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Dev Kantesaria: Great Compounding Machines That Crush The Market (Plus, New Stocks He Has Bought) $FICO $V $MA $SPGI + More
01:02:21
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- [00:00]
Brett Schaefer
Foreign.
- [00:05]
Ryan Henderson
Welcome to Chitchat Stocks. On this show, host Ryan Henderson and Brett Shafer analyze businesses and riff on the world of investing. As a quick reminder, Chitchat Stocks is a CCM Media Group podcast. Anything discussed on Chitchat Stocks by Ryan, Brett or any other podcast guest is not formal advice or recommendation. Now please enjoy this episode.
- [00:33]
Brett Schaefer
Welcome into Chit Chat Stocks, a podcast to help you find your next great investment. My name is Brett Schaefer, joined as always by Ryan Henderson and today we continue our Super Investor series with Dev Cantasaria and Valley Forge Capital, an underfalled fund manager who is taking Buffett's lessons for the 21st century. His fund has beaten the market for close to 20 years and he has a lot of lessons from for our listeners, so we're going to get right into it. But if we have had some new listeners recently and if you are enjoying the podcast, please give us a five star review on Spotify or Apple Podcast as a free show. This is the best way to show your appreciation and help us grow. So without delaying Ryan what is Valley Forge Capital Management and who is Dev Cantissaria?
- [01:25]
Ryan Henderson
Yeah, defcantosauria has sort of a unique background relative to other fund managers. I feel like most fund managers that we've studied typically spend some time on Wall Street. They have financial backgrounds. Maybe they worked at an investment bank or they were an analyst at another shop for a few years before they tried spinning it out and developing their own shop. Dev Cantissari has a completely different background from the early days. Cantosari recalls that he wanted to be a surgeon, so he attended mit, the Massachusetts Institute of Technology for those who are not from the States, where he majored in biology and then went on to study at Harvard Medical School afterwards. However, while at Harvard he had sort of a change of heart. In his own words, he says, I realized in my third year of medical school that although I love the intellectual aspects of medicine, practicing medicine wasn't something I could see myself doing for the next 30 or 40 years. He ended up finishing his medical school and joining McKinsey as a management consultant. So another McKinsey success. As much as we bash on the.
- [02:32]
Brett Schaefer
Consulting, well, you know, maybe this is one one vote in the positive for McKinsey. And you know the Enron guys can be the negatives.
- [02:39]
Ryan Henderson
Yeah, but after McKinsey, I mean he wasn't really there for that long. Kantasaria joined the venture capital world where he spent 17 years. Specifically, he worked in the healthcare world of VC. So I say all this because we look at his portfolio in a second, we're going to screen share and I'll talk through some of the positions as well. You'll see he puts very little of his previous domain expertise to work in his investment approach. He gives some interesting perspective on how his time as a VC ultimately did help him as a public equity investor down the road. He says, as a venture capitalist, I gained a tremendous amount of experience on the operational side of businesses, which is an important background to have as a public equity investor. Building businesses, being a Director, working with CEOs, serving on committees, all of that is helpful in assessing public companies. I actually think that's really insightful. It kind of goes back to the Buffett. I can't. I believe it was Buffett that said it, but he's basically like, I am a better businessman because I'm an investor and I'm a better investor because I'm a businessman kind of thing. And just having that actual operational expertise or experience is really helpful. Eventually though, in 2007, after I believe two decades roughly in the VC world, Cantosaria decided to start a public equities focused fund with $300,000 of initial AUM. That might be the lowest starting AUM of any investor we've studied on this show. I think. I can't think of anyone else that started with a lower figure.
- [04:18]
Brett Schaefer
I bet that was just mainly his own money given that he worked 20 years in the venture capital world. It was in 2007, so in today's dollar is a little bit more. But yeah, that's a small one. And as we could see here, it seems like he was financially free, flexible, didn't have to really work and do this to make a living. I'm sure him and his family were quite comfortable after two decades in the VC world. So as you're about to say here, he really just wanted to get his track record public and prove that he could do this.
