buying discounted assets, you have to be very patient because it can take some time for the market to appreciate that underlying value. Peter Lynch once stated, I'm accustomed to hanging around with a stock when the price is going nowhere. Most of the money I make is in the third or fourth year that I've owned something. I like to think about how certain stocks attract a certain shareholder base. If a company has growth rates in excess of 40 % for a number of years, that is going to attract a lot of growth investors, which elevates the share price.

34:59And as As the shares gain momentum, this will inevitably attract momentum investors, and many value investors will get out when the valuation gets a bit ridiculous. When that growth slows, the shares start to sell off and it might enter a secular downtrend if that growth continues to stall. Once the stock falls below a certain point, the momentum investors are probably the first ones out, and if the 40 % growth metrics simply aren't there anymore, then the growth investors will be next to jump ship, causing a further decline in the share price before the shares hit some sort of floor and value investors create that new base in the share price.

35:35There are cases where Warren Buffett would have been considered a hunter by buying beaten down shares. The most classic example is him buying American Express. American Express was a textbook case study of being greedy when others are fearful and buying a good business when the market unfairly punishes the share price. American Express went through the salad oil scandal in 1963, where the company was liable to pay tens of millions of dollars in the scandal, which sent the share price plummeting. But Amex's cash cow was totally unrelated to the scandal. So just to make sure that the cash cow wasn't really impacted in the minds of consumers, Buffett went around and did this scuttlebutt research by visiting businesses to see what their view was on Amex in light of that scandal, and all of his research suggested that not only was their core business in a really good position, it was actually accelerating.

36:27Despite the core business firing on all cylinders, the stock traded at less than half the market multiple and at a double-digit growth in revenues and earnings over the previous decade. Buffett made this stock a 14 % position in his partnership, and the shares compounded at over 30 % per year over the next five years before he exited that position. So there could be a number of things at play as to why a manager wouldn't add to something if it's at a better value than when they initially entered the position. The first could be that they simply don't have the cash to do so and they aren't interested in selling their existing positions.

37:00Another reason that's more fascinating is that they don't want to introduce career risk. If a manager were to bet big on a name and double down and be wrong, then that could really hurt their reputation as an investor and it could potentially lead to investor outflows, forcing them to sell at potentially inopportune moments. Michael Lewis's book Moneyball also highlighted the prevalence of career risks on Wall Street. With all of the peer pressure that can be present, loss aversion can be amplified for investment professionals. The pain of being the one investor who went bust and is publicly humiliated is much greater than the joy of having the best investment returns.

37:37This incentive can lead managers to pick a strategy that is least likely to fail rather than doing what they actually believe is best for their investor base. Viewing things through this lens, it can make sense why many managers aren't excited to add to their big positions that are down substantially. This brings us to part two of the book, which covers how these great investors handled the winners in their portfolios whose share prices had increased. So in this part, Freeman Shore gets into what he refers to as the raiders and the connoisseurs. Raiders are those that bought a winning stock but sold out too early, and connoisseurs are those that bought a winning stock and rode their winners.

38:16Starting with the raiders, the raiders are the stock market equivalent of golden age adventurers. Having penetrated through the dense jungle, found the lost temple or buried treasure, they filled their pockets with all their ancient coins and gems they can find, then turn their tail and ran. Unlike golden age adventurers, they are rarely chased by angry locals or rivals. The only boulders rolling after them are in their imaginations, and they are terrified of getting caught and losing everything. Since our winners can offer hugely asymmetric payoffs, Freeman Shore does not suggest behaving in the way that the Raiders did.

38:53One of the investors he invested money with had an incredible hit rate on his investments, making money on 70 % of his bets. However, he hadn't made any money for his investors because he would constantly let go of his winners on a small gain of 10 or 20%. I recently had lunch with a fund manager who had bought Copart back in the 2000s, and he ended up selling it in 2011 because he thought it was getting a bit expensive. Since then, Copart's shares are up by more than 20x. And then another example I'll share here is this year I interviewed Francois Verschon, In his letters he writes for his partners each year, he shares what he refers to as podium of errors, where he highlights the mistakes that he's made over his career.

