SPRING 2021 Doddsville

Brian Bares, Bares Capital Management — P. 4 CBS Students Investment Ideas — P. 22 Sean Stannard-Stockton, Ensemble Capital — P. 26 Dan Rasmussen, Verdad Advisers — P. 48

Rodrigo De Paula, MBA 2021 Matt Habig, MBA 2021 Alison Tien, MBA 2021 Bill Ledley, MBA 2022

Tom Moore, MBA 2022 grahamanddodd.com Franklin Shieh, MBA 2022 csima.info

Page 2 Welcome to Graham & Doddsville

We are pleased to bring mussen’s early investing you the 42nd edition of influences, approach to Graham & Doddsville. This small-cap value invest- student-led investment ing, and contrarian publication of Columbia thoughts on the value of Business School (CBS) is fundamental forecasting. co-sponsored by the Heil- Our conversation about brunn Center for Graham “Superforecasting”, nar- & Dodd Investing and the rative shifts, and current Columbia Student Invest- market trends is a fun ment Management Asso- and timely read. Meredith Trivedi, Man- ciation (CSIMA). In this aging Director of the Heil- issue, we were lucky to be We continue to bring you brunn Center. Meredith joined by three entrepre- stock pitches from cur- leads the Center, cultivat- neurial investors who all rent CBS students. In ing strong relationships started their own funds. this issue, we feature the with some of the world´s winners of the 14th An- most experienced value We first interviewed Bri- nual Pershing investors and creating numerous learning oppor- an Bares, founder of Square Challenge. 1st tunities for students inter- Bares Capital Manage- place winners Paul Chan- ested in value investing. ment. We discussed Mr. dler ('21), Jack Devine Bares’s early interest in ('21), and David Kilgariff investing, experience with ('21) share their buy the- launching and running his sis on Dolby (NYSE: own fund, understanding DLB), presenting a com- of institutional allocation, pelling case based on and his first-principles DLB’s underappreciated based approach to funda- transformation. 2nd mental analysis. Mr. place winners Bill Henry Bares lays out his pro- ('22), Tom Moore ('22), cess, which focuses heavi- and Dickson Pau ('22) ly on business and man- present their buy thesis agement quality. Brian is on Angi (NASDAQ: ANGI) also the author of “The and walk through ANGI’s Small-Cap Advantage”, improving economics as published in 2011. it transitions towards pre -priced transactions. Next, we interviewed Professor Tano Santos, Sean Stannard- Lastly, you can find more the Faculty Director of the Stockton, CIO and co- interviews on the Value Heilbrunn Center. The founder of Ensemble Cap- Investing with Legends Center sponsors the Value ital Management. Mr. podcast, hosted by Pro- Investing Program, a rig- Stannard-Stockton walks fessor Tano Santos. Pro- orous academic curricu- through Ensemble’s Venn fessor Santos has recent- lum for particularly com- diagram for investing, ly conducted interviews mitted students that is taught by some of the which focuses on the with guests including industry´s best practition- overlap between manage- Anne-Sophie d'Andlau, ers. The classes spon- ment, competitive moats, Florian Schuhbauer and sored by the Heilbrunn and “forecastability”. Klaus Roehrig, Elizabeth Center are among the Sean also shares case Lilly, and Anna Nikola- most heavily demanded studies of successful yevsky ('98). and highly rated classes (Mastercard) and unsuc- at Columbia Business cessful investments (Time We thank our interview- School. Warner), with interesting ees for contributing their learnings in both cases. time and insights not only to us, but to the Lastly, we interviewed whole investing commu- Dan Rasmussen, found- nity. er of Verdad Advisers. We discussed Mr. Ras- G&Dsville Editors

Volume I, IssuePage 23 Page 3

SAVE THE DATE

The Heilbrunn Center for Graham & Dodd Investing at Columbia Business School presents

THE 31st ANNUAL Graham & Dodd Breakfast

Featuring:

Kim Lew, President and CEO, Columbia Investment Management Company

Date: October 29, 2021

Tickets to go on sale in August

www.grahamanddodd.com

For inquiries, please contact: [email protected] Page 4 Brian Bares, Bares Capital Management

Brian Bares founded some newsletters and BB: Bares Capital annual reports in high Yeah. Warren Buffett is Management in 2000. school and happened clearly on the list, but he BCM manages $5.6 upon a publication called wasn't quite the billion across two Outstanding Investor superstar when I was concentrated, Digest, which chronicled growing up that he is qualitatively oriented a lot of what Buffett was today. He was actually strategies: Mid/Large- doing and some of fairly low profile, even in Cap and Small-Cap. Buffett's contemporaries. the city of Omaha in the Brian is the author 80s and the early 90s, of The Small-Cap And then, of course, I and then he exploded Advantage, published into superstardom in the in 2011 by John Wiley read the Berkshire Annual Letters and was mid 90s. I clearly looked & Sons. He is also an up to him, and reading external advisor for pretty much hooked at that point. I went to the Berkshire Letters Brian Bares, the M.B.A. Investment was a huge catalyst for Fund at The University University of Nebraska, Bares Capital studied math and me and my interest in of Texas at Austin. He investing generally. But Management graduated from the actuarial science, moved to Austin shortly after thankfully, I think I got University of my hero worship out of Nebraska with a B.S. college and worked for an investment manager, my system at a fairly in Mathematics early age. (1995) and has who had some earned the CFA institutional clients and a designation. high net worth practice. My earliest mentor was The firm was small and it my father, who is the was growing very ultimate contrarian and Editor’s Note: This quickly, and I got the very self confident and is interview took place privilege of having a lot completely comfortable on March 30th, 2021. of responsibility fairly operating alone when he early. And that gave me feels like his reasoning a great inside Graham & Doddsville and rationale are solid perspective on the for making a particular G&D: Brian, thanks for various aspects of the being here with us. I decision, especially in firm. So I learned a lot business. And so I think was hoping we could both from an investment start with you walking us I inherited a fair amount standpoint, and in of that. And that has through your dealing with the background and what been a key in my operations, trading, success I think. started you down the compliance, etc. And investing path? that gave me a lot of confidence when I made The founder of the firm I Brian Bares (BB): the leap at 27 years old previously worked for is to launch my own firm. a guy named Mark Sure, well, I grew up in Coffelt, who was also an Nebraska. My father was early mentor. He taught an eye surgeon, and I G&D: me a fairly powerful enjoyed watching him In terms of your early lesson about hiring kind of expand the scope influences and mentors, smart young people and of his own business, either personally or folks empowering them to engage in some that you looked up to make decisions. And the entrepreneurial ventures from afar, who were the autonomy and the and that dinner table major influences on you? agency that I felt as a talk sparked my interest And with Buffett being young contributor on his in business, and he was from Nebraska and kind team was a very very interested in stocks of the local investing powerful motivator for and would select his own hero, how much of a role me, and it made me portfolio positions from did that play in your want to work harder and the 52-week low list in development? smarter for him. And the weekend newspaper. And I started reading (Continued on page 5) Page 5 Brian Bares, Bares Capital Management

that is a lesson that I've BB: And so I just gravitated taken and applied at our Absolutely. It was from first principles firm. critical. So my towards this idea of I've never met David experience at the time concentrated portfolios. Swenson, who is the was with a firm that was But given the state of Yale CIO. But his book highly diversified in its the industry, I didn't Pioneering Portfolio portfolio implementation know whether somebody Management when it and almost purely who was 27, with very was published in 2000, quantitative, which are little experience, who was a huge catalyst for exactly the opposite of didn't work on Wall me starting the firm and what we do today. And Street and hadn't lived growing the firm, and it so, as I was working for in New York could was very critical in our this company, I noticed actually compete early success, because it that institutional successfully for was essentially a guide allocators were using a institutional allocations. book for where series of intermediaries, And it was that book institutional allocation primarily investment that gave me my “A-ha” was headed, and where consultants to choose 10 moment where I said to we could potentially fit to 12 public equity myself, that the into what is now known managers each holding institutional allocator as the endowment 100 stocks. And to me, it community will gradually model. just didn't make any adopt this endowment model, which Ironically, some of my sense at all, because everybody's paying internalized investment greatest mentors after due diligence at the starting my firm were active fees and getting passive results. And at expense of relying on a actually institutional lot of these third parties, allocators. They helped the time we would add a 50th, or a 60th name to institutional investment me navigate some consultants and the like. critical decision points the portfolio, and it was along our path to almost inconsequential I thought that success. So people like in the grand scheme of internalization of the due Ellen Shuman, who ran things for the end client. diligence process would allow for unconventional, the Carnegie Corporation “I noticed that of New York for years younger, less tenured and Anders Hall, who institutional managers, like what I was at Duke, and now is was contemplating at the CIO at Vanderbilt allocators were using the time to successfully compete for large University. They are two a series of people that are probably institutional allocations. unaware that they're intermediaries, And if there was any mentors to me, but they kind of a stroke of have been extremely primarily investment structural genius in founding the firm, it was influential in my consultants to choose professional life. a recognition that the 10 to 12 public equity endowment model would be widely adopted, and G&D: managers each there would be a kind of categorical shift towards That's great. You holding 100 stocks. concentrated long-only mentioned Swenson's public equity managers book and launching the And to me, it just like Bares Capital. firm at a young age – didn't make any sense was that the signal that And so we've rode the kind of told you, hey, at all, because wave of adoption of I'm ready to do this and concentrated managers strike out on my own everybody's paying as almost a new asset here? active fees and class like infrastructure, private equity, or

getting passive venture. And so the 60-

results.” (Continued on page 6) Page 6 Brian Bares, Bares Capital Management

40 stocks bonds model getting that first client The second thing is I gave way to the and so that zero to one wanted to make sure endowment model, conversation is a very that I could articulate a which included a number difficult one. repeatable investment of additional pie slices in I think there's a couple edge, and we can talk the institutional asset things that are about the investment allocation pie chart, and important, the first is process itself in a the public equity piece that the personality moment, but I think we shrunk, but the characteristics of the had a pretty good story constitution of managers actual manager are around that. And then within that piece important. The first thing third, in a time and reshuffled in favor of I learned is that I can't resource scarce early concentrated managers outsource the iteration of Bares Capital at the expense of the fundraising to somebody Management, I needed diversified 100 stock 1% else if I'm a new to focus on the smallest managers from the manager. I have to go part of the US equity mainline Wall Street and give the market, which is micro firms. And so we were impassioned pitch for cap, and essentially sell the beneficiary of that the money myself, the scarcity of a gradual shift over the because I'm the one that concentrated portfolio, last few decades. believes in this process implemented in micro the most, and they're cap. G&D: going to want to meet And that was very me and do the due appealing to the It sounds like you had a diligence on me and endowment managers. very clear vision for the make sure that they're The capacity limitation value proposition that comfortable with me as meant that I was you would have to these a manager to make that signaling that I wasn't allocators. What were initial allocation. an asset raiser, that I those early fundraising was going to close and I conversations like “...the personality kept that promise of because of your age, characteristics of the closing and occasionally and just given that you giving money back to hadn't been a portfolio actual manager are investors as we were manager at a firm successful. So just sort before? What did you important. The first of fighting my own point them to, to thing I learned is that economic incentives to convince them that you raise portfolio diversity were worth taking a shot I can't outsource the beyond what was on? optimal for future fundraising to compounding was something that BB: somebody else if I'm a allocators did and still do Well, that's the trick, new manager. I have seek out in boutique right? I am pretty managers. fortunate in having had to go and give the I think another some institutional impassioned pitch for important point is that I validation, some success was also doing this at a and growth in assets the money myself, time that was pre- under management. And Madoff, and so there was so, I have a lot of because I'm the one a little less, frankly, emerging managers that believes in this operational due diligence asking me this exact than there is today. It question. Because there process the most, and was also coincident with are a lot of people out the proliferation of there that are pretty they're going to want hedge fund allocations. good compounders, to meet me and do the And so there was a lot of good analysts, but they money going to brand have a difficult time with due diligence on the fundraising, and me...” (Continued on page 7) Page 7 Brian Bares, Bares Capital Management

new startup hedge expansions and then, of course, growth, funds. And that those contractions. and it's hopefully under- same people, in many or unappreciated sources cases were due “you have to say, of growth that drive that diligencing the public qualitative excellence. equity managers. I think ‘Well, what is the So we think that to that the early Bares make these qualitative Capital story sort of felt share price or determinations, you a little bit analogous to reflection of’, and it's need to get out from some of these startup behind your computer, hedge funds. At the time simply a reflection of and you need to get in there was a little bit rental cars and in more of an appetite to internal airplanes. And obviously take a bet on newer compounding of we did this for two managers. decades before COVID business value per hit, and then we've been kind of resting on our G&D: share, absent ability to replicate this Definitely. Maybe distributions and work over Zoom, but shifting gears a bit to we're already getting your process and your dividends and back out into the field own competitive multiple expansions and starting to reboot advantage, it seems it's this process that I think really in the boots on the and contractions.” we have become known ground research, for. We're trying to meeting hundreds of So there is a long term create a competitive companies a year and convergence between advantage for Bares doing the hard stuff share prices and Capital by doing that's tough to replicate. business compounding. qualitative work that Could you talk a bit And everything that you other people are either about your investing know about a business is not resourced to do or approach and how it’s in its past. But the DCF unwilling to do. developed over time? exercise shows us that A lot of people would everything that maybe argue that determines the value of visiting companies is a BB: a business in the future. surefire way to introduce Sure, so I'd say the first So valuing will always be human bias. But in my thing is that because of a predictive endeavor. experience, that's just my own relatively unique And so we want to focus kind of an excuse not to history, we didn't inherit on those predictive do the work. It's really any investment DNA factors that should drive hard to build a team and from anyone else. exceptional get the resources to get Everything was sort of compounding over time. them on the road and to built from first principles, And those happen to be get them enough reps to and so when I thought qualitative. They happen the point where an about the problem of to be moats, or analyst can truly distill investment competitive advantage exceptional from management, which is and the word “moat” is average. But the way to how do you get share getting a little too execute effectively is to price outperformance overused in our just get them as many over the long term, you business. reps as possible. And by have to say, "Well, what But competitive the way, we just don't is the share price a advantage is the first see a lot of our reflection of", and it's category, and the next is competitors out on the simply a reflection of management, both road doing this type of internal compounding of capital allocation and work – they're trading business value per strategic execution and ideas with their friends, share, absent operational they'd rather be sitting distributions and implementation. And dividends and multiple (Continued on page 8) Page 8 Brian Bares, Bares Capital Management

behind their screens. shows or visiting Some interesting And so I think it's really customers and patterns that have come is a differentiator for us. competitors, anything out of our work are what And we firmly fall into that we would need to we call encore the camp of believing in do to shore up our performances, which are the value of qualitative qualitative essentially successful research and that if understanding of these managers moving from you're aware of these three buckets, the one company to another, natural biases that competitive position and and typically following everybody talks about, the growth prospects those successes has you can compensate for and the people running been a fairly good recipe them through these businesses. for success for us. awareness. But It's important to note Another very simple ultimately, we’re putting that we're not trying to pattern that's kind of into practice the art of do this so that we can counterintuitive is when evaluation of these better predict the next one of our analysts qualitative buckets, and quarter's earnings, it's comes back from the we just get better – we really about the long- field and starts a think we get better and term understanding of sentence with, "Brian, better at it over time. the potential for per you'd never believe what share business is happening at the compounding. company I just visited..." “And we firmly fall It's almost like market into the camp of inefficiency coming alive. G&D: It's something that you believing in the value When you look at as can't get from a Yahoo many companies as you profile or a Bloomberg of qualitative do, and take in as many snapshot. The comment research and that if qualitative data points as might be indicative of a you do, are there new level of energy you're aware of these common frameworks infused into a company as a result of some new natural biases that that you tend to put these insights into and people taking the helm everybody talks keep those updated to or a new effort that they benchmark against have internally, which about, you can different ideas? Because could create large tangential growth compensate for them it just seems like you're pulling in a ton of opportunities. through awareness.” information. I'm curious And oftentimes, when how you sift for insights we happen upon this in that process. pattern, it's not an I think this work is intentional search. It arguably amplified in might be because our BB: small companies, where analysts are in a city there's fewer market All good investment visiting with every public participants engaging in analysis in my view is company over the this type of work. And so pattern recognition. And course of two weeks. while we study the so that's why the reps And they're looking at Amazons and the are so important, something we may have Googles and the Apples because you see looked at a couple years of the world, we're emergent patterns for ago, and a new pattern largely focused on this success, and the more has emerged at a sort of small and mid- you do it, the better you stagnant idea that's in cap area and the get at it. We obviously our qualitative database. qualitative research isn't prefer certain types of And so when we find just going and seeing patterns that intrigue us patterns that might these companies, but it's and allow us to have indicate future success, actually training on their some confidence that like encore software or going to we're not spinning our (Continued on page 9) their industry trade wheels on a company. Page 9 Brian Bares, Bares Capital Management

performances, or razor- speed on a micro-cap screening for factors like razorblade models, or company, and low EV to EBITDA or for build once sell many sometimes the access is low price in relation to times dynamics of a little bit easier to get book value or earnings. software information the information that We think that’s probably services companies, you're looking for. But a recipe for getting into these are indications the flip side of that is value traps, and the that it's worth spending that sometimes you find market is just getting some time to dig a little a great little company, more efficient over time. bit more deeply to see if but the public float limits And so a low price in there's something there. you to maybe a smaller relation to, say, book position size than you value is probably would otherwise have in indicative of a business G&D: small cap or in mid cap. that's under-earning on Going back to your initial I would say that an its capital base and in focus on micro and small unheralded benefit of permanent economic caps, and now investing being in larger decline. mid and large-caps, are companies is that you there aspects of that tend to have other “...we're not evaluation process market participants between management, more focused on the screening for factors growth and competitive near term. like...low price in positioning that you A friend of mine worked weight differently when at one of the large asset relation to book value you're looking across management companies company sizes? and said that when he or earnings...that’s finally got a shot to run probably a recipe for a portfolio, he had 18 BB: months to prove himself. getting into value Yeah, there are gives And when I think about and takes for being in that being the typical traps, and the market micro versus small time horizon of a PM of a is just getting more versus mid cap. The fact large asset management that a company has company, that to me efficient over time. [A gotten to, for example, says that there is truly a mid and large-cap is time arbitrage low multiple] is usually an indication that advantage for people probably indicative of there's something that have a five, seven, special about the or 10-year outlook. a business that's competitive dynamics or the growth prospects or under-earning on its the management of the G&D: capital base and in business. And so, I think That makes a ton of that it is actually, believe sense. I’m curious when permanent economic it or not, a more fruitful valuation kind of comes decline.” search for these into the process – how qualitative do you think about characteristics in larger making sure you're Rather than a contrarian companies, fruitful buying at the right price? indicator of value, like meaning more the industry associates

numerous, whereas in with the price-to-book micro-cap, that's where BB: factor from the Fama- companies go to die. Yeah, with such a French three-factor There are a lot of concentrated portfolio, model or the net-nets of landmines in the space. we don't want to make a Ben Graham, for us, a And so you have to be a mistake on the quality of low value factor multiple little bit more selective. the business. And so we is just an evolving Obviously, the effort don't do valuation work marketplace where the there, it takes a little up front using factor (Continued on page 10) less time to get up to proxies. So we're not Page 10 Brian Bares, Bares Capital Management