- [04:48]
Ryan Henderson
Yeah, he said that impetus or the reasoning behind starting this was to formalize his track record as an investor. And this was designed as a fund specifically for family and friends. However, today Valley Forge Capital management has roughly $5 billion in total assets. So he has gone from 300,000 to 5 billion in total assets in the span of, I guess that's about 18 years. Now. We don't have all his history because when you have a fund of 300,000 in AUM, you don't have to file a 13F. So we don't have all his records for Valley Forge. But the reason I talk about all this background is because it's so bizarre given what his portfolio looks like today. So I'm going to breath sharing the screen here, but 31% of the portfolio is in FICO, 26% is in S&P Global 13 or I, I believe no, 18% is MasterCard, Moody's, 15%, Visa 7%. Basically it's all he. He majored in biology, graduated from Harvard Medical School and spent two decades studying, analyzing and being a part of early stage healthcare companies. But instead of leveraging that domain expertise, Kantessaria seems to own exclusively large cap wide moat established businesses.
- [06:12]
Brett Schaefer
So he hates biotech.
- [06:14]
Ryan Henderson
Yeah, he just, he's. I guess maybe it's scars from 20 years of being in that world, knows.
- [06:21]
Brett Schaefer
How hard it is, I guess. Yeah.
- [06:23]
Ryan Henderson
While he was working in the VC world, he says he studied the models of many great investors and the one that ultimately resonated with him most was that of Buffett Munger. So here's a quote he said, I've studied a lot of playbooks over the years starting at age 8, and the one that resonated with me the strongest was the Buffett Munger playbook, which is to focus on business quality. And as Brett's going to talk about here in a second, a core component of Cantas Aria's approach is low turnover and not really trading in and out of positions that much. This is something that he has espoused and practiced, I believe, since the beginning of Valley Forge. And in an interview he sort of alluded to the idea that this cautious, not so active approach has been something he's had for a long time and sort of born with. So here's one more quote from him before I pass it back over to you, Brett. He says, I think there is a genetic component of just how someone is built from day one. I also have noticed a pattern that some of the great investors throughout history come from very frugal environments. Seeing your parents be careful, buying groceries, buying a car or buying a house brings a certain caution and carefulness to investing. In terms of your personality, I think it's kind of an interesting insight and I probably agree. If you grow up with parents who are extremely risk tolerant and it works out for them as a kid, I imagine you think, oh, I can take big bets. What's the worst that can happen? And on the flip side, you see them discerning over each dollar. It kind of builds that value investing mindset. Like how much am I actually getting for this dollar from an early age?
- [07:59]
Brett Schaefer
Yeah. And it comes down to another stuff he has said in his brief public appearances that temperament, emotional stability and all those other psychological factors are something you are either born with or not that can serve you as an investor. And if you don't have those, you probably shouldn't be an active investor. And that's why so many out there struggle that try this but let's move on to his investing philosophy. They're very secretive as a fund. Well, not very secretive, they're fairly secretive. They don't really have many public facing letters and publications. I know there's been reference of them before but I couldn't really find them. He's done Kantessaria a few podcast and media interviews over the years. If you want to add another one dev, come right on this show. You have an open invitation. And he also has a few vague quotes on the website and 13F filings. This is really the only material we have to analyze his investments style. But what we thought to do through this episode is take some of his long running investments and use them as case studies. But I'll go through this investing philosophy first. Their mission on the website, taken directly from the front page here is quote Our mission is to significantly grow the buying power of our investors. We seek to outperform relevant equity benchmarks over the long term using a bottom up fundamental approach executed in a disciplined and consistent manner. Pretty simple there, and that's extremely vague. Just the first thing someone might read when reading that website. Their bottoms up fundamental approach. No technical analysis, no macroeconomic stuff. They're not top down like a Druckenmiller Soros what have you. And then if we go to their website's philosophy tab, they have a grand total of only six, which you can easily count. Short paragraphs that are only a couple of sentences describing their investment style which we can sum up as finding businesses with strong organic growth, predictable earnings, capital efficiency and prudent management. Finding industry leaders focusing on compounding machines and ignoring cigar butts. Cigar butts being like deep value plays in the Buffet ism there. Analyzing companies over a multi year time frame to look beyond the current quarter, concentrating heavily in your best ideas and managing risk through through business quality, buying at a margin of safety and using minimal leverage while maintaining a liquid portfolio. So there's a lot there. Some of that self explanatory. As an aside though, Ryan I thought this was interesting. He said that they are long biased and minimal leverage, which means maybe that they short a little bit and use margin. Or maybe they just say that to have an option. I thought that was interesting, but we look at the sections above. We'll go through some of this other stuff in other sections as well in the podcast here. Margin of safety Pretty easy to understand. You don't overpay for a stock. You don't pay a hundred times sales no matter how good the business is. Having a long term time horizon of a decade or longer can help you have an edge over the people focused on the next quarter that's self explanatory and then concentrating your ideas is self evident in that portfolio construction with about three 5 to 10 stocks as your best ideas.