39:34His gold medal for 2024 was Syntas. While he never purchased shares in Syntas, it was a company that he understood the business, he understood its competitive advantages perfectly, and it was a pitch right in the middle of his sweet spot. But when he analyzed the company in 2016 after a major acquisition, he determined that the stock was a little bit too expensive for his taste at 26 times earnings. Since then, the shares of the company have compounded at 25 % per year, netting a gain of over 700 % for investors over the past nine or so years. Although it can be tough to watch a company on your radar continue to run while you don't own it, it's even more tough when it's a company that you knew well, but decided not to capitalize on the opportunity.

40:18Similarly, Freeman Shore found time and time again that selling a great business early was a mistake. Furthermore, because of this failure to hold winners, the Raiders would inevitably run into some large losses in due course that would wipe out the small gains that they had proudly locked in. He writes here, I quote, The most successful investors I worked with all had one thing in common. They had a couple big winners in their portfolio. Any approach that does not embrace the possibility of winning big is doomed, end quote. It's easy to see why some investors can be quick to lock in gains on winners like the Raiders did.

40:54Freeman Shore lists a number of reasons for this. First, selling for a profit just feels good. When we win, testosterone and dopamine are produced, and these hormones produce a feel-good response. So once you do it once, we'll want to do it again and again. We need to be in touch with our emotions as investors and recognize that just because we have an emotional pull towards taking a specific action doesn't mean we should follow our instincts in that direction. Since it feels good to take a profit, holding onto a winning stock is like practicing delayed gratification. We're delaying that feeling of taking a profit one day after another each time we decide to hold onto a stock.

41:34So in a way, holding our winners is similar to choosing a healthier meal over pizza and ice cream and taking a walk instead of lounging on the couch all day. Second, buying and holding is frankly a boring endeavor. It's more fun to make moves in your portfolio and think you're being smart by taking a small profit in one name to allocate to another opportunity. Chris Mayer outlines the importance of having a long holding period in his book, 100 Baggers, as the typical 100 bagger took 20 to 25 years to pan out. As I outlined in my episode last week, I believe one major edge that an individual investor can have is simply patience.

42:12We live in a world where people are obsessed with the short term. What's the market going to do this year? What do you think of the tariff announcements? Where's interest rates going to go? The list goes on. People are bored and they want something to happen, which leads them to tinker with their portfolios. Philosopher Blaise Pascal stated, all men's miseries derive from not being able to sit quiet in a room alone, end quote. Many people would admit that stock XYZ will produce much more earnings five years from now. Yet they're still selling or even avoid the stock now because they expect a poor quarter coming up or some other short-term problem.

42:51Or worse yet, they're worried about general market concerns or these macroeconomic headwinds. Since so many people are bored and are looking for excitement, it's no wonder that many investors are interested in the current hot industry, new IPO, or the latest technology trend. They aren't necessarily looking for the best risk-adjusted returns, but for something that will help temporarily cure their boredom. As an antidote to boredom, it's probably better to pick up a hobby like golf or traveling rather than filling the time with forecasting macro or constantly making portfolio changes. Freeman Shore recommends generally hanging on to your big winners because they're just so rare.

43:30The successful investors he studied all had a couple of big winners while ensuring that the bad ideas did not materially hurt them. Having a process that prevents you from winning big because you take profits once a stock is up 20 % means that you could potentially be the person who gives away a winning lottery ticket. Our gut instinct might tell us to do the exact opposite of what these successful investors do, which is to sell our winners too early and hang on to our losers with the hope of them bouncing back. Let's take a quick break and hear from today's sponsors. Trey Lockerbie, CEO of Plood Note Pro.

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47:19All right, back to the show. As Peter Lynch once put it, some people automatically sell the winners and hold on to the losers, which is about as sensible as pulling the flowers and watering the weeds. If we follow the notion that winners tend to keep on winning, then selling a stock that is up to buy a new stock is like rolling the dice once more, as we know that only 49 % of top investors' good ideas would go on to make money. The odds of these investors picking a big winner is much, much lower than that 49 % metric. Freemanshore also touched on the perverse incentives that can be present in the active management industry.