market is relatively screening or filtering – efficient, and it is it's completely absent BB: assigning these low from our process. We multiples to businesses think about what Well, we think about all that are probably businesses we want to of those things, and the economic melting ice own, and once we've confidence interval cubes. And so we want identified them, then we tightens for us when a to be in the highest value them. And our business’s revenue and quality names run by the portfolio is a conviction expense structure are best people with the best weighted expression of more predictable. Which prospects for growth. We our best total return basically means that do all of our qualification prospects from our your reliance on your upfront based solely on preapproved focus list. intrinsic value estimate those qualitative factors, should be correlated and so the bulk of our with your confidence in process is being out in “...we do absolutely your predictions about the field doing the hard no computer the various line items work of prequalifying starting with revenue businesses without screening or filtering going through the knowledge of current expenses and resulting stock prices. – it's completely in free cash flow. The result of our absent from our For a business with very predictable free cash qualitative work is a process. We think focused list of about 30 flow, we have a little businesses that we about what higher confidence about would want to own the intrinsic value regardless of price. And businesses we want to estimate, versus a business that's growing then we do appraisal own, and once we've work on this list. So the like a weed that has lots appraisal work happens identified them, then of embedded call options at the end of our process and tangential growth rather than upfront. And we value them. And opportunities. An unpredictable growth it's a little our portfolio is a counterintuitive, because dynamic isn't to us a I think most people if conviction weighted signal that we should they were starting an stay away. It's just that investment strategy expression of our best we should be less reliant on the point estimate of from scratch would look total return prospects at the thousands of intrinsic value that we public companies from our have come up with. And available to them, and so we're different than they would probably use preapproved focus other managers in that some factor screening or list.” we don't just blindly filtering to try and rank order our portfolio whittle down what looks on price to intrinsic value, sell the most like an unmanageable G&D: universe to something expensive, and buy the more manageable. How do you think about cheap. portfolio weighting? Is it We say the price to But I think that that's more about conviction where a lot of people get intrinsic value ratio is and clarity with respect one of many factors that into trouble, because to growth prospects or they're using primarily we consider when the other qualitative making portfolio value-based screens to factors and being very try and find businesses, management decisions. confident that the thesis We have to think about but you're leaving out all will eventually express the great businesses the confidence in the itself in the way that you management, the when you do that. And expect? Or is it more so for us, we do growth opportunities, about upside potential the competitive absolutely no computer vs. downside risk? (Continued on page 11) Page 11 Brian Bares, Bares Capital Management

advantage, the dynamic bat. I would say, though Hathaway as a textile nature of the industry in that this is where variant mill back in the day you which all these perception really shines. would have missed the businesses operate. And This is one area where boat on what that then despite our there truly is an business was all about. concentration, we want analytical variant You wouldn't have to think about portfolio perception that can be contemplated the diversification as well. expressed in your acquisition of National You're about 80% portfolio. If you think Indemnity and all the diversified after eight about it, in its simplest subsequent businesses, stocks, but nobody in terms – if a business but you could say the their right mind would makes a material management bucket was have eight regional bank acquisition, it can sort of clearly pretty strong! stocks in a concentrated rewrite the appraisal The slider is probably a portfolio. We want to with the stroke of a pen. 10 out of 10 and the know what the economic That’s unpredictable, moat should improve drivers of value are in both in size and timing, over time as he does his our portfolio and make and so nobody on the thing. And the growth sure that we’re not buy side or the sell side prospects don't look taking any unintended would risk their careers great for a textile mill macro bets with a incorporating something but that's missing the concentrated set of like that into a DCF or point, again, there's a lot positions. appraisal. However, of different ways that there are things about this business is going to grow through G&D: an M&A strategy that can be analyzed from a acquisition. You mentioned growth qualitative standpoint, The question is how as one of the pillars of and you can get you much of a disconnect your process. And I'm comfortable with a between price to intrinsic curious, especially when conclusion. I may not value do we need to you're doing this deep know when and how underwrite this qualitative work, how these acquisitions may opportunity? And that's you go about valuing materialize but I know where, in my opinion, growth that is that the range of portfolio management foreseeable, like a outcomes is not normally and security analysis will company that just distributed, but it's always be one part art entered a new market heavily skewed to the and one part science. versus kind of the option upside with the right value of a gifted management. And if we management team and can find a team of “The question is how allocating capital to people that we get much of a disconnect future opportunities, and comfortable with, that then how you layer that maybe has a track between price to into the forecast that record of success in this intrinsic value do we drives your valuation. area, we might underwrite something need to underwrite like that, and we may BB: not have the ability to this opportunity? It's more art than give precise credit in a ...Portfolio science, and we try not DCF. But we can allow to be too for it as an embedded management and accommodating to the call option that's management or give definitely worth paying security analysis will them too much credit for for in some way. always be one part what is possible there, I think Warren Buffett is we try to be fairly probably the very best art and one part conservative in that example of this. I mean, area, just so that we science.” if you would have done a don't make colossal DCF on Berkshire mistakes in swinging the (Continued on page 12) Page 12 Brian Bares, Bares Capital Management

G&D: 10 in sales, and some be innovative and may We’ve talked about a are 10 out of 10 in be a potential disruptor history of strong capital capital allocation. Like in in their field, that's allocation being an golf, there are a lot of something that is an important factor for ways to get it down the embedded call option management. Are there middle of fairway, and that increasingly has other pieces that you're everybody's swing looks proven itself to be very looking at, like a proven a little bit different. valuable especially in the ability to expand into Ultimately, the questions current environment. new markets or other are whether this person or group of people can aspects of their previous G&D: operating performance? be trusted with our capital, and do they When you’re on the road have a good set of and meeting with BB: incentives, and do we companies, are there have proof that they’ve Yeah, I think the any key questions or been successful in the traditional value investor things that you're past, and do we have a crowd that I once looking for that you’ve high degree of identified myself with found helpful in getting a confidence that they can would have this mental better sense for execute going forward. picture of a great capital management? allocator being a Henry Singleton or Warren “Ultimately, the BB: Buffett, where they are sitting in an office questions are whether The first icebreaker, especially with a founder making decisions about this person or group buybacks versus or owner operator, which dividends and things like of people can be is yet another pattern that. And capital that we look for and allocation is obviously an trusted with our gravitate towards, is just to have them tell us important part of capital, and do they analyzing management, their story. And it as is understanding have a good set of usually gets them management's opening up, because incentives, analyzing the incentives, and do we people like to talk about themselves. And so they proxy statement, and all have proof that these sorts of things. All start chatting about the of that is sort of table they’ve been history of the company, stakes work for us, but and how they grew it we think that successful in the past, and the challenges that competitiveness, and do we have a high they met early on, and strategic execution, how they overcame understanding and degree of confidence those challenges. And having a vision for the then you start to get a company, how they that they can execute pattern for how the relate to employees, are going forward.” person thinks, and then they planning to do you tend to ask, what M&A, and what's their are you working on now? skill set in that area are Highly innovative Where's the business also very important. companies are an area going? And what are you where we differ a little worried most about? There's a lot of personal bit from the traditional characteristics that What we have tried to Buffett crowd. Warren describe great do is to put ourselves in famously said that he managers, and I like this their shoes and say, "If I applauds the effort but analogy of a talent stack were running this prefers to skip the ride or the skill stack that business, what are the when it comes to people need to have in critical questions that I research and order to be successful. would have," and then development. But for us And some are 10 out of if a business is proven to (Continued on page 13) Page 13 Brian Bares, Bares Capital Management

we try to focus on those the business. We want piece of the puzzle. And things. And oftentimes to come in armed with a so it's maybe more something comes out of really deep qualitative factors in the those conversations that understanding of the thesis that change that we don't contemplate – business and the could drive a decision each of these competitive set, and ask there. Are there conversations is a good strategic questions. examples of the thesis learning opportunity. People appreciate that. changing from what you And so sometimes we And they also like that underwrote previously pull something out of we're long-only. So they that you tend to be on these businesses that we tend to be okay with the lookout for that at that point hadn't talking to us. They're not could signal a sell contemplated, and we worried about us being decision for you? go back to the office, short the name or asking questions for nefarious incorporate that into our BB: decision making and purposes, they can do make sure that we've checks on us and see Yeah, there's a number shored up the thesis. that we have a long- of factors involved here. Because if we didn't term group of clients, So let's just start contemplate it going in , and that we're usually basically with our sell it could be a potential friendly in voting discipline. We'll sell if red flag, especially if it proxies. something's wildly indicates a deterioration overvalued, and wildly in the competitive overvalued is obviously a aspects of the business. “What we do is we non-technical term, but if something is caught up There's a lot of different make sure we don't in a bubble of non- things that might come waste management’s fundamental buying we’ll out of the conversation, consider selling for price but we don't have one time. We want to reasons alone. About 10 sort of silver bullet years ago we owned one question. We ask about make sure that we're of the names in the 3D competitors and not asking about tax printing space, and all of buybacks and dividends, a sudden 3D printing and all of it is rates or basics about was on the front page of interesting, but it's really the Economist and the more of a mosaic, and the business. We Wall Street Journal and we're just trying to fill in want to come in it got caught up in some the pieces. Let's just say speculative buying. Not we don't have a secret armed with a really at the GameStop levels sauce question that we [laughs], but it was ask, and if you sat in a deep understanding caught up in a bubble of meeting with us we of the business and non-fundamental wouldn't have some enthusiasm. earth-shattering the competitive set, questions that you And so we sold our wouldn't have and ask good entire position, and then contemplated, our of course its market advantage comes more strategic questions.” value promptly doubled from the comprehensive again – Murphy's Law. nature of our search, We will rarely make and the qualitative those sell decisions contrast among G&D: based on valuation companies. alone. More typically it's Going back to portfolio selling an overvalued What we do is we make construction and position and buying a sure we don't waste specifically the sell more undervalued one management’s time. We decision – you based upon a want to make sure that mentioned that the price combination of price to we're not asking about to intrinsic value tax rates or basics about calculation is just one (Continued on page 14) Page 14 Brian Bares, Bares Capital Management

intrinsic value and our the portfolio. And then certain types of names qualitative assessment. we'll go up to 15%, or and factors and things And then occasionally even higher, if we're like that. But our core the third reason that we highly confident. It's a philosophy hasn't would sell is that the conviction-weighted changed. One good thing pieces of the thesis portfolio, and the about having built this deteriorate for some weighting for each name from scratch on first reason. And the is fairly sizable principles is that we deterioration is usually compared to most don't look at anybody coming from a re- managers. else’s 13F. I don't care if underwriting of our famous successful confidence in those three investors are buying or qualitative buckets. G&D: selling our names. We've If we have high degree Got it – thanks for that. been in the crosshairs of of confidence in Just going to shift very famous short sellers management, for towards the current in the past, and we win instance, and they do market environment. some we lose some but something that we don't When you were starting we're around a 65% agree with, for example, out, it seems like there percent batting average, a large needle-moving was a smaller set of and in a concentrated acquisition where they investors that were portfolio that's pretty don't have experience in explicitly looking for the good and usually leads that area, that will type of compounders you to outperformance usually be a signal for us that you tend to focus over the long term. to move on. If one of on. How does the those managers that we opportunity set you see have a high degree of today compare to other “One good thing times in your career? confidence in retires, or about having built moves on, that's usually a sign for us to move on this from scratch on BB: and redeploy capital into another high confidence Well, let me just start by first principles is that idea. If we're caught off saying it's always been we don't look at guard by some hard. I think Munger competitive threat that famously said that it's anybody else’s 13F. I we didn't contemplate in supposed to be hard. our thesis, we'll move And it's hard today, and don't care if famous on. everyday is like waking successful investors up and drinking through And so there's a number a firehose of are buying or selling of things that could poke information, and we holes in the qualitative can't possibly digest our names.” thesis that we have on everything, we can't these companies, but possibly have our fingers there's no automatic And so we try not to pay perfectly on the pulse of triggers, we don't do too much attention to everything, and we are stop losses or anything the noise or the crowd. concentrated in part like that. If we are There definitely has been because we can at least confident in our work, an increased recognition focus our time and and we like the name, of the types of names energy on a handful of and the stock price that we research and the companies and try and backs up because it gets types of characteristics get competitively caught up in a moment we look for, the high- advantaged research, of pessimism, we're quality compounder and have a high degree happy to back up the names, but I also see of confidence and a truck and really get the typical sort of differentiated view on a pretty large in our crowding and clustering handful of companies. position size. We behavior in other typically start with 8- But over 20 years, we've managers that is seen the ebbs and flows 10% position sizing in (Continued on page 15) of investor appetite for Page 15 Brian Bares, Bares Capital Management

indicative of them G&D: avoiding original work. To that point – as you “There's a They seem to be think about moats and commoditization heat comforting themselves the speed at which with the social proof of things are changing, and death of the universe their peers. And so we the bifurcation that you work hard to have a just talked about, do you coming for you if you portfolio that's reflective get the sense that moats operate any business. of our original work free are becoming less of outside influence. durable as we move on? And so we don't give To us that's a point of Or is that just kind of pride. When we're what we're seeing in the permanent perpetuity thinking for ourselves, headlines, and that's for exceptional we're typically offering what's top of mind our investors a relatively because of sky high economics at any differentiated portfolio. valuations and maybe company in our DCF I think that the more the underlying durability perplexing thing for me hasn't changed too models for that much? is that the overall reason...I think that market is kind of two- tiered today, where you BB: there probably is a either pay a really high optical multiple for a Well, I don't have the technological name of the paper off clear disrupter and a obsolescence risk business that has a very the top of my head, but good chance of being there was a research that's increasing for much larger, or you pay report published a a more normalized couple of years ago on all companies.” market multiple for the “topple rate,” which businesses that are on is the rate at which

the receiving end of companies are leaving disruption, and maybe the S&P 500. It's G&D: economic melting ice increasing decade by Do you factor in kind of decade, so I would say cubes. And so that's just what's going on in the that there is evidence part of every investor’s general market or what's that perhaps the dilemma, which is how going on in the macro duration of certain much will you pay for environment at all into moats is decreasing. I disruption. Going back to portfolio decisions like love Professor our earlier discussion, how much cash to hold? this is where we earn Greenwald at Columbia's Just curious how you quote from his book our fees, trying to think about cash and Competition evaluate those predictive being fully invested Demystified, “In the end qualitative elements in when there is everything's a toaster.” an attempt to put speculation going on in There's a together a portfolio that some areas of the can outperform. commoditization heat market. Fortunately for us, the death of the universe tools required to coming for you if you navigate the current operate any business. BB: And so we don't give environment are core to Yeah, so we don't hold our investment process permanent perpetuity for exceptional economics at cash tactically; we try to and have been for 20 stay fully invested. The years. There are a lot of any company in our DCF models for that reason. nice thing about the way managers that are that we have structured screening on factor So, yes, I think that there probably is a our business is that we models that appear to be are an institutional sub lost in the woods when it technological obsolescence risk that's advisor. And so we don't comes to the current have 100% of anybody's environment. increasing for all companies. (Continued on page 16) Page 16 Brian Bares, Bares Capital Management

money, and so we don't BB: That’s probably the have to be smart about Yes, I mean, all of this is hardest thing for short term market a discussion about basic somebody starting up is direction, being long or “product market fit.” You knowing how to segment short, or worrying about want to be selling your or categorize investing in other parts services to people who themselves. You hear, “I of the capital structure, specifically want that just want to invest, I whether to have a little service. And so, we have don't want to deal with bit more small-cap India a lot of conversations clients, I just want a versus private equity in with people who ask us $100 million to invest China. Those are to do things that are how I want to.” Unless decisions that are made putting us outside the you have a rich uncle or above our pay grade by “straight up the middle you find that one institutional allocators. of fairway” services that allocator that will let you And so we stay fully we offer, and we tend do that, that isn't very invested in the best not to have productive reflective of the realities handful of companies conversations with those of the marketplace. that we can find in our people. We know exactly Some institutional market cap category. who we are. And there allocators care about Now, it is true that we are huge swaths of the market cap, some care tend to look for institutional allocator about geographic focus businesses with high community that are just like US versus rest of the returns on invested not the right fit for us, world, some care about capital, and we prefer and we know that and filling this bucket or that that they can get that that's okay. bucket in their return without excessive institutional allocation. use of leverage. And so As a manager I have to those companies tend to “we have a lot of understand who I’m be cash generative, and conversations with pitching to, and what they themselves they want, and how to typically hold a fairly people who ask us to service them effectively. sizable excess cash do things that are And so that is absolutely balance, and so on a something that I think a “look through” basis, we putting us outside the lot of emerging actually are experiencing managers get wrong. a higher cash drag than “straight up the Maybe they're using the fully invested middle of fairway” cash tactically, and portfolios of our clients they're trying to appeal would otherwise services that we offer, to people that don't want indicate. and we tend not to them to do that, or maybe they're investing G&D: have productive globally, when they're failing to realize that You mentioned the LP conversations with many institutions base with institutional those people. We separate US from rest of portfolios being a factor the world, or maybe and letting you run the know exactly who we they're investing across type of portfolio you'd the capital structure. want to run. For are. And there are And perhaps that's not someone considering huge swaths of the something that people starting a fund, are their want when they're inherent limitations in institutional looking for purely public terms of the way you equity exposure. want to structure the allocator community Naturally there is some portfolio based off of that are just not the element of, unfortunate whose money you're as it may be, filling a ultimately managing? right fit for us...and particular bucket or checking a particular box that's okay.” (Continued on page 17) Page 17 Brian Bares, Bares Capital Management

for a potential allocator. what you want to do, consuming effort seek them out and drop required to launch the everything and try and firm. G&D: join them. Awesome. If you have advice for people moving G&D: into the field, or making “...my advice would Definitely, that’s great an impact early in their be live frugally and advice. I wanted to bring career, anything you can up your book, The Small share there would be then find the people Cap Advantage, and I great. heard on another that are doing interview that it was exactly what you originally called The BB: Little Book of Little I think the one piece of want to do, seek them Stocks, I think. I like that title a lot. advice would be to live out and drop frugally. And it sounds kind of counterintuitive everything and try coming from somebody BB: who has been a fund and join them.” I think that title is still manager for 20 years, available if anybody but early in my career, I wants to write it. lived this advice. I went That's kind of what I did to a state college on full with my first job in scholarship and saved investment G&D: money during college, so management. I talked If you were to write an that I could “cast about” my way into a job with update in 2021, is there a little bit for my first job this guy and said, "I'll anything that you'd be and make sure it was work for free." And he thinking about adding or the right fit, rather than said, "What's the catch?" things you'd want to dive having life “stick a gun And I said, "Well, pretty into deeper that you've at my head” and force soon I'm going to be found interesting in the me to work at someplace indispensable to you, intervening years here? that I didn’t necessarily and then you're going to like, because I needed have to pay the paycheck, and my me." [laughs] And he BB: life depended upon it. gave me the smirk and I had a pretty cavalier And so when I started said, "Okay, come on paragraph in the book my firm at 27, I had board." And so I just where I just sort of said, saved what seemed like happened to find the “I don't think that price a lot of money then to right opportunity and the to book as a value factor give myself a couple of right person and has underlying years to turn my firm personality to where I fundamental validity as a into a success. was able to be predictor of future And living frugally also successful. But I do outperformance.” It's meant that I didn't have think looking back that I probably just a reflection to keep doing something had this key advantage. of contrarian psychology, else that I didn't like in I was living frugally and and that's after 80 years order to advance my had time abundance. I of the Fama and French career and my long-term wasn’t saddled with Three Factor Model interest. It just gives student debt, and I working perfectly, so it you flexibility and wasn't married, I didn't felt pretty bold to make confidence to chase have kids at that time. If that statement in the down these opportunities I had those things, it book. where they appear or to would have been a lot harder to do all this, So it was kind of a go find them yourself. cavalier statement back So I guess my advice especially if I had some time inflexibility then and as it turns out would be live frugally since the book's and then find the people personally that would (Continued on page 18) that are doing exactly have prevented the all- Page 18 Brian Bares, Bares Capital Management