- [11:08]
Ryan Henderson
Yeah, I find that I saw that same terminology in some of his work where he's long biased minimal leverage or I've seen him say like mostly long only. I don't know if that's necessarily just a protection so that he doesn't have to pigeon himself pigeonhole himself like you never want to. If you're a fund, you want to have the option of investing in whatever you find attractive while still kind of having a theme to your investment philosophy, which in this case is long only or long biased I should say, and high quality companies. But it kind of gives him the out if he ever does want to make a separate investment. The other part, which would make sense but I haven't seen in any of his 13 Fs is if you are buying these compounding machines selling puts I believe. Sorry, I'm getting my options right in my head. Selling puts could be a viable strategy potentially if you're open to buying them at a lower price and you are very confident in the business quality.
- [12:10]
Brett Schaefer
Yeah, that's true. We don't know exactly what is happening here. 13 Fs are not comprehensive from portfolio trades. We don't have international. We'd have shorting, we would have options. So maybe we would have seen that there, but I'm not sure if it's only buying or selling. Irregardless, what we want to talk about here is what Kantessaria and Valley Forge means by owning the best businesses in the world and what he calls a great compounding machine. I made a couple of care a list here that will include in the newsletter with this episode, but I kind of came up with four and maybe if Ryan, if I'm missing something, you can add some at the end here. First is finding the perfect intersection between growth and predictability. So you want something with through either market share gains, overall industry tailwinds, pricing power that this business can keep growing and keep growing at a quick pace for A long period of time. Uses an anti example in one of his interviews as a Hershey or Nestle being something that's low growth but on the other hand is something that is predictable which means you can have confidence that the business will still be a leader in its sector five to ten years from now. He uses a lot of technology companies as examples of fast growers, not predictable than a lot of consumer staples companies. Use the Hershey and Nestle example, predictable but not fast growing. He's looking for that intersection where a few stocks out there have fast growth and predictability, then even fewer are going to have both and trade at a reasonable price. The second one he's looking for is a durable industry dynamics which also relates to predictability. He said, quote we like to buy things where the industry dynamics and the business model have already been seen successful. So you're not starting a new industry from scratch. People have wanted and used this service or product for many, many years, likely decades. I think that one makes sense because if you're going to hold something for a long time, you can have that Lindy effect strategy where you don't know if this industry is just going to disappear on its own and that would totally ruin some business. Third one here is finding buying opportunities. Quote when we enter the business, I would say one third of the time it's because the stock is significantly dropped and there's a misunderstanding about an issue and we disag with how the rest of the world is thinking about the company two thirds of the time. Surprisingly the opportunities we find are what I call market neglect. And this is what happened with FICO six years ago. So he says they find buying opportunities for these great compounders because of a news or narrative out there that is wrong about the stock. This could have been the rating agencies in 2009, 2010, probably Visa and MasterCard 2011 time period when they got cheap. Although I don't know exactly when he entered those positions. Or the market just forgets about a high quality company because they've been boring. Maybe lower growth, maybe something has changed. Not many people are appreciating it and people just ignore it because nothing exciting has changed. But it's still a wonderful business now. Last one here I have is business model characteristics characteristics. He's looking for capital and asset light meaning the business does not need to take a ton of new capital to grow organically. Second, reinforcing competitive advantages. Third, pricing power and fourth, operating as a small but extremely valuable part in the overall industry supply chain. So all those connect Together, you know, competitive advantages, pricing power, small part of the supply chain all leads to, you know, earnings growth, free cash flow, growth, cash flow accumulating on the balance sheet. Ryan, we're going to go through his portfolio analytics and statistics. But before we do anything to add from your research on his investing philosophy.