47:54The main theme is them making an investment decision for a non-investment reason. For example, if a manager is awarded a bonus based on one year or three-year performance, then they may be keen to sell a stock that is run up to ensure that they get that bonus at the end of the year. Or if the fund has recently outperformed the index, then they may be keen to sell the stocks that have run up with the expectation that those loftier valuations will have difficulty maintaining that same performance. And that's a reasonable assumption, but it's such a short-term decision in nature. Managers can especially get trapped in the comparison game of focusing on their fund's performance relative to their peers or to the index, since this is the primary selling point in attracting fresh capital.

48:40So the manager that sells a stock that's up 30 % on the year might get a pat on the back because they're outperforming the index that year. They receive a nice bonus at the end of the year, but they might actually be doing their investors a massive disservice in the long run. With all of this discussion on short-term versus long-term thinking, many of our listeners are probably familiar with the famous marshmallow test. In the test, a marshmallow is placed in front of a young child and is told that if they don't eat the marshmallow in the next 30 minutes, they'll be rewarded with an additional marshmallow.

49:12The researchers then left the child alone in a room with the marshmallow sitting in front of them with no distractions such as TV or music. In just a few minutes, most children tended to get fidgety, and in most cases, the child would succumb to the temptation and shortly thereafter, downs the marshmallow. But let's face it, half an hour in a room with no toys must feel like 30 years to someone that age. Freeman Shore writes, The point of this test is that it demonstrates a phenomenon known as intertemporal choice. If something is offering us immediate pleasure, such as taking profits, we struggle to see the pain it will cause in the future.

49:48We become nearsighted and sacrifice potentially large long-term gains for small short-term ones. Raiders cannot help but eat the whole marshmallow." This brings us to the final type of investor outlined in the book. This is the connoisseurs. The connoisseurs are the last and most successful investment tribe discussed in the book. They treated every investment like a vintage of wine. If it was off, they got rid of it immediately, but if it was good, they knew that it would only get better with age. When it came to the marshmallow test, the connoisseurs would have been the ones who resisted the urge to eat the marshmallow.

50:26One of the funny points that Freeman Shore makes in the book is that connoisseurs aren't any smarter than any other investors. In fact, they had a worse hit rate on average. Their secret sauce was that when they did find the occasional winner, they won big. As Freeman Shore puts it, they rode their winners far beyond most people's comfort zone. He shared a few more points here that he picked up from the connoisseurs. They tended to look for businesses that they viewed as low negative surprise companies. This is an excellent point that Joseph Shroposhnik actually brought up on the show a few weeks ago.

51:00You want to be able to have a clear view of where a business is likely to be a few years down the road. So it needs to be somewhat predictable and it needs to keep you out of what Joseph referred to as bad situations. When you buy an unprofitable business or an over-indebted business or a company that's clearly very cyclical or unpredictable, you increase the odds of eventually finding yourself in very, very bad situations. When you find a company with a good management team, a moat to protect their existing business, at least for the intermediate term, and you have a strong balance sheet, then you can be reasonably confident that earnings will be higher five years from now.

51:39You tend to prevent yourself from getting into those bad situations. Perhaps there are times where the entry valuation is a bit high or earnings don't grow quite as fast as you'd like, but it's better to see a minus 20 % return in this situation than getting minus 80 % after chasing the next hot, unprofitable tech company that's nearly impossible to predict. The second point he makes here is to look for big potential upside. So I equate this to finding companies with a long runway to grow. So if we look at a company like Coca-Cola, for example, their international revenue really hasn't grown much in recent years as global soda consumption is in a decline.

52:18So their core business and their growth is largely dependent on price increases. So we can't really expect a lot of growth going forward from a company like Coca-Cola. Additionally, they also pay a pretty sizable dividend, and this indicates that management really isn't looking to invest a lot into future growth. And then I look at other big companies like Amazon and Tesla, for example. I see enormous potential for growth in these companies. So They don't pay a dividend. They're reinvesting significantly in the business, hoping to be much bigger 10 or 20 years down the road. And I don't own shares in these companies.