publication, price-to- allocators. And so I think Creating Shareholder book has just stopped that those things are Value, I thought was a working. And I think, as probably the most pretty good I said earlier, it's interesting takeaways encapsulation of the how probably a reflection of from the book. The main a business generates per an increasing amount of thrust of the book, small share value over the market efficiency, where -caps outperform large- long term, and why you a low price to book is caps, isn’t some earth- should look for certain probably more indicative shattering revelation to things. That's one that of a business under anybody. we give our analysts. earning on its capital If I did another book, I The Swensen book base and so people are probably wouldn't do it Pioneering Portfolio ditching that as a value on the same subject Management is a little factor in preference for matter. If I did bit outside of the value businesses that have something else, it would investing canon, but it better prospects. I think probably be on the is, I think critical for that was kind of an qualitative elements of understanding interesting kind of tidbit the investment process. institutional allocators. from the book. When I read investment And it's hard for literature now, I think emerging managers to that's probably where understand what “...price-to-book has there might be an institutions are like, because they've never just stopped opportunity to add something unique. worked in that working. And I think, Portfolio management, environment. security analysis and the In any business I would as I said earlier, it's qualitative elements of want to understand what probably a reflection those two endeavors my customers want and could be an interesting how they behave. of an increasing foundation for another Business is not just how book. to manufacture a great amount of market product, it's identifying efficiency, where a and effectively servicing G&D: customer demand, and low price to book is When I think about the that's a key part I think of our business that just probably more value investing books that I was introduced to gets left out of the indicative of a early, it was very much conversation. And I think in the vein of the one of the reasons that I business under Intelligent Investor and have been successful is that I think I understand earning on its capital net-nets, and then you kind of find your own what our clients want. base and so people style from there. And so And when I talk to some part of Columbia, which emerging managers, and are ditching that as a has been really they describe to me value factor in interesting has been the what they're doing, emphasis that we've oftentimes in my head, preference for gotten on books like I'm thinking to myself, Quality Investing, or “you've obviously never businesses that have Common Stocks and had a meaningful better prospects. ” Uncommon Profits. Are conversation with an there books that are in institutional allocator.” that wing of the value Many emerging I think that I had a lot to investing house that you managers think they can say on firm structure would recommend to simply sit in their office and how to kind of build folks? and pick stocks all day. a firm that may have They think that is the job some elements of and that seems fun to differentiation that would BB: (Continued on page 19) appeal to institutional The Rappaport book, Page 19 Brian Bares, Bares Capital Management

them, and they're that I like the book, and fee retention business introverts and they don’t I think it’s now 20 years rather than the want to do anything old, which is another compounding client else. But success in our entire conversation capital business, business is just so much about how topical it truly because once you're more than that. I mean, is anymore, but it was successful, it's lucrative, when you look at the critical for me in my and everybody wants to very best investment early years. And it was keep the assets around. managers, you notice definitely a non-standard And we've kept our parts of their talent book that I didn't hear portfolio concentrated – stack that are present in many other investment it's kind of a marker in addition to being great managers talking about the ground that says security analysts and when I read it. we're in this for client great portfolio compounding, we aren't managers. You’ll notice G&D: an asset raising firm, we that they're great don't have any managers of people, that It sounds like the way marketing or sales they're entrepreneurial, you think about the people on staff, it's just that they have a investment management me and our President a customer focused business has a lot of handful of other people mentality, that they can parallels with the way on the research team articulate what they're you look at a business that go and talk to doing very well. you might invest in as a prospects and clients. And that's not just company with a important for selling competitive advantage, yourself and your and the different skill services. Oftentimes, sets you need for the “we've kept our institutional allocators management team. portfolio will look at you and say, "Can I trust this person BB: concentrated – it's to come in front of my board, or in front of my Absolutely. And to that kind of a marker in clients or in front of my point, what's the moat team, because my around Bares Capital the ground that says selection of them is a Management? And how we're in this for client reflection upon me." And do we expand that so that dynamic is moat? Part of the answer compounding, we is the qualitative missed as well. There's aren't an asset just a lot of nuances of research process – not our business that are many people are doing it raising firm, we don't underdiscussed, like us, and if you were a especially if you just typical startup manager, have any marketing say two people and a stick with the typical or sales people on Barnes and Noble Bloomberg terminal, investment section trying to build an staff, it's just me and reading list. So for investment management aspiring managers, I company, you probably our President a wouldn’t limit reading to don't have the fee handful of other investment philosophy income to get a fully and process. I would resourced team of people on the extend my reading list to people out on the road include books like and collecting all of this research team that go Swensen’s, where you qualitative information. and talk to prospects can start to understand And by the way, if you what your prospective are successful, you'll and clients.” customers think and how probably follow your they make decisions. economic incentives into a more diverse portfolio. So this was a long- Then you have the winded way of saying incentive to get into the (Continued on page 20) Page 20 Brian Bares, Bares Capital Management

G&D: are a lot of new ideas successful in professional It seems like there's so competing for the investing. And despite much information out existing approved list of our resources, our team there, and especially focus list names that we is still operating with when you're a have approved, and we time scarcity. And so we generalist, you could have to make sure that try to fish in ponds spend your day doing the intensity of the where there are a lot of countless things. So I'm research on those focus fish. We try to focus our just curious about how list names remains high. research time and efforts you tactically structure I'd say that we all where it's likely that we your days, and what emphasize process over will have the most you've found to be most outcome. And it is a fruitful search. And so, efficient, maybe for a process. I think that back to the earlier day where you're not on naming the firm Bares comments about the the road, how do you Capital Management is pattern recognition, we actually spend your probably the biggest spend time in software, time? mistake of my career. It precision instruments, information services, should be called something else, because and other categories BB: it really is a team effort. where just about every constituent out-earns Well, that has evolved And it's not all me, I'm their cost of capital over significantly over 20 not the next Warren extended periods. We years of building the Buffett – I'm not sitting don't spend a lot of time business, I mean, day there just picking stocks in steel companies and one, I was picking health all day long. It's a team airlines and industries plans and negotiating of people that have where businesses are office leases. And now, functional responsibility capital intensive price thankfully, I built a team for basically every area takers, not price makers. that includes an of the firm, and I've They don't get a lot of operations staff who are become more a manager love around the office responsible for the of the business than I and a lot of time and account statement ever was 20 years ago. attention. I mean, we balancing and trading still look at them, but and operations and we're not spending an compliance and dealing “I'd say that we all enormous amount of with regulators and that emphasize process time on them. sort of thing. And then we have the investment over outcome. And it team, who are G&D: responsible for selecting is a process. I think In terms of outside the securities and managing that naming the firm portfolios. And so I've office, what do you like kind of carved out for Bares Capital to do? What ends up myself the pieces of the taking up most of your process that I like, which Management is time? are managing the probably the biggest research process, and BB: talking to clients and mistake of my career. prospects. Well, I actually like to It should be called have a nice separation And so I split my time something else, between work and between those two home. Family takes up functional areas. because it really is a the preponderance of my Managing the research non-work life. I have process is making sure team effort. And it's three boys and they're that we have the right not all me…” into sports and other people in the right hobbies, and I try to positions, that the take advantage of the productivity of that staff is high. And then there But it's difficult to be (Continued on page 21) Page 21 Brian Bares, Bares Capital Management

short time I have with might miss because really cool, and now it's them before they leave you’d assume that this totally discovered. the nest. And I really was the way the rest of Unfortunately now just enjoy being with the world works? everybody's moving friends, and that here. enjoyment has been amplified through BB: quarantine I think. The So the answer is yes. G&D: mandated isolation has And I think it is really This was awesome – reinforced my more about the social thanks for the time, appreciation for getting proof of being in Brian. together with friends for Midtown Manhattan, or dinners, hiking, sitting San Francisco, where around a fire pit, your supposed laughing, having good independence of thinking conversations. I’m happy starts to get suddenly that it is starting to replaced when your good become safe to resume friends who you know these activities after and like start buying vaccinations. certain names, and you And I'm also actually feel like you should be in very lucky to have a lot them too. And so, one of of friends that aren't in the great lines of investment feedback we got from management. They don't one of our early really care at all what I investors was, “the thing do and actually love I love about your team is that. It's also a huge that no one else owns benefit being in Austin, the names you own.” which especially 20 This comment was years ago, was kind of a probably 10 or 12 years backwater for ago, but they said, investment “everyone I talk to owns management. I'm not Visa and MasterCard,” constantly running into and it was the same five people in the business or six names that were and talking about work, in all of these hedge and I don't find myself fund portfolios at the engaged in that constant same time. The John comparison with other Malone complex, the people in our business, credit card networks, and I think that's a and other crowded pretty psychologically names. healthy thing for me, And we just had this honestly. differentiated portfolio. I don't know if it's me and my personality, or if it's G&D: Austin, the way we built Maybe just bouncing off the firm on first that, do you think being principles, or if it's all of outside of New York and the above. But it has the West Coast, helps produced some someone avoid an differentiation in what element of groupthink in we do and how we do it. an investor mindset? Do And so I like that, I love you potentially recognize Austin, and I would things in companies much rather live here where if you were than in San Francisco or constantly in a huge city New York. And I got like New York that you here in ‘96 when it was Page 22

Dolby Laboratories, Inc. (NYSE: DLB) - Long 2021 Pershing Square Challenge (1st Place)

Paul Chandler Jack Devine David Kilgariff [email protected] [email protected] [email protected]

Price (4/12/21) $102.14 Market Cap $10,378 52-wk High $103.88 Enterprise Value $9,303 52-wk Low $52.13 3-yr Adj. Beta 0.95 Avg Daily Vol. (3 mo. Daily, mm) 0.5 WACC 5.65% Paul Chandler ’21 Nominal Shares Outstanding 101.6 Dividend Yield 0.90% Float (%) 63.90% TEV / FY ‘22 Total Revenue 6.8 x Paul is a 2nd year MBA at Short Interest 1.80% TEV / FY ‘22 Cons. Adj. EBITDA 16.7 x CBS. Last summer, he interned at Goldman Sachs Recommendation: in the Natural Resources Investment Banking group. LONG DLB for ~22% IRR with a 5-year price target of $205 based on a DCF with a terminal multi- He also interned in Private ple of 17.3x FY1 EBITDA and WACC of 5.65%. Equity at Eden Capital, Halmos Capital, and Doril- Business Description: ton Capital. Prior to CBS, Dolby develops audio and visual IP and licenses it to the media industry. The market for their tech he worked at PA Consult- includes content creators, streaming services/content distributors, and manufacturers of consumer ing Group in the Energy & Utilities Practice. Paul devices, which is where Dolby monetizes their IP via royalties. These end markets include: graduated with a B.A. in • Broadcast: (41% of 2020 rev.) includes televisions and set-top boxes (STBs) Economics from Yale. • Mobile: (21% of 2020 rev) includes smartphones and tablets • Consumer Electronics: (14% of 2020 rev.) includes DMAs, DVDs, soundbars, etc. • Personal Computers: (12% of 2020 rev.) includes Windows and Mac OS and PC hardware • Other: (12% of 2020 rev.) includes gaming consoles, auto, Dolby Cinema, and Dolby Voice Dolby’s premium products create value across the entire media ecosystem:

Jack Devine ‘21 Jack is a 2nd year MBA at CBS. Last summer, he interned at Goldman Sachs in the Natural Resources Investment Banking group. Investment Thesis: Prior to CBS, he was a I. Significant business transformation: supply chain supervisor and engineer at ExxonMo- • Dolby has proven itself over 50+ years of tech cycles and has built a premium reputation in AV bil. Jack graduated with a B.S. in Operations Re- • Dolby has historically been a “standards” licensing business, relying on audio encoding tech, search and Engineering where they were virtually a requirement for playback in consumer electronics, like DVD players from Cornell. • Standards allowed Dolby to realize mandated, recurring revenue for each device shipped • Since about 2013, management has strategically shifted to develop next generation, consumer -facing audio and visual products that work on top of their standards-based products • Premium products include Dolby Vision (a High Dynamic Range visualization engine), Dolby Atmos (3D spatial sound technology), Dolby Voice, Dolby Cinema, and Dolby.io (media APIs) • The market has not fully captured this fundamental shift in strategy: where device makers seek out Dolby’s products to drive incremental sales of their SKUs II. Upcoming adoption cycle enables above consensus revenue growth: • Increasing internet speeds and faster processing power enable higher quality AV experiences in David Kilgariff ‘21 the home, bolstering demand for Dolby products David is a 2nd year MBA • Existing customers will expand usage of Dolby student at CBS. Last sum- technology across their entire product line-ups, mer, he interned at BofA Securities in the Technolo- moving beyond premium SKUs, and new custom- gy, Media & Telecom In- ers will adopt Dolby technology due to its superi- vestment Banking group. or performance and powerful network effects Prior to CBS, David was a Manager within Accen- • We estimate that Dolby has already been grow- ture’s TMT Strategy Con- ing its market share by ~10% CAGR since 2013, sulting practice. David but this growth has largely been masked by a graduated with a B.S. in Mechanical Engineering declining legacy DVD business (see next page) from Johns Hopkins. • We expect revenue growth of ~15% 5-year CAGR, driven by a weighted avg. ~5-6% CAGR TAM expansion and steady ~10% CAGR share growth • Broadcast: Atmos and Vision are underpenetrated in the growing 4K TV market, existing in 9 of the top 10 smart TV makers, but mostly in premium SKUs • Mobile: Apple’s accelerating adoption across multiple product lines is a major win. iPhone 12 is the first smartphone to enable video capture in Vision and will encourage more OEMs to adopt Page 23

Dolby Laboratories, Inc. (NYSE: DLB) - Long

III. Significant hidden operating leverage in the business: • Dolby operates a majority 95% gross margin licensing business, yet operating margins have eroded sig- nificantly over the last 10 years • We believe margin erosion was largely attributable to its finally bot- tomed-out, legacy DVD business, where it held a powerful standards- based audio encoding monopoly • Normalizing out DVD rev. using management estimates and histori- cal shipment data, we find an under- lying “New Dolby” business that grew revenue at ~15% CAGR with ~60% incremental EBITDA margins • We believe that Sales & Marketing and Research & Development have significant fixed cost scale, and have grown effi- ciently as management shifted to launch the new Atmos and Vision offerings and build a global, scaled salesforce IV. Business model has sustainable competitive advantages: • Across multiple media formats, Dolby has built double-sided networks from content creators to device manufacturers. These network effects create significant barriers to entry while also creating value across the entire ecosystem • Near-term accelerants of networks include premium streaming services, 5G handset upgrades, and internet upgrades • Dolby’s expanded product portfolio and bundled technology offerings create higher switching costs for OEM customers • Significant IP protection is supplemented by ”Intel Inside” style ingredient marketing on streaming services and end devices Valuation: • DCF with 5.65% WACC, 17.3x FY1 EBITDA terminal multiple • No growth from multiple expansion • Forward revenue continues to compound in line with “New Dolby” last 5-7 years (~14-15% CAGR), with observed ~60% incremental EBITDA margins • Additional upside if use cases within gam- ing, music, and auto grow corresponding end markets faster than we anticipate • R&D (15% of incremental revenue), S&M (18% incremental) scale in line with pre- vious “New Dolby” growth – no additional operational de-leveraging • Earnings power analysis provides comfort- able downside protection (P/Adj. BV = 1.2x, P/Adj. EPV = 0.8x) • Base case assigns no value to Dolby.io API business– which management be- lieves could double the company’s TAM and possibly lead to multiple expansion • Base case assigns no growth to Dolby Cinema or other Products & Services— both of which could be significant Risks and mitigants: • Bundled customer relationships: Pricing with large OEM customers is nuanced and includes bundles across products and end markets, making it challenging to forecast unit economics short term. Dolby’s complicated relationships point to their stickiness with customers and the competitive moat they’ve developed • Competing with customers: Major OEMs (Samsung, Sony) develop AV technologies that could partially compete with Dolby. Double-sided networks reinforce the need for a neutral party to succeed and Apple buy-in indicates positioning • IP Risk: Dolby may be unable to enforce patents or face roll-offs. We observe the average patent expiration to be 2029. Dolby branding and trademarks also partially offsets some of this risk, and global patent enforcement arm has success- fully operated across multiple cycles • Controlled Company: Dolby family controls 85% of voting rights. This can be viewed as a long-term strength, as Dolby can resist the urge to short sightedly raise prices too aggressively on technology cycles and maintain partnerships Page 24

Angi, Inc. (NASDAQ: ANGI) - Long 2021 Pershing Square Challenge (2nd Place)

Bill Henry Tom Moore Dickson Pau [email protected] [email protected] [email protected]

Bill Henry ’22 Bill is a first-year MBA student at CBS. Bill most recently worked on Citi's High Yield Credit Research team focused on Recommendation: Healthcare. He started his Long ANGI with a $45.26 price target over 5 years, representing 166% upside and an IRR of 21.6% career at SunTrust Robin- son Humphrey in credit origination before moving Thesis Summary: to their credit research Angi Inc. (ANGI) is a dominant home services marketplace that is shifting from a lead generation to team. His B.S. in engineer- ing degree is from the a pre-priced transaction model with better economics, and is best positioned to capitalize on an University of Virginia with a enormous, growing TAM with favorable tailwinds from millennial home ownership. M.S. in Commerce and from George Washington Business Description: University. ANGI is the world’s home services marketplace comprised of three business segments: • Advertising & Europe: (~23% of rev) Home services professionals (pros) pay to advertise on Angi- e’s List, HomeAdvisor, and smaller sites. • Lead Generation: (~66% of rev) Customers input project details onto HomeAdvisor, and pros pay for leads (contact information) matched based on project type. • Pre-Priced: (~11% of rev) Customers input project details and are provided with an “Uber-style” one-click price. ANGI matches the job with the pro and guarantees execution. Investment Thesis: I. Huge, Mostly Offline TAM with Tailwinds: • Highly fragmented market valued at $500 billion and currently >80% offline Tom Moore ’22 Millennials over the median home buying age (34 Tom is a first-year MBA • student at CBS. He started years) projected to nearly double by 2026 his career with PwC in its management consulting • As the largest online player, ANGI has a signifi- group focused on strategic cant supply advantage over competitors in a planning and forecasting market requiring a solution for millennials, who are projects. Tom is an AVP for now the largest segment of home buyers. the Columbia Graham and Doddsville investment • Near-term Serviceable Obtainable Market of pre- newsletter and is interning priced services estimated at $290 billion for low with Tensile Capital Man- agement on its public equi- and medium consideration jobs. ties team this summer. He • Growing TAM aided by aging US housing stock graduated from UT Austin with degrees in Finance requiring more maintenance, and home services and Plan II Honors. is less cyclical than traditional housing construction spend. • We estimate that 18% of ANGI's GMV will be converted to the advantaged pre-priced model by 2030, vs 1% today.

II. Pre-Priced is a Step Function Change: • ANGI’s 2020 take rate on pre-priced jobs estimated at 32%, vs <5% for lead generation. • ANGI can take more from pre-priced jobs because the model drastically reduces friction for both customers and service pros. • Booking through pre-priced saves a customer Dickson Pau ’22 over an hour of time relative to offline process, Dickson is a first-year MBA removing friction from being quoted a price over student at CBS. Prior to business school, he worked the phone and renegotiating in person. at Ascender Capital as a • 73% of service pros surveyed said they generalist covering Asian small and mid caps. Dick- would take a pre-priced job offered by ANGI, son graduated with First with 21% unsure. Honors from The Chinese University of Hong Kong • Pre-priced jobs are attractive to pros: surveyed with a Bachelor of Business pros reported being willing to take a 10% Administration. He is in- discount from average prices in exchange for a terning with T. Rowe Price this summer. guaranteed job. • Pre-priced, guaranteed jobs prevent holes in pros’ Page 25 schedules. 27% of service pro time is spent on non-revenue generating work (marketing, negotiation, back-office), and on 19% of jobs, customers cancel last minute. • Supply increase due to mental shift – moving from a pro cost center to a revenue center • Pre-priced expands ANGI’s moat over big tech. Lead generation business competes with Google and Facebook, but tech giants are uninterested managing thousands of suppliers and fielding calls to negotiate disputes. • Pre-priced drives users to the ANGI mobile app (50% 2020 user growth), where transaction frequency jumps 50% and mem- berships are more likely. We project ANGI LTV / CAC to improve from 3.0 to 7.1x by 2026.