- [15:52]
Ryan Henderson
No, I actually like how sort of narrow his focus is. And there's I think a quote out there. I can't remember what interview it's from. I don't have it in front of me. But he basically says our fishing pond for companies is 50 companies in the world. That's kind of the pond he fishes in. He's determined their quality, he likes them, he's waiting for the right price. But he doesn't think there are that many, that many businesses out there that are that fit those characteristics that, Brett, you just talked about in terms of durability, either monopoly or duopoly or sometimes an oligopoly. And we're going to talk about here in a little bit, pricing power as well. So those characteristics. I kind of like the narrow focus. It's nice to see such a. I feel like so often I've been looking at great investors lately and you kind of see a ton of big tech, especially as funds grow or just kind of quite, quite a diversity in terms of the stocks that people buy. With Dev Cantosari's portfolio, it's very focused around a certain theme which we're going to talk about here in a second.
- [17:05]
Brett Schaefer
Yep. And as a tease to listen to the whole episode, we do have a quote from him regarding the big technology companies and artificial intelligence that we're going to probably do either. If it doesn't fit anymore in the episode, we'll do it at the end during our takeaways. If you are serious about investing, you need to consider interactive Brokers. I've said this before and I'll say it again, the number one reason I use interactive brokers is because they do not cut corners. IBKR gives investors powerful capabilities that make a difference in the long run. For example, they offer margin rates up to 53% lower than the industry. They provide up to 3.83% interest on instantly available cash. They allow you to easily make extra income on your fully paid shares of stock held in your account through their stock Yield Enhancement program, plus much more. We considered a number of different brokerage platforms when we were deciding who to trade through here at Chit Chat Stocks. And all in all, Interactive Brokers was the clear choice. Head on over to ibkr.com.com restrictions apply. Interactive Brokers is a member of sipc.
- [18:15]
Ryan Henderson
Okay, let me go through some of his current portfolio analytics slash statistics. So I mentioned it a second ago. There's a pretty obvious recurring theme when you look at his portfolio. So let me first go through some of the statistics of his business or, sorry, his portfolio. So the weighted average market cap. These are all the weighted average statistics of his portfolio. Quick shout out to fiscal AI. I basically I used them to look at Dev Cantasari's portfolio. I plugged all the companies into a dashboard and then it gave me the weighted average statistics of his of the companies in his portfolio. So market cap $237 billion. So yes, he's skewing very large. He looks at primarily large cap companies. Operating margin average was 47%, which is that I think tells you a lot. These are very much either monopolies, duopolies, or the leaders in their industries. And they're able to sustain significantly high, really high operating margins because 47% on average is incredible. The revenue annual growth rate is 10.6% on average over the last 10 years. I think that's also. Not only does that say, hey, this, these are businesses that can grow, but they're not growing at absurd rates. It's not like these are businesses hitting inflection point. It's just a durable, above average growth. And the other part here. So I said 10.6% revenue growth. EBIT growth has been 13.8%. So you've had gradual margin expansion across the companies in his portfolio for the last decade. And he actually talks about that, like all the businesses he owns, he owns because he thinks there will be margin expansion from here. And he said that publicly in interviews as well. And then return on Invested capital is 28%, return on assets, 21% across the whole portfolio. So he really focuses on companies with low capital requirements. And I've got some stats to explain that. So I'm going to use capital expenditures as a percentage of operating cash flow. So this is basically the operating cash in their business that gets reinvested into purchases of physical goods. FICO 1% S&P Global 3% MasterCard 2% Moody's. This one kind of surprised me. 11% Visa 6% Intuit 2%. They're all extremely low. MSCI 3% ASML, which you think is very capital intensive. Actually only had 17%, which was a little lower than I was expecting. And then Equifax was surprisingly 34%. There can be some variability in that figure, especially if There's a low operating cash flow year. But to put these numbers in perspective, a company like Meta who has been investing a lot into AI and CapEx lately spends half of their operating cash flow on CapEx or they have over the last 12 months. So these are very, very capital light businesses. And when you look out across the whole investable universe, the companies in Dev Cantissare's portfolio have a unique ability to grow naturally that is without the need for real investment. And in this case we're looking at specifically the capex to operating cash flow which shows you how little money they need to spend on on physical investments in order to grow. But it doesn't stop there. If you look at most of these businesses they could also turn off their some of their non capex expenses and still grow. So for example, if FICO reduced its R and D budget this year, it's research and development which is not capex.