52:51I'm just sharing some high-level examples in here. As a result, the potential upside, I think, for Amazon and Tesla is significantly higher than, say, a Coca-Cola. All right. Third point here, connoisseurs were also very concentrated in building their portfolio. So when they were confident in an idea, they built up big positions. They could end up with 50 % of their total assets invested in just two stocks. And it was those stocks that would make them so successful. And then the last point here, of course, they would let their winners run. In the book, Freeman Shores shares a few case studies of stocks that were held for a period of around three years, which I wouldn't really characterize as a super long-term investment.

53:30The big money really comes years down the line. So if we look at a stock like Costco, for example, it's up just over 100 % in the last three years, and it's up over 2 ,000 % in the last 20 years. So$10 ,000 invested three years ago would be worth just over 20 ,000. But that same 10 ,000 invested 20 years ago, it would be worth over 200 ,000. So depending on your rate of compounding, oftentimes the real magic starts to happen after year 10 or so. And the sum that you end up with will be substantially larger than your initial investment. And that doesn't even consider the opportunities to add to your investments along the way.

54:08However, as Hendrik Bessenbinder highlighted here on the show, just a small portion of stocks are able to compound at above average rates for 20 plus years. The Pareto principle shares that 80 % of the results are derived from 20 % of the inputs, but in the stock market, it's more like 100 % of the results are derived from just 4 % of the inputs. So from my perspective, if I know I'm not holding a really great company, then I just want to get rid of it as soon as possible. Now, there's this widespread belief in the investment industry that more stocks in your portfolio will lead to less risk. So first off, they tend to not bet big when they find a great idea.

54:48And when the stock runs up, they either trim it, they think it's the prudent thing to do from a risk management perspective, or they might even have regulatory limits that prohibit a position from getting too large in the portfolio. This regulatory limit puts a very narrow view on the world. You could own 100 stocks that are all very risky, and some might perceive that as safe because you own 100 stocks. On the other hand, one could argue that a one-stock portfolio that just includes Berkshire Hathaway is very low risk, assuming you have a 10-plus year time horizon, and you'd still be pretty diversified because you have all these different types of companies that Berkshire has exposure to.

55:27So more stocks does not always mean less risk. Freeman Shore also points to another study that outlined the benefits of concentration for active managers. Professors from Harvard and the London School of Economics, they analyzed the stock picks of active managers from 1991 through 2005. And instead of looking at the overall returns of the managers, they looked at how the manager's top positions performed. And they actually found that when you group together the top positions of every manager in the study, the aggregate portfolio ended up doing pretty well, and the lowest weighted positions significantly underperformed.

56:03So that actually goes contrary to what Freeman Short talked about at the beginning of the book, where a lot of these managers didn't know where their best ideas come from. And intuitively, I think that it makes sense that these great investors' best ideas did do well. So I was once chatting with an active manager about the positions he held. He held two software names that were very similar businesses. So the first name was his top position. Really great company. It was growing really fast. It's just a core holding of his he's had for a long time. And then the second name was just a regular holding.

56:36It was a regular weight assigned in the portfolio. And I had asked him about his thoughts on the smaller weighting because I was a bit confused why he owned it, given that it's a similar business, but it's compounding at a lower rate. So presumably, the return is going to be lower, given that the valuations were fairly similar. So he simply said that he has regulatory limits on that top position, and he just couldn't find anything better than that. If that investor were managing his own capital with no restrictions, then he likely would have made that top position significantly larger because he saw it as low risk, high returns.

57:12But the dynamic is different when you manage money for outside shareholders and you have these regulators watching you. So it goes to show that there are totally rational reasons as to why a manager would invest differently for outside investors than they would go about investing their own money. And to no surprise, his top position is also a key driver of his great performance in his fund. So being more concentrated would have really played to his benefit and potentially even not brought about any more risk at all in the portfolio. The study you've referenced also suggested that professional investors can have a reputable skillset in picking stocks, but one of the problems they've run into is having the ability to pick a portfolio of good stocks, say 20 of them, that have a high probability of delivering market-beating returns.