III. ANGI is the Dominant Player with the Best Management: • Scaling pricing accuracy in the pre-priced model requires solving hundreds of thousands of micro-markets (400 metros x 500+ services), conferring a significant, self-reinforcing data advantage to the largest player. • ANGI generates revenue that equals that of its next four primary competitors combined, and generates FCF in excess of NI allowing for aggressive investments compared to unprofitable private competitors. • 84% owned by IAC, who wrote the playbook on scaling online marketplace businesses. • Historically, IAC identifies an attractive market, consolidates via acquisitions, tinkers with product market fit through extensive A/B testing, and spins off at maturity (see MTCH) • Handy (pre-priced cleaning services marketplace) co-founder Oisin Hanrahan recently elevated to ANGI CEO, demonstrating ANGI / IAC commitment to pre-priced model as its growth engine moving forward. • “This is a testament to what we see as the future of the business.” - Team interview with IAC CEO Joey Levin Why the Opportunity Exists: • Sell-side gross margin estimates imply minimal growth percentage of jobs transacted in pre-priced by 2022 (4.2% estimated in 2020, 5.4% 2022 sell-side, 7.4% 2022 base case) • Bears believe the ANGI model is Google arbitrage, and will be unable to solve supply tightness • Investors shorting ANGI to create synthetic Vimeo position ahead of Q2 '21 spin from IAC Valuation: • Base Case: • Assume 24% of low priced jobs converted to pre- priced by 2026 • Margins to increase due to higher take rate and im- provements in marketing and selling efficiency • Three valuation methods: FWD EV/EBITDA, FWD P/E, and DCF. • WACC for DCF at 7.8% • Average 2025 target price at $39.57 • Bull Case: • Stronger margins as subscription model increases purchase and job frequency further • Bear Case: • Assume take rate pre-priced jobs decline more rapidly to drive adoption • No improvements in purchase or job frequency • Probability-weighted Price: • Assume probability distribution skews to the right. Base case at 50%, Bull case at 30%, and Bear case at 20%. • Blended target price: $45.26 Primary Research & Interview Insights: • On the difficulty of pricing home services and how aggregating data helps: • “Drywall, brick, wood… all [variables] make a difference. The more jobs you perform the more data you have. And we have performed the most jobs.” – Joey Levin, CEO of IAC • “The dataset of pricing [home service jobs] nationally doesn’t currently exist… We have the opportunity to become the ref- erence point for home services pricing." – Brandon Ridenour, Former CEO of ANGI • Service Providers See the Appeal of Pre-Priced: • “It would be great to not have to haggle and just focus on the work.” “Filling in empty time slots is a big benefit.” “A steady stream of work that I don't have to hunt for would be huge.” – Assorted Service Providers • Technology can make a meaningful difference in the ability to pre-price jobs accurately • “If you can give me the materials, the size of the access point, and the size of the issue, I can generally price the job from my computer.” – Owner/Operator of Commercial Plumbing Company • “Maybe a little more than half of my jobs are clean cut [he can accurately estimate the time / price in advance], but if you have a customer do a thorough job with photos that would help a ton. Knowing that stuff makes a huge difference with pricing.” – Independent Plumber • The Lead Generation model leaves much to be desired, especially for independent operators • “Putting in money up front for leads that might not turn into actual business is expensive and time consuming.” – Inde- pendent Handyman, Wicked Pissah Handyman Page 26 Sean Stannard-Stockton, Ensemble Capital

Sean Stannard- of years and then moved O'Shaughnessy's book Stockton is the to what was then called also pointed to president and chief Curtis Brown & momentum as being an investment officer of Company, which was the important factor and Ensemble Capital predecessor to Ensemble that growth really does Management, which Capital. Our founder drive value. Those he co-founded in Curt, who's now retired, concepts stuck with me 2004, and portfolio had formed a sole early on. manager of the proprietorship and was Ensemble Fund running about $65 “Over time, I’ve really (ENSBX). million in friends and family money for 15 developed a process Ensemble Capital clients, and I joined him. manages $1.4 billion that's about trying to Sean Stannard in separately It was just the two of us. understand the future managed accounts, on We formed Ensemble -Stockton, behalf of private of a business. As Capital as a partnership clients and Ensemble in 2004 and then we much as we hate Capital institutions. built the business up Ensemble’s equity over time. As far as my making forecasts, it's investment strategy evolution as an investor focuses on owning a is concerned, like a lot of inevitable that the concentrated portfolio young investors, I only value of a stock of competitively started with traditional advantaged deep value as many do. is its future cashflow. companies. Munger talks about the “value inoculation” and If you think you can't Editor’s Note: This the idea that investing forecast that, then interview took place should be about gaining on March 26th, 2021. access to a stream of just go buy a different

cash flows, and that you stock. Graham & Doddsville pay less than that cash (G&D): To start, can flow is worth in order to you walk us through outperform, just Curt was more of a your background and intuitively made sense to classic growth investor, how you got interested me right away. but always with a in investing in the first valuation sensitivity to place? his analysis. As we Back then, like a lot of started working Sean Stannard- younger investors, I together, I started really Stockton (SSS): I was didn't have the skillset to developing my own that kid who was 13 think about deep philosophy of what is it years old, found a book competitive advantage that makes a great on stock-picking, gave it analysis and was instead business and recognizing a read, knew nothing drawn to the that historical results of about it at all, but quantitative work of a company or value on instantly fell in love. As I people like David its balance sheet are was going through high Dreman and Jim relevant indicators to school, I discovered O'Shaughnessy, whose future value, but they economics and loved it book “What Works on are not the same thing and went off to college Wall Street” was a great as future value. Over knowing I wanted to pick early read. I started time, I’ve really stocks for a living. I trying to understand, developed a process went through college "Well, what does the that's about trying to with that in mind and evidence say is the best understand the future of spent a lot of time way to do this process?" a business. As much as reading about investing. A lot of that evidence we hate making After college, I worked points to discounted forecasts, it's inevitable at Scudder Investments valuation methods, in Boston for a handful although (Continued on page 27) Page 27 Sean Stannard-Stockton, Ensemble Capital

that the only value of a doing, which is always has today? And what do stock is its future the case with your first you think it is about the cashflow. If you think stock pick. way that your firm is you can't forecast that, At Curtis Brown & Co, I structured and the way then just go buy a was also participating in the analysts work different stock. building a business. The together that creates a only operational competitive advantage G&D: Was there a experience I have is in for you as a business, particular investment or operating Ensemble for you as a firm? set of investments when Capital, but Ensemble you got to Curtis Brown Capital is not just a team SSS: I think that the & Co that really showed of analysts who sit biggest thing that's you the power of around with evolved at Ensemble investing in these spreadsheets. It's an over the last nearly 20 competitively organization that serves years is more and more advantaged businesses? 220 private clients, it focus on building a meets with people, systematic discipline to SSS: I think most of my interacts with markets, how we do things. At the early lessons were and has an HR function. end of the day, we think mistakes I made on my Building that business that the practice of own that taught me definitely taught me that investing is what not to do. My very there is very nuanced fundamentally a first stock pick ever strategic analysis that is qualitative process. It is when I was just out of the heart of running a fundamentally about college was an business. The heart of trying to understand the investment in Tommy any investment that you future. You can draw on Hilfiger made simply make is trying to lots of quantitative data because it was trading at understand those to help inform your eight times earnings. I strategic issues and outlook, but at the end figured I had found a what it means to run of the day, you have to cheap stock and these businesses. The make a judgment call. thought, "Well, then I'm statistical data that you And that judgment can a genius and obviously can get out of draw on quantitative it's going to go up a lot Bloomberg tells you next inputs, but it is because it's so cheap." to nothing about those absolutely based on And it was a total things. qualitative insights as disaster of an well. And yet, the investment, thank problem with qualitative goodness! “At the end of the day, analysis is you can have a lot of bias and a lot of I always think if you we think that the noise that creeps into that process, especially ever go to Vegas, you practice of investing have to pray that you as you build a team of lose big the first time, is fundamentally a people. because if you win on qualitative process. It your first trip to Vegas, So each individual you think you're brilliant is fundamentally analyst has various and you keep going back biases that they may or until they take all your about trying to may not be aware of and money. So having your understand the there's a degree of noise first stock pick work out in their decision-making is a terrible disadvantage future.” or in the inputs that they because it makes you assume. The evidence is think that you know overwhelming that if you what you're doing and G&D: What were some give an analyst the same having your first stock of the key learnings as company and have them pick blow up on you is the business evolved do the work at different really important because from when you joined in times of day, like after it teaches you that you 2004 to what we know it have no idea what you're (Continued on page 28) Page 28 Sean Stannard-Stockton, Ensemble Capital

lunch, rather than right who's developing that, qualitative work and after their coffee in the but each analyst is going thinking about what the morning, you can get to review it as well. We key considerations are in very different answers. might ask questions any business. Every That's noise. about it or challenge it. business is unique, but As we've built from a At the end of the day, if there are certain types couple individuals into we're trading on a stock of questions we find an organization of nearly at a certain valuation, ourselves asking 20 people, I've really the entire team has repeatedly. been focused on doing accepted it and given everything we can to the okay. Todd Wenning on our create a systematic team had developed a Venn diagram of this process that honors the There might be some qualitative nature of sort to describe his own difference of opinions, personal investment what we do, but also but nobody's saying, seeks to reduce bias and philosophy prior to "No, we shouldn't but joining us. I was an noise in our individual this, our valuation is and joint decision- admirer of the simplicity wrong." On the more and conciseness of how making. This is why on qualitative side, we have the one hand, we have a he had illustrated his a process for force thinking and he very qualitative process ranking each company in around analyzing the developed this version of our portfolio, seven the diagram a few years competitive context in different critical which businesses ago to describe our questions that we think approach. operate. And yet the inform our ability to other hand, we basically assess the business over I think of our process as use an algorithm to the long-term. The lead manage position sizing always evolving. I know and the secondary that some people say, in the portfolio (although analysts all make those that algorithm is drawing "We want everyone to ratings, so everyone has have a process and stick on qualitative inputs that to know enough about we transform into to it forever." But if you the business to stick to a process in a quantitative data that we understand questions feed to the algorithm.) period of disruption, like like, "What is the the one that we are in likelihood that this G&D: How do you split right now, and you don't business’s products and ever evolve, you're just up responsibilities services remain relevant between you and the going to fall behind. So if over a 10 year or longer are not constantly other two analysts on time period?" But that your team? evolving your process, does not mean you need then you're basically just to know all the slowly dying. Because SSS: I play the role of intricacies of the reality is changing, your analyst, not just CIO. I accounting of every fixed process is going to think of myself as like a business that you're not get out of sync, unless player-manager, in that, the lead on. So it is very you're constantly yes, I am the CIO, but much a joint process. revising it. I'm also one of the analysts. Arif Karim, G&D: You have a great Our process as we Todd Wenning and I Venn diagram on Twitter implement it today was each are the lead analyst which outlines your really formalized about a on about a third of the investment philosophy at decade ago, but it portfolio, and then it's Ensemble (see continuously evolves. incumbent on the lead following page). Could The different factors that analyst to share and you walk us through how we look at in this Venn defend their analysis you came up with this? diagram are not rocket with the rest of the science. We essentially team. We collectively think about the horse sign off on valuation SSS: It came about and the jockey, or the models, so there's a lead through just doing this (Continued on page 29) Page 29 Sean Stannard-Stockton, Ensemble Capital

business competition. business and the forecastable. management team. Moat and relevance are the G&D: Great. Delving Management's behavior horse, the company. into moat first – you makes a big difference Management is the highlight the difference here as well. Over time jockey. between the durability of we've put more and a business and the more value on culture The third pillar is what relevance of it in the and recognize that there we call forecastability. mind of the customer. are businesses in which What we mean by that is What do you mean by it’s structurally possible both our circle of that? for competition to come competence, but also along, but it’s not going the intrinsic SSS: When you think to happen for societal or forecastability of a about the durability of cultural reasons. We’ve business. There are the competitive talked about First some businesses that advantage or the moat, Republic a lot, and their are just intrinsically there’s how wide the levels of customer more forecastable where moat is right now and service. In theory, you'd there's just little debate then the durability of the say, "Well, the big banks about what growth rates moat over time. All can just replicate a high are going to be, and businesses are customer service then there are other constantly being environment for high net businesses in which you attacked a little bit, so worth clients." And the have huge skews. We've there is an element of answer is, "Yeah, but owned Netflix for five entropy in which moats they're not going to." years. There have been are slowly decaying at all Banking is an industry a lot of investors who times. To a large degree, that has a terrible long- thought that the as much as you'd say, term track record of business was a zero and "Well, I want my customer service. You not financially viable. business to be building would really need to You don't see the same their moats bigger and take a generation to arguments taking place bigger," a lot of the work refocus the big banks to with Pepsi, for example. is actually just trying to compete with First Some businesses are maintain the moat and Republic. There's more or less intrinsically fend off the entropy of (Continued on page 30) Page 30 Sean Stannard-Stockton, Ensemble Capital

nothing structural, but that might not be flow forever. Well, that's there's real cultural growing much volume, a great investment - reasons why it doesn't but is increasing pricing? 12% annualized returns. happen. And maybe you can tie But in reality, there's The concept of relevance in your thoughts on the just no guarantee. And relates to the idea that a concept of mortgaging businesses that grow at moat is great, but what the moat into that as very low rates are losing if your customers don't well. wallet share of GDP, so care about what it is you they are intrinsically losing relevance relative do? Then it doesn't “Over time we've put matter that nobody can to other economic compete with you. Off more and more value activities. We believe the top of my head, that that those think of an example like on culture and businesses face the risk of hitting a stall speed. traditional sugared Coca- recognize that there Cola soda. It's not like You see this other companies came are businesses in phenomenon a lot in along and breached nature, where basically Coke’s moat. It's that which it’s you’re either you're growing or you're dying. Americans and people structurally possible around the world started We think of businesses caring less and less for competition to the same way.

about carbonated sugar come along, but it’s water. That’s a decline in We don't want to invest relevance. not going to happen in dying businesses, even if it's going to be a for societal or long time before they One of the things that die. So, the nominal GDP we've tried to emphasize cultural reasons. growth rate hurdle we in our writing is the We’ve talked about require is really just a difference between way to avoid stall speed recognizability and First Republic a lot, risk. As to price versus relevance. Everybody in unit growth, in theory, the world recognizes the and their levels of you'd say, "Well, it's all Coke brand just as much customer service. In revenue. So who cares?” as they did 20 years or that price alone is ago. But the relevance of theory, you'd say, best as there are not the core sugared Coca- associated cost of goods Cola drink is far lower "Well, the big banks sold. But it's unusual to today than it was in the can just replicate a be able to raise prices past. It's very difficult to forever. At some point, forecast relevance over a high customer service you hit a terminal level 10-year time period, but in which you are that’s part of what we’re environment for high constrained by the level paid to do. One way to net worth clients." of inflation. think about it is we're trying to avoid the value And the answer is, Everybody loves pricing traps, or businesses that "Yeah, but they're not are decaying. power. Warren Buffett going to."” has said that the most important indicator of G&D: In the past you’ve whether a business has talked about looking for a competitive advantage companies that are SSS: In theory, you is whether they have growing in excess of don't need to be growing pricing power. And we GDP. Does that mean to have value. Let’s say think that's right, for you look for a healthy you have a business with sure. However, one set balance of volume and a 12% distributable free of businesses that pricing growth as cash flow yield and exhibit pricing power are opposed to a business guaranteed flat free cash (Continued on page 31) Page 31 Sean Stannard-Stockton, Ensemble Capital

those that have trapped mortgaging their moat. that comes from trapped their customers. It's not One of the businesses customers versus pricing that they have pricing that clarified this idea for power that comes from power because their us was Live Nation, delighting customers so customers like what they whose Ticketmaster much that they're happy do so much – it’s that business has a lock on to pay more. When their customers are concert ticket sales. We Netflix raises its price by trapped. Every time they initially looked at it and a dollar, people don’t raise pricing, their thought to ourselves, immediately churn off – customers accept it, but "What an incredible instead they say, "Oh they hate the company business!" I should note my gosh, I can't believe just a little bit more. And – I haven't followed it for I get all of this content when you do that, you a number of years, so for 12 bucks a month. keep pushing up the it’s possible that things I'm not worried about it price and you push up have changed. But after being $13." Same thing the opportunity for a we dug deeper, we with Apple – they have disruptor to come in realized, "Everybody the price of phones up to underneath you. We hates them." $1,000 and people still think of it as each year, can't wait to buy one. that company is actually It's totally different than creating an off-balance Everyone who attends old school cable sheet liability and is the concert is mad they companies taking cable exposing itself to paid such excessive bills up so high that competition. They are amounts in fees. The people were just artists also hate enraged. That’s what Ticketmaster. Live we're trying to avoid. “We really Nation is supposed to be about connecting people differentiate between and benefitting the G&D: Yeah. If you're actually improving your pricing power that artists who are putting on the concert. If both product or upgrading comes from trapped sides of that equation your product to your don't like the company, customer, that's creating customers versus well, that means that value and you can charge a higher price for pricing power that they are going to become more and more that. Whereas if you're comes from delighting incentivized to try just providing the same something else. exact product year after customers so much year and not making any changes, but the that they're happy to You might say, "Yeah, customer has no choice, pay more. When but they can't." But over over time you're time humanity solves becoming more fragile. Netflix raises its price problems, even by a dollar, people insurmountable, SSS: That's right. Fragile intractable ones. So we is a good way to think don’t immediately just don't want to be about it. When you investing in businesses mortgage your moat, churn off – instead in which customers and you are becoming more they say, "Oh my gosh, others in the ecosystem fragile. And that's the off are incentivized to try -balance sheet liability. I can't believe I get all and exit the relationship It's hard to quantify, it's with the company. Even hard to see, but it's of this content for 12 we think it can't happen. there. It's very real. bucks a month. I'm not We just say, "You know what? It will at some G&D: You’ve also worried about it being point." written about an inverse concept, which is latent