- [22:14]
Brett Schaefer
Right.
- [22:15]
Ryan Henderson
It's expensed, it's, it's on the income statement. If they reduce that, would it really have any impact on their revenue growth for the year? I doubt it. These are companies that just don't need a whole lot of incremental investment in order to grow.
- [22:31]
Brett Schaefer
Yeah, I agree but fico's margin is so high already it's not going to have that much of an impact going forward. But that's just because this business model as we'll get into has even higher profit margins than Visa or MasterCard. The most, I think enlightening part of looking at Cantissaria's portfolio is that operating margin of 47% that is way above the market average which I think is 10 to 15%. Something in that range, maybe higher for operating. But either way 47% is best in class, better than probably Microsoft, Adobe, some of the top software businesses out there. These are the elite capital light business models in the world. That's what he's searching for. So when he buys something as we'll get into later, that could be an indicator that there is an opportunity for long term investors. Especially because of his holding period which he hopes to have as forever.
- [23:32]
Ryan Henderson
Yeah, and I find it amazing to think he targets companies that he thinks will have expanding margins and these companies already have high margins to begin with like S and P Global a decade ago had pretty high operating margins. But you look out and I just gave you the portfolio average statistics there margins or sorry earnings have outpaced revenue growth on average they have. He has had margin expansion across the portfolio despite buying businesses where you look at Them and you say, okay, it's already got 30, 40% operating margins. How much more can these things grow? It's gradual, but they're still able to have earnings growth outpace sales growth. One more quote on the types of businesses that Cantissaria actively looks for and then I'll pass it to you, Brett, for a case study. Our first case study for the day. So here's a quote. We like companies that have operating leverage whose margins go up over time. So we own companies that have significant market caps, 50 billion, 100 billion, and they still have the potential to grow margin significantly. We, we like businesses that are capital light. So we don't like businesses where you have to invest a lot in fixed costs. We avoid companies that have high R and D risk. So if you have to invest a billion dollars to find the next blockbuster drug, that's not the type of return on investment that's predictable for us. So there is no right way to screen for these types of companies. We're going to talk about our first case study now here in a second, but any thoughts on that quote, Brett?
- [25:05]
Brett Schaefer
I like it. I like the ability or the, not the ability, that's the wrong term. The thought that accompanies qualities you don't need to screen for and that gives you an advantage over everyone that's using screeners. Although I still like using a screener now and now and again. But I'm not the exact same investor as Cantasaria. The capital light part is interesting because a lot of people use capital intensive businesses as okay, we invested so much and now we have a moat because we have economies of scale. But if you say we want wide moat pricing power plus capital light, that actually has a very small Venn diagram overlap and you're only going to get into, as I'll segue into our next section here, something like Fair, Isaac Corporation, Visa, MasterCard, S&P Global or Moody's and a couple other companies out there.
- [25:56]
Ryan Henderson
Yeah, it's a good point. They're, they're just really, in general, I would say capital intensity. Like you look at Amazon, the fulfillment network that they've built. That is a, that is a moat.
- [26:09]
Brett Schaefer
It's not exclusively the money Candace already has owned Amazon. It was there, yes, his exception to the rule.
- [26:15]
Ryan Henderson
But. So there are probably more companies that have built up physical advantages that you could call a moat. But when you find those companies that are capital light and don't require significant investment in order to sustain their moat, like some of the companies we're about to talk about it. Really. It can be such a gem when it comes to investment returns. So let's talk about the first case study here. Fair Isaac Corporation. When did he buy it? What have the returns been like for him and why did it work out so well for him?