58:03So perhaps the best managers can find one, two, or three ideas per year and maybe have a handful of good ideas at any one time. Then owning a portfolio of 20 to 25 stocks can prove pretty troublesome. Freeman Shore does share some cautionary tales to trying to be a connoisseur though. Being a connoisseur can be the most popular thing to do in bull markets when everyone's making money. This is when concentration can hurt you. Imagine buying Microsoft in the late 99, or many tech stocks in 2021. A bulk of the bull market's returns come in the final third of the cycle, which is when the most number of investors are going to get lured in and become the most greedy.

58:46It's also very easy to fall for groupthink. When a handful of reputable investors own a stock and it seems to just keep going up, then we might trick ourselves into being in a safe situation when it's actually most dangerous. High momentum to the upside can give us the illusion that we're doing the right thing when entering a trade. If you're worried about a trade or investment going too far and want to hedge your bets, you could potentially trim your position over time, especially when you feel that the stock is getting a bit ahead of itself relative to the fundamentals. Bubbles today are still a widespread phenomenon, and we really won't be able to tell if we're participating in one or not until after it's already burst and the speculators have been washed out.

59:28Getting to the conclusion of the book here, In working with many of the best investors in the world, Freeman Shore discovered that their success ultimately came down to execution. He has a brief five-point winner's checklist at the end of the book that I can share here. First, focus on your best ideas only. Odds are that you're better off investing more into your best or second best idea rather than your 50th best idea. Second, position size matters. This ties right into the first point. He encourages those who want to outperform, not to over-diversify. Third, be greedy when you're winning. Run your winners.

1:00:04You need to embrace the possibility of winning big. Embrace the right tail, the statistical long shots of the distribution curve. Stop trying to make a quick 10 to 20 % and give your investments the possibility of growing into 10 baggers. Fourth, materially adapt when you're losing. Either add meaningfully to an existing investment or sell out. Both give you the possibility of changing the ultimate outcome. You can turn a loser into a winner. Expect to find yourself in a losing situation. Have a plan to materially adapt and stick to it. And finally, fifth, only invest in liquid stocks. Make sure any publicly listed investment is liquid enough to enable you to execute your idea.

1:00:45And there's really nothing worse than knowing what to do, wanting to do it, but being unable to do it. So what he's really getting at here is that if a stock's illiquid, you might not be able to buy it or sell it as you please. So you might as well avoid such stocks that have a chance of giving you that issue. One of my other big takeaways from the book was that although we can know that a select few stocks are going to drive the majority of our returns, we really have no way of knowing which stocks those are going to be in advance. I had a discussion with my co-host Stig Brodersen the other day about his biggest winners.

1:01:20Some stocks he's bet big on and they've been flops, and others have been huge multibaggers. A couple of his positions are up 7X or 9X from their cost basis. But the thing is, he had high conviction going into both his winners and his losers. So he, just like everyone else, didn't know which investments were going to be the big winners. But once the market validated his initial thesis, he held onto his positions so they could become multi-baggers, 7X or 9X. And he was also open to changing his mind if the market was telling him that he was just dead wrong. Before we close out the episode, I wanted to briefly discuss the great work that my colleagues, Sean O'Malley and Daniel Malka are doing over at the Intrinsic Value Podcast.

1:02:06Each week, Sean and Daniel, they break down a company's business model, competitive advantages and valuation. And it's by far one of the best resources I've found for company breakdowns. So I'll actually be having Sean on the podcast here in a couple of weeks to discuss a few of the names they've added to the intrinsic value portfolio. And just this morning, I was going for a walk to start the day and I was listening to their episode on Reddit. When Reddit initially IPO'd in 2024, my mind immediately thought, well, here comes yet another unprofitable tech company that will continuously dilute shareholders.

1:02:39However, Sean and Daniel are really as sharp as they come from an investment perspective. So I wanted to hear them out on the idea and hear their thoughts. And additionally, I'm actually a user of Meta's advertising platform. And I've been pretty pleasantly surprised by just how good Meta is at sending my small business customers for my brother and I for our e-commerce store. and I figured that if Reddit could somehow also crack the code on advertising, then there's likely some solid potential upside for investors. After listening to Sean and Daniel's episode and taking a look at the company's most recent earnings reports, my opinion on them from an investment perspective has changed a good amount.