$13."” pricing power and you’ve We really differentiate (Continued on page 32) between pricing power Page 32 Sean Stannard-Stockton, Ensemble Capital

used Netflix as an full levels. I think it has culture and a great example of a company become more and more ecosystem around it? that could raise price important for investors more, but chooses not to understand this SSS: Earlier in my to. How do you make dynamic and understand career I was more sure that a company that current pricing may focused on just the actually has latent not reflect long-term shareholder's pricing power and is pricing. perspective on creating a value surplus management decisions – for customers versus I've said in the past that, for example, the need to just the inability to take one of the insights for be good capital price due to competition me on this was when allocators, they need to or other factors? Facebook bought be strategic Instagram for a billion masterminds in terms of SSS: Yeah, that's a dollars. And I very building the business great question. The idea foolishly thought that it and all that sort of stuff. of latent pricing power was like the dumbest Over time my thought as very much a function acquisition ever because process has evolved to of the economy they paid a billion dollars recognize that's all super becoming more of an for a business that had important but the intangible economy. If no revenue and only 17 shareholders’ you're in a tangible employees. But what I participation in value business, selling tangible didn't appreciate and creation is the last step things, you can't afford was naïve on at the time in the process. You have to set price too low was the idea that to create value first and because it costs you Instagram could charge foremost for your something just to make for the service they were customer. And then once the product and get it to providing if they wanted you do that, then there somebody, right? So to. may be value that can you're constrained by accrue to shareholders. how low you can set They have all these Even if you're creating pricing. But when you're users and they're just value for your selling an intangible choosing not to add any customers, you need to item, the incremental ad load to the product have other players in costs of each new sale yet, but it doesn't mean your business, all your may be very, very low. that they can't, right? other stakeholders, your Therefore you have this employees most For instance, with the kind of step change in importantly, but also Netflix example, when revenue over time as the vendors and other they add a new business is monetized people that you might subscriber, there are more fully, which has engage with to do your some minuscule costs to been our thesis on business. They also need the server levels they Netflix. But to your to have a value creative need, and support levels point, you can't tell it for relationship with you. they need – sure. We use the rule of maintenance spend. It's being generally correct Over time we put more not that there is no cost, rather than precisely but it's very, very low and more emphasis on wrong when figuring out those elements and got because they don't have what normalized pricing to go out and buy more disciplined. We power is. recently shared on content for that individual subscriber and Twitter an article from G&D: Switching gears to around 2003 showing give it to them. The the management pillar, content has already Wall Street analysts how have your views on criticizing Costco for been purchased. When management evaluation you have that dynamic, paying their employees have evolved over time? too much and giving you have the ability to And what have you set pricing at much them too many benefits. found to be most helpful The idea was that such lower levels than might in evaluating a company be considered normal or that actually has a great (Continued on page 33) Page 33 Sean Stannard-Stockton, Ensemble Capital

behavior was bad for Today we have a much don't yet know very shareholders. But of more formal process. much about, may fit into course, Costco has just We’ve recently published the process we're talking trounced Walmart from a how we think about about. There's a stock performance stakeholder value widespread standpoint, even though creation. For us, all of understanding that Walmart is probably the this is completely owner-operated best in the business at aligned with shareholder businesses tend to be constraining the value value. So many people good businesses, and I that accrues to their act like things like ESG think the reason for that employees. We owned analysis is somehow in is that owner-operators Costco back then and parallel or unrelated or intrinsically understand took the other side of even contradictory to stakeholder value that trade. shareholder value generation. Because this creation. From our is their own business perspective, that's just and they're the operator, “We recently shared on wrong. There are so they know in the real Twitter an article from certainly things world you want your companies may do that employees delighted around 2003 showing are purely charitable, with their relationship but stakeholder value is with you. You don't want Wall Street analysts not about charity. to keep their pay as low criticizing Costco for Stakeholder value is as possible so that they about creating win-win are just barely on the paying their relationships with all of brink of leaving at any the players in your given moment. Owner- employees too much ecosystem. That’s how operators understand and giving them too shareholders make the that. most money – once many benefits. The those relationships are all going in a positive Family-owned idea was that such way, then the businesses in particular behavior was bad for shareholder then has the understand multi- opportunity to claim generational stakeholder shareholders. But of their share of that value value and can make creation. decisions that may not course, Costco has just seem optimal, but only

trounced Walmart because they’re playing G&D: Relating to the on a different time from a stock Costco example, is lot of frame. Anytime we hear times these sorts of CEOs talking performance decisions are very authentically about the standpoint, even unpopular because they importance of employees may result in earnings and taking actions that though Walmart is miss by investing reward them, not out of through the income a sense of generosity or probably the best in statement, right? Do you charity, but out of a the business at actively look for CEOs sense that these people who are willing to really are doing great work, we constraining the value invest for the long-term pay attention. If and forgo short-term somebody at Ensemble that accrues to their earnings? gets a big bonus they employees. We owned often say, "Well, thank SSS: 100%, I think that you." And my feeling is Costco back then and when you're doing idea like, "Thank me? You generation in our space, earned this. You created took the other side of a lot of it is pattern all this value and that's that trade.” recognition. We're trying why your bonus is so to identify some signals big." that a company, that we (Continued on page 34) Page 34 Sean Stannard-Stockton, Ensemble Capital

COVID was a test of and the company is buy a cyclical as long as management teams to going to create value for we know generally see how they really think them. where we are in the about stakeholder value. cycle and understand it’s There was a company in “For example, when going to move up and our portfolio that we down. But there are wrote about that in April we first invested in some cyclicals that are 2020 came out and said just super erratic cycles to their entire staff, Landstar Systems, and you don't know what "Volumes are down 50% which is a third-party the long-term trend is. in the last two to three That's the sort of weeks, but we're going logistics company for business that we're to have no layoffs for the going to avoid. next quarter until we get trucking, it struck me a better sense of what's a lot like Charles The second element of going on." A quarter is forecastability is really not a very long time, but Schwab & Co and our own circle of in April of 2020, a competence. We’re a quarter was a very long company's generalist team and we time. But they told their institutional business think that there is a lot employees, "There's just of value to being a won’t be any layoffs. for RIAs and generalist. For instance, And we can't tell you you'll often hear us beyond that yet, but for investors. These are comparing stocks or the next three months, totally different companies in our just know you're good." portfolio to companies industries, but we from other sectors. For example, when we first Meanwhile, their main recognized the invested in Landstar competitor reduced concept of a network Systems, which is a third staffing by 20% on the -party logistics company same day and promised and pleasing different for trucking, it struck me shareholders that they people in different a lot like Charles Schwab would strive to be & Co and company's profitable in all operating parts of the network institutional business for environments. You want RIAs and investors. to optimize for long-term to create a flywheel.” These are totally profitability, not different industries, but profitability every single we recognized the moment in time. G&D: The final pillar of your framework is concept of a network forecastability. Can you and pleasing different people in different parts Home Depot is another talk more about how you of the network to create example of the mentality think about that across a flywheel. I think that we look for. They spent different sectors, from the generalist view is a $2 billion in additional the more predictable really important one and compensation for their ones to the more one that we really employees who went to dynamic ones? embrace. We won’t own work while the rest of us the sorts of businesses were cowering in our SSS: I mentioned that really require homes. These are there's two elements to domain expertise at a frontline employees that, the first being deep, deep level to get operating an essential intrinsic forecastability. comfortable. business who had to go For example, a raw

to work in April when we commodity seller is G&D: You’ve also were all horrified. That's obviously very variable. mentioned the concept exactly what you want to But if a business has of finding idiosyncratic see. Recognition that high cyclicality but still businesses that look like investing in your people has a steady longer-term one thing but are because they're creating cycle, that doesn't value for the company bother us at all. We'll (Continued on page 35) Page 35 Sean Stannard-Stockton, Ensemble Capital

actually another. Could business that doesn't you walk us through have a peer group, you “So really, there are what this means? create price inefficiency two elements of these in the market that we SSS: Ferrari is a great hope to take advantage idiosyncratic of. The second element example of this. If you businesses that we're look at Ferrari you could is that idiosyncratic say, "Well, clearly it's a businesses by their attracted to. One is car company." And it’s nature don't have a true that they sell cars. competitive peer set and that they are often therefore are Yet, the economics look misunderstood nothing like other car competitively companies, which tells advantaged. Every because the use of you they are doing business has some level something different. In of competition. But if peer groups and peer you have a business fact, it's basically a multiples is so luxury company. They that's doing the same are selling multi-million thing as its competitors, common that if you dollar mechanical works then it has more of art. So it is much competition than a have a business that business that is doing more like a luxury doesn't have a peer company and yet you something very different can’t neatly compare it from everyone else. group, you create to car companies or jewelry companies or G&D: After you look at price inefficiency in handbag companies. those three pillars how does valuation come into the market that we Businesses like that that play? How do you hope to take will often be assigned to ensure, especially over domain-focused the past 10 years where advantage of. The analysts. So you end up multiples for these kinds second element is that with a bunch of car of compounders have analysts analyzing increased so much, that idiosyncratic Ferrari, and they just you're paying a fair price don't have the expertise today and not businesses by their and even worse, they overpaying? nature don't have a apply what they know about car businesses to SSS: It's just a point of competitive peer set this business that is not fact that the value of a a car company, which stock is the present and therefore are creates a systematic mis value of the future, pro- competitively -valuation. But it also rata share of cash flows doesn’t make sense for from the company. advantaged.” the luxury analysts Assessing that is either because it sells difficult! But at the end cars, and they just might of the day, whether you not appreciate certain use a P/E ratio, a DCF Our process revolves technical aspects of what model or some industry around trying to Ferrari does. specific valuation metric, estimate those future all you're doing is trying cash flows, find the to approximate that present value and pay So really, there are two same question - what's less than that. It's not elements of these the present value of all simple, it's not easy, but idiosyncratic businesses this future cash flow? If that's what we're trying that we're attracted to. you're doing something to do. Many of the One is that they are else, then you're playing companies in our often misunderstood a totally different game portfolio trade at P/E because the use of peer than we do and you're ratios or other simplistic groups and peer probably speculating. valuation measures that multiples is so common are higher than the

that if you have a (Continued on page 36) Page 36 Sean Stannard-Stockton, Ensemble Capital

overall market. If you example, if the moat is worth something took a quick look you great, our understanding between $80 and $120. might say, "Well, they is great, but Hopefully it's aren't very focused on management is starting concentrated around value. Look at the to really abuse the $100 but there's some multiples on their relationship with variability. stocks." But remember customers, we're out. In that we're exclusively this scenario, our trying to invest in valuation process breaks When most businesses businesses that are down, so we just drop get taken out or sell out deeply competitively the stock. through an acquisition, advantaged and that they sell at a premium, right? If you're running a generate high levels of “We want to be in our free cashflow. really good company, best ideas with the you don't want to be offered fair value and When you have a high least risk and the say, "Okay, sure. I'll return on invested take cash." You want a capital, you don't have most upside. Our premium bid in order to to invest as much to turnover in the give up a valuable, high- grow at any given rate. quality asset. Similarly, Therefore, on average, portfolio has we require a premium our companies generate bid to give up our more free cash flow per averaged around 40% companies. There is a dollar of earnings than - 50% in recent years, threshold at which we the average company. will just exit but it's And since we care about which is higher than above our assessment of the cash flow, not the most other investors fair value. If something earnings, we’ll pay a is only 10% above our higher multiple on using our kind of fair value, there’s still a earnings for a business meaningful likelihood that has higher free cash approach, but most of that it is actually flow per dollar of it is what we call undervalued. If it is 50% earnings. But none of above our fair value, the that says that we can't internal turnover. likelihood that it’s mis-value a stock. undervalued is much Certainly in the Rebalancing our lower. environment that we're position sizes within in today, we are focused on trying to avoid our portfolio.” The final reason we sell overvaluing companies. is relative opportunity within the portfolio. We G&D: How do you The second scenario is a have a very disciplined, decide when to sell a stock becomes quantitative, systematic company? overvalued. We have a position sizing an approximation of fair framework, and we are SSS: There are three value that we track for constantly evaluating all reasons that we sell. each company, and we of our holdings versus One, our thesis falls don't sell a stock just each other. We want to apart. When we think because it's trading at be in our best ideas with about these different fair value. We recognize the least risk and the conviction buckets that that our fair value is just most upside. Our we talked about earlier a central tendency of a turnover in the portfolio in the interview, there's cloud of possibilities. has averaged around a threshold requirement We're trying to predict 40% - 50% in recent for each of those. If any the future here. So we years, which is higher company in the portfolio can’t say, "this stock is than most other has even one of those worth exactly $100." If investors using our kind questions fall below a we have a $100 fair of approach, but most of threshold, we’re out. For value on a company, it probably means it's (Continued on page 37) Page 37 Sean Stannard-Stockton, Ensemble Capital

it is what we call internal economy is at a mid- It didn’t require a turnover. Rebalancing cycle point, operating forecast to recognize our position sizes within normally. There are that Americans could be our portfolio. We're only times when that's how mandated to stay in exiting about 10% of our we operate. But certainly their homes. And not holdings fully to bring in the last year has not recognizing that that another company. The been one of those times. would impact the rest of the turnover is I think that it would be economy and business internal to the portfolio. deeply naive to have conditions would be spent the last year being naive. The flip side of G&D: Does the macro macro agnostic. For that is right now to look environment or the instance, in early March at $2 trillion of increased market environment, of 2020 we came to the cash in American whether it's speculation realization that we household bank accounts or froth in certain areas, needed to observe what versus a year ago. It factor in at all to was actually going on would be deeply naive to whether it's a decision to right in front of us from say, "Well, that isn't hold more cash or to a macro perspective. really relevant." Of invest in a certain type course it's relevant! of business versus Consumers are the another? “At the time we customers spending the money. And a lot of SSS: The macro bought MasterCard them have a lot of cash all of a sudden. environment does, but everybody knew it not really the market environment. If stocks was a great business. that we don't own are So we don't spend time trading at crazy levels, Everybody knew it thinking about what is GDP or inflation or it's not really relevant to was going to grow for us. Might the crash in interest rates going to those stocks cause our a long period of time be over the next year or stock prices to decline? two, but we spend a lot Maybe, but I don't know and everyone of time trying to think about long-term macro- that we can forecast that understood the profit with any level of economic variables, like certainty, so generally margins were great. what might interest we’re ignoring the rates or inflation or real market environment. But I don't think GDP growth be like over the next five to 10-year That said, the market many people environment drives our time period and where trading behavior because appreciated just how are we within that cycle? if the market I think many investors environment is valuable the business mistakenly believe that they can avoid having optimistic, then we're was and what probably going to own macro-economic less of any given stock. valuation it should assumptions, but we But we're not going to think the only way to change our portfolio trade at. Sometimes avoid it is to have because we think the we go back and implicit ones that you market is due for a are not aware of. correction. retroactively analyze what P/E ratio a If an investor says they don't care about macro On the macro level, we business would have would like to be kind of but they are using a macro-agnostic at all had to trade at to normalized P/E ratio of times. We'd rather just 16, well, why is that P/E spend time focused on generate a market ratio 16? If you disassemble it, you'll find individual businesses rate of return.” and just assume that the that there's an interest (Continued on page 38) Page 38 Sean Stannard-Stockton, Ensemble Capital

rate and inflation and amazing business model, using a credit card. The real GDP assumptions but people haven't fully innovation just enabled embedded in there. You appreciated what Visa and MasterCard's just don't know what happens to value when a payment rails to be used they are. And we'd business has this high of for smaller and smaller rather be explicit in our a return invested capital, micro-transactions, and assumptions. as low a cost of capital it has been very through access to debt beneficial to them. That G&D: Could you walk us as they have, and this doesn't mean that their through a case study of long a duration of rails will never be a successful investment growth opportunity. disrupted. But I think in that you've had in the retrospect, we can say past, and what you saw The core insight we had that we were correct in that others didn't at the in MasterCard was just a our assessment that time of the investment? recognition that this was technology disruptors a much more valuable were not actually SSS: MasterCard is a business. This was attacking the rails. They good example. We've complemented by the were building on top of owned it for about a fact that there was the rails. decade now. At the time market concern about we bought MasterCard the technological everybody knew it was a disruption of the G&D: Any investments great business. payment rails. Our view over the last five or so Everybody knew it was was that technology years that stand out as going to grow for a long disruption was going particularly painful period of time and occur on top of the mistakes and what did everyone understood the platform that Visa and you get wrong when you profit margins were MasterCard built rather made the investment? great. But I don't think than disrupting their many people appreciated platforms. We didn't SSS: So I think one just how valuable the know this for sure, but mistake that led to an business was and what we believed it to be the important learning was valuation it should trade case. When Apple was Time Warner. We at. Sometimes we go preparing to launch invested in them prior to back and retroactively Apple Pay, we were them being acquired by analyze what P/E ratio a initially nervous. We AT&T. This was around business would have had were long Apple at the 2015, prior to us owning to trade at to generate a time too, but we were Netflix. Back then, there market rate of return. nervous for Mastercard. was the idea that Netflix Costco is a good Apple had a lot of cash was going to become example. You'll find that and a lot of smart HBO before HBO became historically Costco could people, and they had Netflix, which played generally have been connections to out, but that didn’t mean bought at a P/E of 40 to customers’ credit and HBO couldn't also be generate a market debit cards and bank super successful. So five return, but at the time accounts via iTunes. We to six years ago, we saying it was worth 40x were thinking they could thought HBO could would have been crazy really launch their own become a global and seemed too high. payment rail system by powerhouse. We thought And yet, in retrospect, leveraging the installed Time Warner could bring we know that was base of iPhones. it all around the world, actually the fair value. use a super low price But what did Apple point, get tons of I think that was very decide to do? They just subscribers, and invest true about MasterCard built on top of the in content - basically the when we first invested in existing rails. So when whole game plan that it and we think continues you use your Apple Netflix ended up to be true today. It's watch to get on the New executing. understood to be a high- York subway, what are quality business with an you doing? You're just (Continued on page 39) Page 39 Sean Stannard-Stockton, Ensemble Capital