- [26:48]
Brett Schaefer
All right, let's tease this and hopefully make it interesting for people. Again. This is fico which does FICO scores people might know about. As of last quarter, Fair Isaac Corporation or what I'll just call FICO was over 30% of Valley Forge's portfolio. But it would be even larger if FICO did not suffer a 40 to drawdown this year. I think that is a great testament to letting your winners ride. Another lesson that we've learned time and time again from the super investors. When you have a big winner, usually that should tell you that you should just keep holding and holding and holding. Now Valley forge first bought FICO, I believe in Q2 of 2018 and they have re upped the position along the way. I think an interesting addition would be in Q4, 2021. This is actually when the upstart hype was the highest which was a supposedly going to be a competitor to fico. And that was a time when FICO was added to the Valley Forge portfolio. Other stocks were dropped because if you look at 13Fs, you know a lot of new buys, if everything's being bought or you know stuff's not being stuff's being bought while their stocks are not being bought or sold. You may have just looked at redemptions or additions from investors that are actually you on investment decision from the company. It could just be okay, well buy equally across the portfolio. Now if stocks are bought and sold along with or not along with every other position, that could be an indicator for someone like Candace Ari who's a buy and hold investor that they're bullish on the company at the moment. So let's go through the stats. From May 1, 2018 to today, FICO has produced a cumulative total return of 694% versus 171% versus the S&P 500. And if we go back to to Q4 2021, similar outperformance 240% versus 46% for the S&P 500. If we estimate his purchase as Q2 of 2018 through to today, FICO has produced an annualized total return of approximately 33%. Absolutely crushing the market. Clearly it's been a big winner for them. But what attracted FICO to Cantissare in 2018 and what can we learn from it? Cantisaria says he is looking, as we talked about, above, the best business models in the world and buying them at an attractive price. Verizon Corporation and its FICO scores are the standard for financial institutions. To determine creditworthiness without going deep into the business model, FICO essentially builds its scoring model and sells it to institutions who then pay the business a fee every time the model is run. For example, it currently charges $4.95 for a mortgage origination. Now, building and maintaining the FICO model has some upfront cost, but selling an additional FICO score along with any price increase on the existing volume comes with 95% incremental margins and zero capital requirements. This is lesson number one, I would say in a good business model, operating leverage with minimal capital requirements, something we've talked about already in this episode. In 2013, Figo had $181 million from its scores business with a 72% operating margin. Last 12 months, this division did $1.1 billion in revenue with an 88 million 8% operating margin, perhaps the highest I've ever seen for an individual business. This led to a 19% compound annual growth rate in operating income for the Scores Business Capital Light high incremental margins. Very attractive because it can lead to consistent cash flow accumulating on the balance sheet. Our second lesson is one that our listeners will know very well. Sorry Ryan, before we get to the second one, you have something to add there?
- [30:24]
Ryan Henderson
Yeah, that is the most profitable segment of any public company I've ever seen. There's and we're going to talk about S and P Global here in a second. Their Indices business is very profitable, but 88% operating margins is insane. That is by far I can't think of anything that comes close and that's.
- [30:48]
Brett Schaefer
Why Kansas area likes it so well. There's other characteristics that lead to that margin, but let's talk about those now. Reinforcing competitive advantages. FICO has a growing network effect that entrenches the Scores business. Everyone in the credit world, from lenders to consumers, uses the FICO score, making it a standard of pricing, at least in the United States. It becomes more valuable for everyone when it is the standard of doing business. There are also switching costs. If you decide to switch from the FICO score on pricing alone, it requires reworking your entire lending operation and helping everyone else in your value chain. Use a different scoring approach. Plus others will trust your loan less, giving you a literal increase in underwriting costs by switching. Similar to the ratings agencies, FICO has a strong brand that has built up for the over the decades by making it the default choice anyone can pull to see what their credit worthiness is at any one time. All listeners here, I think will know what a FICO score is, at least any listener in the United States. Nobody has heard of the Vantage score. Ryan, do you know what the Mantis score is?