1:03:21Just to throw some numbers at you here. So in the most recent quarter, Q1 of 25, Revenues increased by 61 % year over year. Revenues came in at 392 million on the quarter. Daily active users were up 31 % year over year to 108 million. Gross margins came in at over 90%. Free cash flow came in at a positive 126 million, giving them a 32 % free cash flow margin. So after 20 years of unprofitability, they seem to be well on their way to becoming a dominant social media company that's very profitable. When you look at a company like Snapchat, another social media company, they IPO'd in 2017, and they're still deeply unprofitable today over eight years later.

1:04:06In Reddit, they only have a fourth of the revenue that Snapchat has. I was just really impressed by how well Reddit has executed recently. They're generating a lot of free cash flow alongside 60 % growth in their top line revenue. And interestingly, Sam Altman, the co-founder and CEO of OpenAI, he's invested in Reddit for over 10 years. He's been invested in, this might make Reddit more of a beneficiary to the improvements we're seeing in AI. Another interesting stat I found was that Reddit is the sixth most searched term on Google. And to Sean and Daniel's credit, they initially passed on the stock because the valuation was a bit high a few months back.

1:04:46It was over$100 a share. As the valuation came down and declined, they ended up adding it to their portfolio at$87 per share. And then the stock swiftly rebounded to over$140 per share. So they have a nice gain on that position. And there are a few things that are pretty interesting to me about Reddit that I'll briefly highlight here. The first is really the potential with their advertising business. So this is really the core of how they generate revenue. When we look at the United States, their average revenue per user is around$6 in the most recent quarter. And that metric is up 30 % in the past year alone.

1:05:23Meta, on the other hand, they generate an average revenue per user of$17 per user here in the US. And that really showcases that Reddit still potentially has some room to monetize their user base. Although I wouldn't really expect them quite to get to the level that Meta's at because presumably they just don't have the data that Meta has on their users. Additionally, the AI models are really key in delivering these results for advertisers. And these models are just getting better and better. So businesses are incentivized to spend more on advertising as these models get better, and they're getting more bang for their buck with their advertising spend.

1:05:59I'm also somewhat of an active user of Reddit. Sean, he explained that there are really two types of Reddit users. You have those that go to Google, they search a question and just add Reddit at the end of the query. And then you have users who just scroll what Reddit's feed or they're on the app, just scrolling through the app. And I fall into the first category, the former. For example, I was looking up someone to get golf lessons from here in Lincoln, and I got an excellent recommendation from Reddit. So Reddit's great for answering all sorts of very specific questions, whether it be something local or something within a very specific niche or industry or whatnot.

1:06:35And scrolling through Reddit from time to time, I've just been really unimpressed by their advertisements. For one, I found the ads to be largely irrelevant. I just don't think the ads are that good. I just don't think they're very compelling. And this could be seen as both a positive and a negative. So if the ads don't look all that great today relative to Facebook's, for example, then perhaps that in itself hurts the investment case. But on the other hand, it might mean that there's substantial room for improvement with the delivery, the targeting of the ads, and thus drastically increasing the average revenue per user.

1:07:09And just to put things into perspective here, in the trailing 12 months, Reddit produced over$1.4 billion in revenue, most of which came from advertising. And today, the digital advertising market is estimated to be$700 billion. So Reddit is just minuscule in this massive and growing market. Anyways, I just wanted to share some of my high-level thoughts on Reddit. If you haven't checked out the Intrinsic Value Podcast, I would highly recommend it. It's a great way to just learn more about many companies you already know and love, you know, Amazon, Visa, Nintendo, a lot of great names that they've covered.

1:07:43You know, given that analyzing stocks can just be so time intensive, it's nice to have this resource that's 60 to 90 minutes that gives just an excellent overview of whether it'd be interesting to dive in deeper or not. All right. So that wraps up today's episode on The Art of Execution by Lee Freeman Shore. I enjoyed giving this book a read since it touched on a few different concepts that I haven't seen in other books. So with that, we'll close out the episode there. Thank you for your time and attention today, and I hope to see you again next week. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes.

1:08:21To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.