But what we didn’t fully the good thing about big competitive moats, appreciate was that the that experience is that it and optimizing and Time Warner made us realize Netflix milking what you had management team was was going to win built for as much cash as so constrained by their because Time Warner possible was great. That devotion to the dividend, and other legacy media was smart. It's only that they were unable to companies were not because a disruptor make the investments willing to compete. came along that a far- that they needed to sighted media team make. We exited the should have recognized stock and then not long When we realized that the real threat. It should after that, they sold to was the case and that have triggered the AT&T at a nice premium Netflix had already been media teams to reorient to where we had sold. raising price at about a away from optimization, But we viewed that sale 7% rate in a no-inflation towards being more as Time Warner environment, that really visionary and thinking essentially throwing in gave us the confidence more about the long- the towel. HBO Max is to invest in Netflix. term. That’s what Disney taking off now, but they Interestingly, look at is doing now brilliantly. could've launched that a what has Disney done They should've started a long time ago, and we now – cut the dividend long time ago, but think they would be a and invest in Disney they're making the right much more successful Plus. They learned the transition. We felt Time media business if they lesson too, but five years Warner had been had done that. We didn't is a long time to wait optimizing their appreciate the non- when a disruptor is business, but clearly logical devotion to eating your lunch. should have switched dividends. We get that into visionary mode, but people don't like G&D: You’ve written they couldn’t do it. dividends to be cut, but I about the difference would much rather a between optimizers, which are businesses company cut its dividend “Interestingly, look to invest in an that are more mature opportunity and defend and are making at what has Disney its long term future. decisions for a steady state, versus visionary done now – cut the CEOs that are looking at That's a good trade-off where the puck is going. dividend and invest because if you pay out Did this example make in Disney Plus. They the dividend, what am I you have an even going to do? Reinvest it greater preference for learned the lesson in something else. If you investing in the visionary too, but five years is have a better category? Or do you opportunity, go do that. think this was just a one a long time to wait They were institutionally -off example of constrained from doing mismanagement in this when a disruptor is that. When we talked particular case? eating your lunch.” earlier in the interview about some businesses SSS: We don't have a are competitively strict preference for It is the rare protected for visionaries over management team that institutional reasons or optimizers. It's that we can switch back and cultural reasons, as want the right style of forth between vision and opposed to anything team running the right optimization. I do think really structural, the business at the right that a lot of very reverse can also be true. time in its lifecycle. For successful visionary Sometimes doing the legacy media companies CEOs have been paired right thing is too hard for optimizing their business with an optimizer, but a company for model in a cable TV the optimizer often institutional reasons. But environment, there were (Continued on page 40) Page 40 Sean Stannard-Stockton, Ensemble Capital

doesn't get the credit. pools is to then go that they’ve done two or Think about Steve Jobs capture those profit three of the best M&A and Tim Cook, or Walt pools. When you find deals in the history of and Roy Disney. There's one, you have to attack technology space, so I lots of pairs out there in it and feed at the profit also don’t think you can which the visionary is pool. We were a bit call them bad capital the big charismatic face disappointed that after allocators. of the business, but the some initial signs of Ruth management team Porat being successful in understands optimization that, it seemed to recede G&D: Could you walk us too. We think both are a bit, but it has now through a stock pitch of important and you just come more back to the an existing idea that need to know the right forefront. Now Alphabet you’re excited about? mix at the right time. is spending about three SSS: Let's talk about quarters of earnings to buy back stock. We Home Depot. We took a G&D: How do you absolutely believe that small position in Home approach that from the they should have a very Depot prior to COVID individual business large strategic cash war and we had a number of perspective, where a chest on their balance housing related holding might have a sheet, in excess of any investments prior to unit that is an operating cash that they COVID. When we initially optimization phase and need. That's absolutely made the investment, then other parts of the the right thing to do we were of the view that business that are more given their business and the level of housing high growth? One the competition. But activity was at example that comes to they don't need as much subnormal levels ever mind from your portfolio as they have today. And since the housing bust. is Alphabet. even buying back the The levels of existing amount of stock they’re home turnover and SSS: What makes doing now, they still are volume of new homes business and investing having cash build higher. being built were both at so hard is that you need To me, that's a whole low levels. This initial to balance everything bunch of the market cap macro view made us exactly right all the time. sitting there in cash, think that even if the We’ve been long earning cash rates of economy grows at just Alphabet for about a return. whatever an average decade now, and when growth rate is, that Ruth Porat came in as housing would grow CFO, we were of the If they don't have faster because it was opinion that it was good anything to do with it, starting from a because the business they should give it to us depressed base. needed to focus more on because we’ve got optimization. This was stocks to go buy with it! I would never in a still a high growth, We only partner with million years have highly dynamic industry, management teams that guessed that a pandemic so certainly you don't we trust. We are very would unleash housing want an optimizer being likely to defer to their activity. It's almost the the CEO and calling all decision-making there, opposite of what we the shots. But Alphabet but we also rate would have thought, and was producing so much companies at different yet that's exactly what more cashflow than they levels on different happened. Everybody had anything to do with metrics. So we would loves to buy a cheap that we thought it would say that Alphabet has stock with a catalyst, but be good to optimize fantastic management we don't actually spend along the way too. on a whole lot of a lot of time thinking metrics, but on capital about catalysts because The whole reason to be allocation questions, it we think that the things visionary and to identify has not been so great. that actually cause a some giant future profit Although they must be given credit for the fact (Continued on page 41) Page 41 Sean Stannard-Stockton, Ensemble Capital

stock to rerate higher economic conditions are earlier with Schwab’s tend to be pretty such that there's a real RIA business. Of course, unpredictable. But in tailwind to the housing some other retail broker Home Depot's case, we industry. But the thing could come out and steal upsized the position that makes Home Depot some market share, but significantly and made it an idiosyncratic on the institutional side into one of our largest business, as we talked with RIAs, the value holding in the month or about earlier, is that 4% proposition improvement two after COVID hit, as of their customers are to try and move all your housing activity started pro contractors. And clients to a different storming back and it those customers custodian would have to became clear that the generate 45% of the be so large, it's almost pandemic was actually a revenue of the business. unthinkable. Being a B2B positive catalyst. Most people think of service provider can be Home Depot as a do-it- hyper-lucrative if you're If we were all trapped in yourself home really mission critical our homes for a long improvement retailer for and if the cost is a low period of time, and we homeowners, like portion of your business needed to start working Lowe's, but only half of customers' overall there, we would use it their businesses is that. expense structure. differently. We're all The other half of their using our appliances at business is being a levels that we haven't in mission critical supplier “The thing that makes the past. We've done a in a B2B relationship Home Depot an lot more home with a fragmented end maintenance than market. Those are idiosyncratic normal because we're conditions for fantastic just using everything a competitive advantages. business, as we talked whole lot more. And about earlier, is that instead of going traveling, which a lot of When you talk to small 4% of their customers homeowners would do contractors, at almost over the summer, people every job, there's are pro contractors. something they don't decided to spend that And those customers money on their backyard have on hand that they instead. You couldn't need and they need to generate 45% of the find somebody to install obtain from a nearby a pool last summer location. There are a ton revenue of the because demand was so of Home Depots in the business...Being a high. country. Individual contractors will drive mission critical past a Lowe's to get to a As a side note, I think Home Depot that's a few supplier in a B2B this is fascinating. There miles further away relationship with a will be pandemic scares because it's just their in the future for sure. preferred place for fragmented end Maybe next time there is shopping. Any time you a scare, we’ll see fast are a platform to market are food stocks or housing another business, the conditions for stocks rallying on business that is built on concerns about a top of your business fantastic competitive pandemic. We’ve all doesn’t want to switch. learned that like with They just want to make advantages.” most every crisis, there sure they're treated well are always certain so they can go do their industries that thrive in own thing, and those are G&D: What do Home a crisis. really great businesses. Depot’s contractor customers care most about between So with Home Depot, we This is the same believe that the dynamic I mentioned (Continued on page 42) Page 42 Sean Stannard-Stockton, Ensemble Capital

convenience, selection, that is most important, only up 2%. Part of that and price? and price is least had to do with important. aggressive building of SSS: I think price is the stores during the least important because housing bubble and a home improvement Home Depot has pricing recognition that they had contractors usually have power, but not because overbuilt. So what parts and labor billing. If the customer is trapped; they're seeing is higher you need certain parts, rather, because it's not and higher levels of whether one part is a the key variable that the revenue per store. I little bit more or less customer is optimizing think that it's likely that expensive is not the for. Does that mean that they are getting close to needle-mover for the Home Depot can charge having their stores contractors themselves. a lot higher prices? Well, running at really full They can basically pass they have slightly higher capacity. We think that along the cost to the gross margins than there is opportunity for homeowner. So it's Lowe's but I think that them to go back to about selection and it is the bigger thing is that building more stores also about the total they're able to move a over time. Not some ability to serve lot more revenue for any huge number of new customers. Home Depot given store, which stores, but to add has their pro-desk, generates much higher slightly to growth which is their online asset turnover and through that lever. But platform customized for higher returns on most importantly, when contractors. If you go invested capital. So we think about growth, onto Amazon, both Home Depot actually we think about the business customers and shouldn’t optimize for simple fact that people individual customers of margin – they should live in houses. That's not Amazon get the exact optimize for return on going to change. Those same interface to buy invested capital. Those houses depreciate. stuff from, but are both important, That's not going to businesses have which is why you can change. And people want different needs than have low margin to live in nice places! individuals do. A businesses like Costco The desire to maintain contractor might need to that are fantastic your home is encoded in download all of their businesses. And you our DNA. Coming back transactions into have very high margin to the concept of QuickBooks. The Home businesses that are not forecastability - we Depot interface allows good investments have no concerns that that. A consumer-facing because they are so say, 20 years from now, e-commerce site doesn't capital intensive that it that people are just not have that sort of feature. doesn’t matter if the going to care about what margins are high. their home looks like. You could also go to We think that a large Amazon and ship stuff to G&D: What do you think part of the growth is just other addresses, but if about Home Depot’s tied to GDP. growth runway? And you pick lots and lots of different addresses, what should they be pretty quickly it triggers doing with their capital What would concern us fraud alerts. But between building stores, is if Home Depot started contractors have jobs repurchasing shares, hitting a stall speed; for sites all over the place etc.? example, if people and they need stuff started losing interest in shipped to those job SSS: One thing that's home improvement sites. Home Depot fascinating is that in the relative to everything understands that. I think 10 years since the else. But we don’t think that it is that total housing bust bottomed, that’s the case – we service experience, Home Depot's revenue think that in aggregate, selection, and being able has almost doubled home improvement will to meet customer needs while their store count is (Continued on page 43) Page 43 Sean Stannard-Stockton, Ensemble Capital

grow with people's created an experience of themselves are spending power. becoming re-engaged. somehow negative for People have now society. But that's not regained the habit of what stakeholder value “So Home Depot home improvement. is about. Stakeholder actually shouldn’t value is businesses whose products and optimize for margin – In the years ahead, services enrich the lives people will just be more they should optimize of their customers, yes, likely to notice But more importantly, all for return on invested something in their house elements of the that they wish was stakeholder base. capital. Those are both different. And since they had done a bunch of important, which is home improvement last Home Depot goes a why you can have low year, they’ll say, "Oh layer further than the yeah, well, I should just traditional thinking of margin businesses like call up the contractor. I putting customers or should just go to Home shareholders first. They Costco that are Depot myself and take put their employees, fantastic businesses. care of this." Housing who they call also has the additional “associates” first. The And you have very high benefit of the millennial reason they do that is if cohort. The year with they put the associates margin businesses that the most millennials first, the associates will are not good being born was 1990, put the customers first meaning that those and everything else investments because people turned 30 years takes care of itself. old during the pandemic. That's the line that they they are so capital They're entering the use. We think that Home intensive that it doesn’t prime home buyer Depot truly understands period and we think that that the way to run their matter if the margins you're going to have a business and to generate are high.” lot of millennials who are as much profit for now earning at high shareholders as possible, enough levels to be in a is to really focus on their Because we believe that position to buy homes employees and really home improvement and spend on home treat them well. It activity levels had been improvement. doesn't mean just being below normal for a long generous and time, there is a tailwind G&D: What's your overpaying people, it from that as well. In the assessment of the means treating them very short term, Home management team there really well, making them Depot is going up and the culture of the delighted to work there. against 25% same-store business? sales comps from last summer, which was SSS: I think the One thing that we saw about five years of management team is during COVID was that expected growth that great and the culture in this way of thinking played out in just a few particular is great. ESG extends to the months. So the comps has become very popular relationship with are going to be very and is often focused on suppliers. Many people tough as they roll whether the company’s don't think of suppliers through 2021. But we products and services as a critical stakeholder, think that it wasn't just a make the world a better but during COVID, Home one-time event – we place. If you think about Depot went out to one of think that Americans had so-called sin stocks like their paint suppliers and been disengaged with alcohol or gambling, said, "Hey, we can't get home improvement for a there’s the idea that the enough hand sanitizer. long period of time and products and services that this pandemic (Continued on page 44) Page 44 Sean Stannard-Stockton, Ensemble Capital

We're worried about our founding years. You can mentioned they spent $2 employees dying and we see that when they talk billion in extra associate need you to help." And about their associates compensation during that paint company, “bleeding orange”. Those COVID, and they've who's a critical supplier are the sorts of already said they're to Home Depot, shut businesses you want to going to make $1 billion down one of their paint invest in. of that permanent. lines, reformatted it to make hand sanitizer and “I'm really glad to see One thing that we're produced a ton of hand seeing across our sanitizer for Home that the businesses portfolio is businesses Depot. Why was that? It that we own, like Starbucks, First was not because Home Republic, and Home Depot had the supplier generally are paying Depot are proactively trapped, it's because raising wages, and doing they are in a mutually well above industry so in some cases beneficial value-creative averages, because it aggressively. We're relationship with that really pleased to see supplier. And the means that as wage that, because we think supplier understood that that wage inflation, in a time of need, you costs get forced which is a good thing for stand by your partners. higher, there won't be the economy, is coming. I'm really glad to see the same degree of that the businesses that Everybody understands we own, generally are that in real life. What's forcing mechanism paying well above so weird is that on them. These industry averages, investment analysts because it means that as forget that stuff when companies will have wage costs get forced they get into their higher, there won't be spreadsheets. But in real to maintain their the same degree of life, there's people in spread, but they’ll forcing mechanism on your life who you have them. These companies value-creative have a lot more will have to maintain relationships with, and their spread, but they’ll when they come to you flexibility to do that have a lot more at a time of need, you strategically.” flexibility to do that help them. You don't strategically, as opposed think, is this an optimal G&D: How do you think to having employees use of my time? You saying, "Hey, I need a say, "No, this is what I about valuation for Home Depot given raise," or regulations do, because they'll be coming in and there for me in the where the stock is trading today? mandating that. So the future. I don't know $1 billion of that COVID when it's going to be. SSS: For every position spend being made I'm not even going to permanent is great, but measure whether I get in our portfolio, we've established an in the short term it's still returned the same value $1 billion of potential I put into it." When you assessment of the intrinsic value based on earnings that's going to have value-creative get coughed out of the relationships, you invest our expectation of future cash flows and we're business, even if at in those relationships lower revenue levels. and some big portion of evaluating the market that value accrues back price relative to that to you. intrinsic value. But we G&D: Switching gears to don't spend much time our closing questions. thinking about current P/ How do you structure The book “Built to Last”, E ratios. Yes, revenue at your days and what does written by Home Depot’s Home Depot was a typical day look like for founders, speaks to this elevated last year, but issue right from their so were costs. I (Continued on page 45) Page 45 Sean Stannard-Stockton, Ensemble Capital

you? morning. G&D: What advice would SSS: The first half of my you give to MBA day, the calendar is kept Another important students interested in as clear as possible. That element is that our team pursuing investment half of my day is really is remote, in that Arif management as a devoted to pure equity lives outside of San career? research. I'm a lead Diego, Todd lives outside analyst on a lot of these Cincinnati and I'm in SSS: The only reason stocks, so I'm focused Silicon Valley. Our next you should do this on researching those hire will also almost because you're super stocks, idea generation certainly be somebody in passionate about it. and all of that. Earlier in a different geographic You're going to be my career, I didn't think area. Our entire staff competing against much about when during was already a remote- people who just love this the day I did different first team prior to work so much. I know types of work, but over COVID. We had about 20 that's true of the people time I came to - 30% time in the office, on our team. We don’t appreciate that every but we told people to need to work weekends person has different work wherever they here, but on our instant times of day when want to work to get the messaging board we're they're better or worse best work done. I’ve chatting all weekend at different types of come to believe that long because there’s tasks. I know that when equity research teams always something I'm first awake and I've that work in-person, in a interesting to talk about. had my coffee, I'm single city together, are On the weekend, I'm energized and I have the at a deep disadvantage. reading lots about ability to dive into some Everyone worries the investing. Not of the deeper work. opposite. They say, necessarily poring "Well, if you're remote, through research reports you're going to lose the in service of some But that's not true of culture and the back and thesis, but just reading everybody. On our team, forth and all of that sort stuff I'm generally for example, we often of stuff." interested in. get emails from Arif at That's only true if you I think that it's really two in the morning have a staff that is not critical that you are truly because he does his best digitally native. Our passionate about it. If work from like 10PM – team is talking all day, you're not passionate 2AM. And that's fine. It every day. We have about it, just go do doesn't make a instant messaging, we something different difference. I just try to have video chat, we because you're going to do what works best for have emails. It is a get schooled by people me. constant discussion who are passionate in In the second half of my here, even though we're this business. This day, I fit in my all in different areas. Yet business is hard work, responsibilities as having people with and even if you're very President and CIO of different lived good at it, you'll have Ensemble Capital. I experiences, in different meaningfully long continue to do research parts of the country, is periods of which is my core really important. Todd's underperformance. So responsibility. But I've perspective living you better be just found that I can outside Cincinnati and in passionate, that's the process a bunch of a non-urban area is only thing that's going to emails at 3PM, in the quite different than my get you through those afternoon, when it's experience living in time periods. starting to get late, Silicon Valley. Neither is Assuming that you are whereas understanding better than the other, passionate, I think that the economics of a but both are very critical in the earlier part of company that I'm not all and helpful inputs to the your career, you look at that familiar with is investment process. much better in the (Continued on page 46) Page 46 Sean Stannard-Stockton, Ensemble Capital

people who've been own process. extract key lessons. successful and learn As you develop that, I Those lessons are the about what they did. think that the third part ones that I feel have Read everything is really understanding really created Buffett's written, all that that investing is about differentiated processes sort of stuff. Learning so much more than for us. When we draw on from what other people business and learnings from other have found works is a spreadsheets. You need disciplines, to try and critical first step. From to have your finger on understand how those there, you need to begin the pulse of everything can be important in the to develop your own going on in the world, investment management philosophy, because you from cultural trends to process, that helps us can't copy your way to politics. Being a curious generate alpha. We success. person and cultivating know that many You can observe success your curiosity, and participants in the and use those learnings giving yourself market are really only to inform your own style, permission to read just focusing all their but you must develop widely on lots of time on market your own approach. The different topics, is really, information and aren’t reason is that it's only really important to that drawing on those other your own approach that longer term success. In mental models. And we you will have enough my own career, early on think that's a really conviction in. I read lots of books important thing to about picking stocks. cultivate. “When something like Then I moved past that and started reading G&D: Any particular March of 2020 more detailed, books on that topic that specialized books on occurs, you have to you’d recommend? things like accounting. have the conviction to But now, a lot of the SSS: Phil Tetlock's book reading that I do is more stick with your “Superforecasting” is a around things that are must-read, as is process. If you're just not just about the art of “Thinking Fast and Slow” stock-picking. by Daniel Kahneman. copying somebody For example, I spent a The third that comes to else, you're going to lot of the last eight years mind is Nate Silver's reading about decision- “The Signal and The start wondering, making research, which Noise.” is very applicable to "Well, what would what we do. As a G&D: How do you spend they do in this portfolio manager, all your time outside of you're doing is deciding work? circumstance?" So to hold, to buy, or to sell. That's what you do SSS: Being an you need to have your all day, every day, every entrepreneur and own process.” moment of time. You are building a business, as constantly being made well as running an equity these different offers strategy means that When something like from the market, and there’s not a lot of free March of 2020 occurs, you need to be making time! I have my family you have to have the decisions. Even a at home; I've got two conviction to stick with decision to not react at teenagers. I spend a lot your process. If you're all is still a decision! of time with them. Like a just copying somebody We've spent a lot of time lot of people who have else, you're going to drawing on the work of children at home, I don't start wondering, "Well, people like Phil Tetlock have some wide variety what would they do in and Daniel Kahneman of other hobbies. Travel this circumstance?" So who have focused on is by far my second most you need to have your decision-making to try to (Continued on page 47) Page 47 Sean Stannard-Stockton, Ensemble Capital

favorite thing to do; investing. In social losing that for the last impact, the value is year has been a real accruing to some third- negative. One of the party beneficiaries rather things I love about travel than to the that if you travel with an shareholders, but that's investor's lens, it gets so fine. That's the point of even more interesting. it. The stakeholder value I was in Colombia a lens is still the right one, couple of years ago and it is just that as an I noticed that there was investor in the end you this one beer I'd never are judged by the return heard of that was to shareholders while in everywhere. I started philanthropy you are asking about it and judged by the return to people said, “that's what beneficiaries. So I've everyone here drinks”. long been very involved And they were telling me with and interested in about how it doesn't discussions on the advertise at all because effective philanthropy everybody already drinks movement and how to it. So why would you better measure and advertise? This wasn't a maximize impact. business that we were going to invest in, but it G&D: Thank you very made the travel much for your time. experience more interesting and it made me think about investing, and I think enhanced my investment knowledge. Then I’m passionate about philanthropy. Early in my career, because Ensemble provides financial advisory service to our private clients, cultivating advice to philanthropic clients became a real focus of mine. Over a quarter of Ensemble's AUM is charitable assets, whether that is non- profit endowments, grant making entities or charitable trusts of individuals. And that's been an area that I've been very interested in, especially in the idea of high impact giving. In my view, charitable giving is the provision of capital to organizations to create social impact, which is very similar to Page 48 Dan Rasmussen, Verdad Advisers

Dan Rasmussen is the decisions. I was also runs Cove Hill, was founder and CIO of interested in finding enormously influential. Verdad Advisers, a something intellectual. He's a brilliant ~$700m in AUM And I got lucky. I fundamental analyst and hedge fund. Prior interviewed at a bunch taught me everything I to starting Verdad, of places and got a job know about how to look Dan worked at Bain at Bridgewater. I loved at individual companies. Capital and that experience. It really He has the best Bridgewater turned me on to understanding of anyone Associates. Dan investing and I’ve met of return on earned an AB from Bridgewater was a very investment and how to Dan Harvard College academic and interesting identify true Rasmussen summa cum laude and place. compounders (his Phi Beta Kappa and an investment in Domino’s Verdad MBA from the After college, I worked being the best example). Advisers Stanford Graduate at Bain Capital for four And then in terms of School of Business. He years, which was also a academic literature, is the New York Times wonderful place to work. Philip Tetlock, Daniel bestselling author of Very different style of Kahneman, Nassim American Uprising: investing, very different Taleb as well, these The Untold Story of set of intellectual people aren't even America’s Largest questions. And I'd say, investors, but they teach Slave Revolt. In 2017, what I do now, my fund you how to think. Those he was named to the strategy is, even though are my big influences. Forbes 30 under 30 I spent very little time at list. Bridgewater, almost G&D: How did your equally influenced by experience at Bain, with Editor’s Note: This Bridgewater and by Bain its focus on fundamental interview took place Capital in terms of what analysis, shape your on April 16th, 2021. I'm doing in my investment philosophy? approach. Graham & Doddsville DR: Bain is very (G&D): Dan, first off, G&D: Were there early oriented around deep thanks much for taking mentors or investors due diligence and the time to speak with that you looked up to? competitive advantage. us. I was hoping that we In other interviews They're focused on could start by walking you've mentioned taking buying high quality through your an outsider’s businesses, which they background and what perspective, especially define in the traditional really started you down early, based on your Michael Porter way. the investing path? undergraduate When I was there, I did background. We’d be a whole series of Dan Rasmussen (DR): curious as to whether analysis under Andrew I studied history and there were any mentors, Balson studying Bain's literature in college. I either personal or from history and the history of spent my prior summers afar that you found private equity. One of working in journalism, inspirational. the things that I found and I was trying to was that the price paid figure out what to do DR: Absolutely. First, I seemed to overwhelm all with my career. My really admire Ray Dalio. the other diligence father is a lawyer and he His big ideas around items. Competitive said, "I get paid by the studying history and advantage was often a hour, but it would be discerning fundamental transient thing. If a pretty good to get paid linkages in economies, is company seemed based on the decision a method of getting to competitively rather than the time the truth that has had a advantaged in 2010, by spent." So I started huge impact on me. 2015 it wasn't looking for a career that Second, Andrew Balson, competitively would provide rewards who was my boss at advantaged anymore. In based on making good Bain Capital and now (Continued on page 49) Page 49 Dan Rasmussen, Verdad Advisers

contrast, the price paid thinking around market DR: I had all these was predictive because it power and market different ideas. I didn't was one of the key structure. I was much think growth rate variables determining more drawn to true forecasts were very how much money you value investing or deep good. I didn’t want to made. You subtract how value investing. Over buy expensive much you paid from time, and maybe I've companies. And in my what you sold it for and evolved a bit from a last year at Bain Capital, the less you paid for the pure focus on deep value if I was assigned the same amount sold, investing, I’ve focused growth rate forecast, I obviously the more more on profitability and would stop and think, money you make. return on asset type why am I doing this? metrics (the more This is silly. What a The other thing that I Andrew Balson waste of my time. And found was that, approach), which are that's not something especially as a junior very important. anyone wants to hear person, you spent a from their 21- to 22- huge amount of time at Thinking about year-old analyst. That Bain developing growth reinvestment experience of expressing forecasts. When I looked opportunities and their my views and then not at our predictive power I rates of return is how really getting anywhere found that if we just said fundamental analysis (in fact, making people 3% for every company can get to a better angry) led me to think, that we'd ever bought, answer. You are much am I a good employee? we would have been more likely to actually be Am I going to succeed 20% more accurate than right, and these metrics working for other using our internal really matter for people? Maybe I'm just a forecasts. My time at valuation. You can see disagreeable, contrarian, Bain led me in a couple that in terms of how dislikable person different directions. One companies are valued, [laughs]. to reflect on was, what for instance in the can we really know as relationship between I even went and got a fundamental analysts? return on assets and career coach, a deep, credit quality, or the rate empathetic, and brilliant One of the parts that I of return on assets and man named Lew don't think is valuable is multiples. Rumford. And I said, growth projections. "Why do people get These are a huge trap. That's an important angry at me all the Forecasting growth concept to understand, time? I'm just trying to sucks up a huge amount although at the end of express my views. I told of energy and making the day value is still key. a co-worker the complicated Excel competitive analysis models produces output G&D: As you were project was a waste of with very little predictive thinking about leaving my time and I showed power. In fact, these Bain and going to him all the research I models often produce business school, was had done and why it was negative predictive there anything that a waste of my time. And power as they tend to be signaled to you that, not only was he not trend extrapolated. If “Hey, I'm ready to persuaded, but he the company has been launch my own fund. reported me to HR, like doing well, the models I've got a market that is what's going on?" And are anchored in the last attractive and I can do so, Lew really helped me three years of data. some of the type of work discern the right path for that I've been seeing in me. It also made me maybe a less skeptical of competitive competitive At that point, like many advantage analysis. I environment”? What was young people, I was just couldn't find much it that triggered that trying to figure out what empirical support for a next step? I wanted to do, and I lot of the traditional (Continued on page 50) Page 50 Dan Rasmussen, Verdad Advisers

was very worried that to entrepreneurs, at markets were about working in a big least young 40% cheaper than public company or working for entrepreneurs. Do it markets on average other people would because it's the only from 1980 to about highlight my weaknesses thing, or because you 2006. By 2006, both more than my strengths. can't see anything else. private and public I was willing to go out Because it's hard, being multiples had converged. and do something an entrepreneur is hard. I'd argue that today entrepreneurial because private markets are I perceived that as the “If you look at what more expensive than place I’d be more likely public markets. to succeed. drove private equity If you look at what drove Like many things in life, returns during the private equity returns it was happenstance. If I period in which they during the period in had met someone at which they were that time who thought were astonishingly astonishingly successful, exactly the way I successful, it was it was buying micro-cap thought and wanted me levered value. to come work for them, I buying micro-cap would have done it. It And these things worked would have been the levered value.” in combination. If you path of least resistance. were buying in a private But at the time, the G&D: Transitioning to market and selling into a ideas I wanted to act on Verdad and your higher multiple public were very controversial empirical research market, or selling to a and I fundamentally process, could you walk strategic buyer in the believe in acting on us through your public markets, you're ideas. I believed in the approach at a high level? going to have multiple research that I'd done Also, could you talk appreciation. And, holy and I wanted to see it through how you landed smokes, when you're play out in the real on the US and Japan as levered, multiple world. Starting my own your primary focus expansion works really, fund was the only way to areas? What made those really well. You're do this. markets attractive? capturing all that benefit. And the amount When I was considering DR: At its core is that of leverage they were what to do after college, study I worked on at putting on these I thought vaguely about Bain, where we looked at companies wasn't all being a history what worked and didn't that big at low prices. If professor. One of my work in private equity. you're paying seven professors said, “Well, But first, let’s ask what times for a company and Dan, being a professor is is private equity? How is levering at 65%, you're the worst possible job. it different than public putting four turns of There's no pay, it's equity other than being debt on that business. highly political, it takes private? There are three Well, it turns out most forever to get tenure. main differences. companies can handle You have to think about four turns of debt. it like being a priest or a The 1st is size - private monk. If there's literally equity companies are But what I saw nothing else that you small, about $180 happening in the wave of could ever see yourself million in market cap mega buyouts in '06, doing but being a history versus tens of billions of '07, '08, was that PE was professor, be a history dollars for your average paying 10, 11, 12 times professor. But if there's large cap stock. The 2nd EBITDA and putting six, literally anything else is leverage as PE deals seven turns of leverage you could see yourself are about 65% levered of these businesses. doing, don't be a history on a debt to enterprise Many of those deals had professor." I'd almost value basis. The 3rd is horrible, horrible have the same counsel valuations. Private (Continued on page 51) Page 51 Dan Rasmussen, Verdad Advisers

consequences during the do any qualitative due return“Coming on capital out ofmetrics the GFC in '08. diligence layering on top matter. You can pull of the screening? Or thosetech different wreck leversin the in One of the lessons I took does it tend to be more differentearly 2000s directions, and thenand, away from that is you that you've done an if you look at the long don't want to put six extreme amount of sweepthe financial of history, crisis, you times or more leverage research and back- get very different on a business. It's just a testing, and you know probabilityone thing distributionsthat became really scary amount. But that this market is where forclear, buying particularly different in the way PE purchase you want to be, and the types of securities. price multiples were qualitative analysis is the financial crisis, is going at that time, 6x+ maybe less of a value Our first view is that we leverage was being add. Where do you come wantthat tolong get- termthat base trends featured in an down on that? ratealmost right. never Select reverse. from increasingly large the set of stocks that are percentage of deals. “What I set out to do in Therethe most are attractive cyclical pool based on history. So what I set out to do was to say, "Hey, I Now,businesses once you're that in gothat was to say, "Hey, I want pool,through you're tryingups and to to go replicate private want to go replicate differentiate between the equity’s early success. I private equity’s early 150 downs,things that but are the in want to go find that pool of securities. companies that trade in success... I want to go Howsecular do you trends choose? almost One public markets that have way neveryou can reverse. choose ”is those same attributes. find companies that by ranking. You can say, They're small, they're are small, levered, "Okay, well, have the levered, they're very screen tell me, which cheap. And I want to and very cheap. And I looks the highest return find a systematic way of based on the past identifying those want to find a conditional probability companies, buying systematic way of distribution." You're them, and managing looking for what's the portfolios of them." identifying those most attractive to least companies, buying attractive. And then you When I first started out, go start looking at the if you did a screen for them, and managing companies. those criteria, most of the results were ex-US, portfolios of them." I’ve found that a human and Japan was the analyst’s judgment is biggest market. In terms still very important for a of a count of companies DR: Quantitative variety of reasons. One that met these basic analysis is great. I is that reading historical thresholds, Japan had believe in base rates. financial statements the most, then Europe, Probabilities are involves a lot of nuance then the United States. conditional on and idiosyncrasy. For We focused characteristics. The key instance, you have a internationally at the question is: what are the company that does a beginning because that's characteristics that divestiture, so obviously, where the cheap condition those the LTM financials aren't companies were. We did probabilities? representative of the some in the US, but we next 12 months or 80% didn't really enter the US You can think of those of the company's in a big way until March characteristics as revenue comes from of 2020, which I can talk basically being factors, Walmart and Walmart more about. the drivers that show up just fired them. These clearly in regressions. are quite simple and G&D: We wanted to dig In equities, there are a logical things that you'd a bit more on your few. Size matters, want to understand screening and analysis valuation matters, about a business before process. Do you tend to leverage level matters, (Continued on page 52) Page 52 Dan Rasmussen, Verdad Advisers

investing in it. when a human is going down. Either you have to be a to help. A human is brilliant AI programmer going to be able to The other things that we to figure out how to code distinguish between think about portfolio your thing to do this or airlines and cruise ships construction really are just have the human and the like. Humans risk-related. We don't study it, and they're can very quickly judge want too much in one going to pick up on what's going to happen industry or want it too these things. I really in the next 12 months. much in one macro think that humans are And how that's going to exposure. We want to cheap robots [laughs]. affect different have some industries. But a diversification. If we've There is value in being computer looking at built a portfolio and we'd able to understand historical financials has have not a single historical financial no clue. You really want technology stock, we statements, read a cash to use human judgment should probably go try to flow statement, and layered on top of a find at least one understand what's going computer, especially if technology stock or on with the business. If you're running a more renewable energy stock. it helps you miss concentrated portfolio. If We should at least find landmines like where a you're running 500 one. company is spending securities, it doesn't huge amounts of money really matter. If you're on intangible assets, and running 40-50 securities “There is value in you're like, "Well, what like we do, it does being able to are these intangible matter. assets?" And you dig a understand historical layer deeper, and you G&D: When you're realize, "Oh my gosh, thinking about portfolio financial statements, this thing is a total, total construction and read a cash flow disaster." Or all their weighting, how do you EBITDA is coming from go about it? Is it a statement, lease revenue. It's these function of relative risk, bizarre things that a or equal weighted? Do understand what's human analyst finds. you hold cash for going on with the opportunities? When you're looking in business.” the extreme of what a DR: We run 100% computer model likes, invested all the time. We which tends to be cheap have a max position size On the other hand, if we situations and deep of 4% (at cost). We like have five auto parts value where people are to start our positions off companies, maybe we pessimistic, you will find small and build them up don't really need them a disproportionate over time because you all. Maybe those are all number of these weird find that with each the same and we're things going on. So quarterly earnings excited about all of them developing a trained eye report, you learn a little but we should just for which of those weird bit more. We find that choose the top three and things will modify your building a set of 1% cut the other two out. probability distribution in positions, then sizing a bad way is useful. them up to 3 or 4% Now I can get into March positions after a quarter 2020 and talk about why I'd say it’s less often or two of seeing their we entered the US that fundamental financial statements, is a market in a significant diligence moves us really really good way of way. One thing that my in the direction of buying running a book. We Bridgewater heritage a stock. It's more likely don't like to go up that taught me is that that it filters things out. much above 4% at cost, different strategies, COVID is a great although obviously different asset classes example for where and things run up and run (Continued on page 53) Page 53 Dan Rasmussen, Verdad Advisers

work well at different relates to value as a have“We growth believe rates there that is times, and the best concept. In a normal are more attractive than predictor of when these market, value stocks are growthless competition stocks. The overone strategies don't work are going to grow less than yearthe long in which-term the because auto a lot of macro variables. growth stocks over the parts company is going Illiquid, small cap, and next one-year period. to mostbeat Amazon professional is March “value” are all a You pay a much higher 2020 to March 2021. connected set of ideas. multiple for Amazon investors have to Value has a lot of than the auto parts You'reworry getting about a short- overlap with small and company. Then a year discount, an abnormal illiquid. later, Amazon grew 20% cyclicalterm discountperformance during a and the auto parts recession, and you're because of the threat “The reason value company declined 1%. getting abnormally high The reason value growthof redemptions rates — that's and investing works over investing works over the why the unique, special long-term is that there momentcompensation for value is in the long-term is that are systematic times of crisis. incentives.” there are systematic expectation errors— people over-predict What we said is, "We're expectation errors— growth. Investors think going to run fully that Amazon is going to invested in our funds, people over-predict grow at 22% and then it but we're going to tell all growth." grows 20%, then the of you, all of our multiple comes down investors, that the best because investors are time to do our strategy Small, illiquid value does disappointed. On the is when there's a well at points in the other hand, people recession and when high macro economic cycle. It think, "Oh, that stock is yield spreads blow out, does well from the awful. It's a melting ice when value stocks are bottom of a recession cube. It's going to abnormally cheap and until the economy is decline 5%, it declines have abnormally high doing well again. That is 3% and the multiple growth prospects.” when value does goes up." And that's why absolutely the best, and value works over time. We published a piece it does well for a few called Crisis Investing, reasons. One reason is But where value really and we created a vehicle that markets are driven works is coming out of a that was equal in size to by liquidity flows. People recession. Those small- our entire business at pull their money when cap value names, they the time to do this — to they're scared, they were cheap pre- buy deep value stocks in dump money in when recession, they sell off times of crisis. We had they're excited and more than the market in the idea in 2018-19, illiquid small caps and the recession. And then created the fund in value are at the tail end you're sitting there at January-February 2020, of that web. If investors the bottom of the and launched on May 1st are panicking and pulling recession and you say, 2020. We played out their money, small cap "Okay, what's going to that whole thesis with and value are going to grow the most over the our business. perform the worst. When next year?" Well, it's all money starts to flow the crappiest, most Again, we do think there back in, they're going to cyclical dogs. Margins should be a cyclically go up the most. At times dropped 80%. And now varying exposure to of market panic, those as the economy small-cap value. But in illiquid securities sell off recovers, margins are the past, we've done way too much, and then going to not just to get that by letting our they come back way too back to breakeven, investors add money at much. That's the first you're going to grow the right time and dynamic. more than 80%. All of a creating vehicles for sudden, these deep them to do that rather The same dynamic value stocks actually (Continued on page 54) Page 54 Dan Rasmussen, Verdad Advisers

than holding cash within faster than what we'd markets, and said, our funds. probably see in the past. "We're going to provide I was curious, would you support for the credit G&D: One other ascribe that purely to markets." And that's question we had, going the Fed’s action or if going to keep the flow of back to the things you these things tend to funds going and keeping screen for, is what role snap back more quickly the funds flowing is does predictability of a over time because going to prevent that business play? Does that markets have become second leg down. And it matter at all? Or are you larger and more liquid or was brilliant and they did indifferent between if it's more efficient? it fast. It was a mining company or unbelievably well something that's more DR: First, yes, that is executed and I'm not predictable, given the the case. This has been usually a fan of leverage? Curious to a good example of Ben government or hear your thoughts. Bernanke's idea of a regulatory actions. They financial accelerator. often do more harm than DR: I'd say that I'm not Why do small shocks good, but this was sure. There are turn into crises? The brilliant. necessarily degrees of answer is because a predictability. There are small shock happens and That's really what led to high volatility and low then the financial system the very fast snapback. volatility type industries, reacts — banks stop After that, you started to but everything is equally lending, investors stop see parts of the unpredictable. And I try investing, people that economy opening again, to live by that are going to build a new and people adapting to philosophy. For factory say, "Let's wait. the new normal quite commodity industries, Should we really build it fast, and people and I've been doing a lot of in April of 2020? It businesses are resilient. work more recently on probably isn't a good It turned out a lot of how the commodity price time to build that new companies that were left environment affects factory. Let's put a for dead in March have those types of stocks. pause in those plans." outperformed. One of Obviously, it affects The impact of financing my favorite examples is them a lot. You want to being shut off has a set MasterCraft Boats. In be cognizant, to the of real-world every previous extent that you can, of consequences, usually recession, you looked at whether it's a good time even more dire than this company and said, or a bad time to be whatever shock hit the "Of course nobody is exposed to that economy. going to buy a boat in commodity because the the middle of a stock that mines or It’s the financial recession." It's a leisure produces the commodity accelerator that reacts to luxury item. usually has a large the real-world event that exposure to it. There are really drives a market And MasterCraft Boats some levels of crisis. What the Fed did started off just as it predictability in in March was smart. would in any other commodity prices that They said, "We've got to recession. And then maybe you can use to stop the financial when it turned out after make those types of accelerator and we’ve their lockdowns, people decisions. got to step in fast." That needed something to do. was one of the lessons So, they went out and G&D: One of the more from '08. They needed bought a lot of boats. It interesting aspects of to move fast, and they was completely the the Crisis Investing piece needed to stop the opposite of what you that you guys put financial accelerator would have expected in together was the timing from accelerating. They a normal recession. And associated with a bounce went to exactly where there were all sorts of back after a crisis. And, they should have gone, things like that, that the this year likely was a lot which was the credit (Continued on page 55) Page 55 Dan Rasmussen, Verdad Advisers

economy just reacted in other passive players’ interesting dynamic and a weird particular way to assets are, they're in it's going to favor active this financial crisis. It large-cap, US index managers, not because was different from other trackers that track the active managers are ones. S&P or the total market. smarter, but just It's like 80% of their because their factor G&D: MasterCraft was assets. What's quite exposures are different. up about six times from interesting is that as its trough when we money shifts from active G&D: Absolutely. We’ve looked the other day. to passive, it's also style seen a bit of a re-rating That makes a ton of shifted, because most from historical value sense. Everyone we active managers are a versus growth over the knew was trying to rent little bit more mid-cap, a last 1-2 quarters. So an RV over the summer little bit more value. And we’re curious, where do as well! One of the so, as people have things stand from your things we’re curious shifted, they've shifted perspective? Valuation about is the impact on styles, and that's also spreads have narrowed, passive flows across been supportive of the but there's still a pretty companies of different rally in the large growth notable spread. What sizes, whether it's small- style. On top of this, looks most attractive to cap, mid-cap, and you've had another you today from that passive ownership random force, which is perspective? seems to expand as you this deflationary force go up the market cap that brought down rates, DR: The period from spectrum. Is that which you could argue Q1:18 to Q1:20 was just something you think really increases the NPV the most painful period about with your levered of growth stocks. That's for small-cap value small value strategy? been another related investors ever on record phenomenon. in the Fama and French DR: There's been one data back to 1926. It strategy, or maybe one All those things have was just the absolute theme, that has worked driven the S&P 500 and worst. It was all driven over the last decade — large-cap US equities by relative multiple buy large tech. One and passive large-cap expansion in large thing that was US equities to do really, growth and multiple interesting is that the really well over the last compression for value. indices always owned decade. For most active That was a painful time more of large tech than managers, the more to be a small cap value active managers did. boxes (like small-cap, or manager, honestly. Even large cap growth value, or international) What we started to see managers owned less of you tick, the worse is the reversal of those the large tech companies you've done relatively. things. Thank God. than the indices did. When people think, "Oh, But those things also You’ve started to see I'm going to sell my have a reasonable large growth multiples active managers. I'm likelihood of reversing. stabilize. They haven't going to go passive." Valuations are quite started coming down but They're not thinking stretched for a lot of they've stabilized. And international, developed, those companies. At you've seen small value mid-cap value. They're some point, people will multiples pop back up. not thinking of some start noticing the Where we are today is esoteric Vanguard fund. valuation premium of big that large-cap growth They're thinking I want index constituents and small-cap growth to own either the S&P relative to stocks that multiples are at 1999 / 500 or the Vanguard are not constituents of 1974 levels. Very, very, total stock market index. those particular indices very elevated, and small (either because they're cap-value multiples are If you look at where international or because normal. Vanguard's assets are, they're smaller.) It's or where many of the going to be an (Continued on page 56) Page 56 Dan Rasmussen, Verdad Advisers

If you leave the US and the same spread of high this“What for cause. you are That as an go internationally, quality and low quality in doesn't happen in Japan. there are really three big any of these markets. Andinvestor as a result, is a personthe pockets of value: (1) The real question is downsidewith intellectual volatility in Eastern and emerging there any tech there? Japan is much lower Europe, (2) the UK and And there isn't, or very than thecapital, US and with Europe. (3) Japan. little and that's been what's driving the G&D: experience,Dan, just to follow Those are the markets market. But within the up understandingon the point of the of that are by far the context of value, that industries you see in this cheapest right now, and question doesn't matter smallbusinesses value bucket. and It to me, the most as much. Japan happens might be small cap interesting markets to be to be very idiosyncratic banks,contacts industrial that allowstocks, deploying capital into. relative to those other or youconsumer to get stocks. in more How The US was the most markets. The UK and do you deal with the interesting market to Eastern Europe are part issueinsightful of structurally or inside deploy money into a of the same North lower growth rates, year ago. The US America, Europe, especiallyviews of in situations, places like recovery has been faster economic regime, same Japan,learn which what's has really had than any other market, cyclical patterns, etc. growth problems for a but as the economic longhappening time? Do you in think, a recovery picks up in “Where we are today well, they're not really some of those other growing,business. so maybe” they areas (where multiples is that large-cap deserve a lower multiple are even lower), the as a rule, as opposed the value stocks there aren't growth and small-cap US, which is a better going to look all that growth multiples are growth environment? different from US value stocks in terms of at 1999 / 1974 levels. DR: We can interpret financial performance. history in that way and Very, very, very that has been true. The G&D: When you look at elevated, and small US has grown faster and these markets and the tech has grown faster relative attractiveness of cap-value multiples still. These other the opportunity set, are markets have not had as you thinking about are normal.” strong growth. But I whether the pieces of don't think that says fundamental Japan's a little different. anything about the performance that you It’s obviously Asian future. There have been mentioned are export oriented. It's a periods when emerging sustainable? Profitability, hugely cyclical economy markets were growing a return on assets, return and a huge export lot faster than the US, on capital, those types of oriented economy. It's like the 2000s, and there factors. How do you got a somewhat different have been periods where consider relative quality set of drivers. And Japan developed international indicators for a market is also really interesting grew quickly. These like the US which is tech for value investors things are very heavy versus another because there's no temperamental and international market? bankruptcy or virtually cyclical. Investors tend no bankruptcy. The to be too trend DR: The US is tech Japanese government extrapolated and say, heavy generally, but the provides a lot of support "Well, the US grew more value industries are the through the banks to in the last 10 years, same in the US as make sure companies therefore it's going to internationally. If you're don't go bankrupt. And if grow more in the next talking Eastern Europe you look at small value 10 years." I just don't or the UK, value stocks performance, quite a think that's an accurate are often industrial or large percentage of way of looking at the manufacturing small value companies in world. companies. You can find the US and Europe do (Continued on page 57) Page 57 Dan Rasmussen, Verdad Advisers

There are lots of to dominate the world. about industrial stocks, if rationalizations that you I'm not sure. you don't have a lot of hear all the time, such population growth, you as European companies My friend Ted Lamade won’t need a lot of being much less well-run has an interesting thesis, growth in physical than US companies. But which is that a lot of capital. So, do you think when you look at who these tech stocks sell there are good reasons runs most of European enterprise software, that these industries companies, it’s like the meaning they're selling may not be as exact same people. software to all the old interesting as a Okay, they went to world companies. And technology? INSEAD instead of for these software firms Columbia, but it's the to grow as much as DR: Those are all same people. They both they've grown, they narratives that can shift. worked at McKinsey, just must be providing a There's always a new set different offices. I really value add that is in of narratives that define doubt that different excess of what those old or shape our management styles are world companies are understanding of the really driving the paying. There's an world. Today we might disparity. economic logic to that. think negatively about oil and commodities, but At some point, those commodities have had “There's always a new software gains should their worst decade ever start translating to in the past decade. set of narratives that productivity gains for Maybe the next decade define or shape our value stocks. Otherwise, will be better for the sole story of what commodities. Maybe 10 understanding of the those software years from now we'll be companies are doing and talking about wild world...These trends their growth trajectory inflation in the US and can persist, but at the couldn't possibly how France is really the continue to thrive unless most interesting place to end of the day, the they're providing value invest because of the future is to their customers. It stability of their would be logical to argue government. These unpredictable. The that perhaps the things are customers of the temperamental and paradigms and technology companies they're oriented and narratives that define might be the winners of anchored on recent the next decade even history. Markets do trend what is in favor and though the innovation because as these that was driven in 2010s narratives gain in out of favor change.” was by the software popularity, they're companies themselves. reinforced by people pulling capital in line Or, Japan. GDP grows G&D: Going back to with those narratives. really slowly, but if you different industries. Oil, look at GDP per capita, for instance, was great These trends can persist, Japan has actually been when emerging markets but at the end of the growing faster than were growing very day, the future is Europe. There are a lot rapidly, but now, oil is unpredictable. The of these different no longer the best paradigms and dynamics in these industry for global narratives that define different markets that growth exposure. what is in favor and out are contrary to the Similarly, if you think of favor change. The narrative of the US banks are challenged by safest long-term having the fastest low interest rates for a strategy is to bet on the growth, the best very long time, then unpredictability and managed companies, banks become less chaos of the future. To and that the US is going attractive. Or if we think (Continued on page 58) Page 58 Dan Rasmussen, Verdad Advisers

bet that something's the valuation multiples be very painful for these going to happen next for electric vehicle stocks things that are priced to year that surprises us. or something and they’re perfection. And gee, those surprises just nuts. Whereas are more likely to benefit industrial companies, G&D: A lot of what things that are really consumer discretionary we've talked about really depressed and cheap companies, and some of comes down to and more likely to hurt the boring things are forecasting and trend things that are really priced at just normal extrapolation versus expensive and require multiples. mean reversion. At CBS, the world continuing to we spend a lot of time go on as it has in order on fundamental security to win. “Tech grew more, and analysis and forecasting, and it's valuable for us G&D: Thanks for that. that was the right bet. to talk to somebody like Have you looked into or But now, that you who's looking for thought at all about the value but taking an market's perception of narrative is priced outside view. Where do disruption and whether you draw the line? Do the market tends to into markets. You can you think it's possible to overvalue disruption, look at the valuation generate alpha and excessively penalize consistently by having a the disrupted? I’m multiples for electric variant view? Maybe curious if that factors in you're not able to at all to your strategy? vehicle stocks or generate a five-year DCF something and with any real precision, DR: This is the growth but you're taking the versus value debate. they’re just nuts...At probabilistic outcomes Disruption versus and maybe some of disrupted. Tech versus some point the those probabilities skew non-tech. The answer narrative that in a certain way, and over the last 10-years that's your source of has been very simple: sustains these things alpha and you're bet on tech, bet on directionally correct? disruption, bet on the will shift, and when it US, bet on growth. does, it will be very DR: I probably have two big points of Part of that has been painful for these disagreement with the based on a real-world things that are priced curriculum at Columbia reality, which is large [laughs]. earnings growth among to perfection.” those tech companies. Disagreement one is on There's real innovation DCF modeling and in the cloud and real Now, you can look forecasting. It's a waste innovation in direct to forward and say, "There of time, it's value consumer products. All are two great risks in destructive, and any of these things were markets. There's historical analysis of real. Real innovation in bankruptcy risk and growth rate projections software that led to real overvaluation risk." The and actions taken based economic advancement. risk of worrying about on growth rate overvaluation risk is projections is going to You can't step away and FOMO. You get left out show you that they're say, "Okay, my auto when some part of the detrimental to parts stocks grew just as economy rips but you performance. If you rank much as tech." Because dodge the drawdowns every stock in the US they didn't. Tech grew when they eventually based on its expected more, and that was the come. At some point the growth rate, the highest right bet. But now, that narrative that sustains expected growth rate narrative is priced into these things will shift, stocks tend to do the markets. You can look at and when it does, it will (Continued on page 59) Page 59 Dan Rasmussen, Verdad Advisers

worst. The more you're business school – how to empirically valid. Base spending on these make good forecasts. rates are an empirically things, you're just Because there is a better valid way of making actively buying into way to make forecasts, predictions. Using things that don't work. there is a scientifically analyst forecasts of better way to make a growth rates is an Now, those things can forecast that does lead empirically bad way of work when it's to better outcomes, but making predictions. The momentum driven. it's not the traditional more we can rely on During the last decade, trend extrapolation in things that have been no matter how off your the DCF approach. Nor is empirically validated, the DCF model was for it developing a massive better our outcomes Tesla, your decision to amount of expertise by hopefully will be. buy Tesla ended up talking to leading working. But was that experts in the industry. G&D: We were going to because your DCF model Or the idea that I'm transition a little bit for Tesla was right? going to invest in an here, but you and Probably not. It was insulin pump company Verdad as a whole put because there was this because I'm diabetic and out a lot of research, huge tectonic shift therefore I have better and we’re grateful for towards tech and information, which is that personally. How do growth. silly. you think consistently writing has affected your The other point that I At the end of the day, I investment process and disagree with is this idea do believe in human the way that you think that a variant perception judgement, regardless if and see the world? can be built on a that human judgment is particular expertise. I expressed through DR: Writing is don’t disagree with the construction of an tremendously useful. By variant perception idea, algorithm or that human putting your ideas down but Philip Tetlock has judgment is expressed on paper you express shown in his work that through fundamental yourself, you see what expertise increases analysis. I'm a believer makes sense, you find confidence without that there's good the holes in your increasing accuracy. The judgment and bad argument, you share world's leading expert in judgment. And there are with others who disagree Soviet studies was no lots of ways to measure with you or critique you. better than your average good judgment, and Writing helps you build Joe off the street in there are lots of people confidence in your own predicting when the that exhibit good voice, in your own style Soviet Union was going judgment and lots of of investing. It also helps to end, but a lot more people that exhibit bad people understand what confident. judgment. you're doing and what you're thinking, which is The best way to make I am not making the really important for forecasts is to use base case against active business. rates, to use these types management or of forecasting fundamental analysis. It The market is wildly methodologies that have can work when done volatile and been proven to work. well, with good unpredictable. It has You have to think in judgment – look at the huge swings that are not terms of base rates, track record of people justified by reason. A think in terms of like Andrew Balson. large part of the historical probabilities, These quantitative investment management and be what Tetlock processes can work well business is to called Super Forecasters. when they're driven by contextualize that Those techniques work good judgment and good volatility, explain that and they should be logic and equally, they volatility, and find a taught. That should be can be bad. But I like to course of action. That's the curriculum at start with what is (Continued on page 60) Page 60 Dan Rasmussen, Verdad Advisers

consistent regardless of you know that the street next“When year. you're We don't early in volatility. Most bad doesn't?” How do you know. Someone could decisions are made in respond to or think pitchyour $500,000, career, the the most markets because of about this question? otherimportant person thingcould pitchis to volatility. Most good zero, and we would have managers are people DR: There's classic no wayget ofexposure proving thatto that have found a way to efficient market theory either one of them was grapple with chaos, that says, "All wrong,people but next and year to unpredictability, and information is priced in." we'llcompanies know that either and or volatility. Writing and The theory says that the both of them were research is one way to price of the security wrongindustries and that that can do that. It allows you to reflects all available somebody else was put things in context, to information at that time. right.raise your level of zoom out and say, "Hey, The logical reaction to play, help you build a gee, what happened that is, "Oh, go find yesterday? In the big information that isn't “Mostnetwork good and managers build scheme of things, isn't priced in." That's the that uncommon? And expertise driven variant areout people your circles that have of here's what's happened perception. I don't really competence.found a way Working to the last few times buy that. I don't buy something like what that there's a lot of that grapplein investment with chaos, happened yesterday information just lying happened. What around. unpredictability,management is anda happens next?” That's lifelongvolatility. exercise Writing in really valuable. But more importantly, and where I differ from learning,and research which is oneis a G&D: You mentioned in the efficient markets wonderful thing. ” a podcast with Patrick theory is that there are way to do that.” O'Shaughnessy that if multiple interpretations you were going to write of the same data. Shown a book it might be titled the exact same fact Those people that had “The Bonfire of the Bad pattern, people are those varying Ideas.” We've talked going to come to very perceptions are going to about forecasting, but I different conclusions. In have to readapt and was curious if there were America, there's a red come up with a new set any other primary bad team and a blue team: of forecasts to ideas that you see from throw them the same set incorporate the new investors today? of facts and see whether information. That's why Breitbart and The New markets are volatile. DR: We've talked about York Times react the Porter's Five Forces a same way. They What I like to do is then bit, which I think are probably won’t. say, "Okay, well, what I rubbish. DCF models are want to do is play the rubbish. I believe that an So, why would two man, not the puck." I expertise driven variant investment analysts don't want to play the perception is rubbish. react the same way to data because I'm just The diversification and the same set of going to come up with a volatility reduction information for a given variant perception that's benefits of private assets company? They come just as variant as is another bad idea with vastly different everyone else's. What I that's leading to a lot of predictions about the want to do is figure out very bad outcomes future. Their perceptions how are the perceptions today. Those are some are wildly variant, and weighted? Is there a of my greatest hits. we don't know who is consensus? Maybe all right. That's the other the perceptions seem to G&D: On the narrative really interesting thing. be tilting this way, around the expertise We have no way to know therefore the risk-reward driven variant view, time whether Bitcoin is going is over here on the and time again, we get to go to $500,000 or if opposite side, because the question, “What do it's going to go to zero (Continued on page 61) Page 61 Dan Rasmussen, Verdad Advisers

nobody's thinking that, minded, Jim ability“When to you're communicate early in but that's equally O'Shaughnessy's book, your ideas is probably plausible because the “What Works on Wall equallyyour career, important the to most the world is unpredictable. Street” and Antti qualityimportant of the thing ideas is to Ilmanen’s book, themselves. That's why I care a lot “Expected Returns”. I get exposure to about valuation have those right up here G&D: Last question, multiples, because and I look at them once what peopledo you likeand to to do valuation multiples are a week. There's always outsidecompanies of work? andHow do your way of some question I have, you end up spending understanding and the answer is yourindustries time these that days? can consensus. Something usually in one of those that is really richly two books. Those are DR:raise I have your two level sons ofand valued has a huge really helpful for quants. Iplay, spend help a lot you of time build with a optimism consensus. Random books I read them. And I read a lot, Something that's really, recently that I love. butnetwork those are and probably build really cheap has a huge William Percy’s “Lanterns my two pastimes. pessimism consensus. on the Levee”, which is a out your circles of Obviously, you want to fantastic book. That's G&D:competence. That’s great. Working What tailor that by industry nothing to do with kind of activities do you and other fundamental investing but it's really, end upin doinginvestment with your really good. characteristics to make sonsmanagement these days? is a sure you're actually selecting for pessimism G&D: Thanks Dan. I DR:lifelong Well, they exercise’re two in as opposed to just sometimes feel like we and zero. it's the basics. selecting low return on get trapped in just Changinglearning, diapers, which is a capital businesses or taking down the list of gettingwonderful them food, thing. take ” something. investing books and we them to school, going for occasionally need to get walks. Broadly that's where I back to the love of come down. The world is reading just for the love G&D: Well, we in that about meta-analysis, not of reading. And then, a context, appreciate your analysis. It's not about couple of quick closing time even more! Thanks what you think about a questions. Do you have much Dan. stock, it's about what any advice for students you think relative to that are beginning in a DR: A little sleep what other people think. career in investment deprived [laughs] but it's It's not about the management? my pleasure. information, it's about the interpretation of the DR: The value of writing information. And even and sharing your writing. more it's about It can be long form, it interpreting other can be short form, but people's interpretations the internet makes that of the information. much easier. If your thing is long form stock G&D: Awesome. You pitches, get on mentioned enjoying and SumZero, get on Value respecting Tetlock, Taleb Investor Insight, get on and Kahneman. Any Seeking Alpha. Post your other authors or books things, get feedback, that you might build a name, build a recommend? It could be reputation. There's just investment related, such value in exposing history, fiction, just your ideas, testing your anything that comes to ideas, learning how to mind. write. And whether you're doing that DR: Let's see. For those internally at your own who are quantitatively company or not, your Get Involved:

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Rodrigo de Paula ’21 Rodrigo is a second-year MBA student, a Meyer Feldberg Fellow and a member of Columbia Business School’s Value Investing Program. During the summer, Rodrigo worked as an equity ana- lyst at MFS Investment Management. Prior to Columbia, he worked at Clayton, Dubilier & Rice as a private equity associate. Rodrigo graduated from the University of Pennsylvania with a B.A. in Philosophy, Politics and Economics. He can be reached at [email protected].

Matt Habig ’21 Matt is a second-year MBA student and a Columbia Fellow. Dur- ing the summer, he worked in the Restructuring Group at PJT Partners. Prior to Columbia, Matt worked for six years in the Institutional Equity Division at Morgan Stanley, most recently spending three years in their Special Situation Group. Matt graduated from Dartmouth College with majors in Economics and Engineering Sciences. He can be reached at [email protected].

Alison Tien ’21 Alison is a second-year MBA student and a Columbia Fellow. During the summer, Alison worked in the Equity Investment Group at T. Rowe Price. Prior to Columbia, she worked in port- folio analytics at Capital Group in their Los Angeles office. Alison graduated from the University of California, San Diego with a concentration in Economics and a minor in Accounting. She can be reached at [email protected].