- [31:49]
Ryan Henderson
I feel like I've heard of it just because I've studied FICO before. But.
- [31:52]
Brett Schaefer
But if I would not have heard of it if I didn't study FICO even briefly, it's not known. People know, hey look, what's your credit score? That's synonymous with what's your FICO score. Now lastly, FICO literally was entrenched by the regulators. I'm using this properly. I'm using the term literally properly. Literally was entrenched by the regulators in 1995 when Fannie Mae and Freddie Mac made it required on all mortgage loans. That's nice. That's very nice for your business. It makes it highly predictable. All this led Cantissari to identify FICO as a strong business, but the cherry on top was the fact that FICO had not raised prices for 25 years prior to 2016. Since then, that has changed and that's why they bought the stock in 2015. It's a lesson in untapped pricing power. On a podcast, Kentosari said that FICO could increase its pricing by 10x and it would still be a high value to mortgage loan loans relative to the cost. Well, they almost did that by hiking prices from $1 to $4.95 today. Even so, about $5 on a mortgage loan that could be worth $1 million or even higher is not going to materially impact any part of that transaction. Even if it was $20, that would still be the case. I think this is lesson number four that we can relate back to that I mentioned earlier. Positioned as a small but vital part in the value chain, Kantosari essentially saw that FICO was finally going to flex its pricing power muscle and bought the stock. If we look back though, at 2018, it was not an optically cheap security. It had an EB to EBIT of 30. Today it's actually 39.4, so getting much cheaper. It did zoom up to 80 earlier this year in late 2024, but overall profitability was hindered by investments into FICO's new software business, bringing operating margin down for years. Even though the FICO scores business was humming along and was about to see huge growth because of the price increases after the software business began to scale and price increases were implemented before FICO scores operating margin has started to climb higher and it's gone up around three times since 2018. I think this is another bonus lesson as Ryan's sharing the chart there from fiscal AI use our link and get 15% off any paid plan. This is a bonus lesson in stock valuation finding a company with masked underlying profitability. Any examples come to mind for you in other kind of lessons in mass profitability? Amazon is the famous one, maybe Netflix, although that was not, that was earlier days. What about anything come to mind for you Ryan?
- [34:38]
Ryan Henderson
Not of this magnitude like this is such a unique case because there was a contract expiration if I'm not mistaken, that allowed them to unlock basically they were able to go back and make up for 20 years of negligible or maybe even no price increases at all and they made up for it in the span of like two or three years with increasing prices like 6x. So I've never seen a company go from 11% operating margins to 38% in two years. But yes, Amazon's probably a good example of a company that continuously masks its real earnings power. Trying to think of other ones I.
- [35:31]
Brett Schaefer
Think easier kind of. Well yeah, I think more lessons are not necessarily masked profitability but we're just going from maybe slightly unprofitable to break even to having that profit inflection where it's not like oh people think the business should have a 20% margin but it actually could be 50. It's that people don't even believe it's actually profitable. I think that's a similar lesson, one that we use a lot. But maybe Cantissaria is a little bit different. He's looking for these situations where operating margin can people think it's a great business but it's even better.
- [36:04]
Ryan Henderson
Yeah, this one is such a one off because of the 2018, 2019 event. But there are a lot of companies where sort of the good company bad company situation where it's like there's a really good subsidiary that's growing really quickly and is going to and maybe has better operating margins. So maybe Philip Morris for example, who already has really good profit margins on their core cigarettes business, they have even better operating margins on their not not renewables but reduced risk products. So iqos and Zyn, that's kind of when where the new age products help the operating margins expand without actually seeing too much of margin expansion in the core business. Sometimes we see situations like that, but those are a Little more gradual than what we saw with fico.
- [36:56]
Brett Schaefer
All right, last thing on FICO as a kicker, they were a serial and are a serial repurchaser of stock. It shares of outstanding have fallen at a 4.8% annual rate since 2005 or a cumulative drop of 62%. So in summary, Kanchasari saw a great business model, untapped pricing power, misunderstood valuation and a management team buying back stock. This is the type of situation where you get into a never sell investment and that is what you dream of finding maybe once a decade as an investor. Now Ryan here, let's go to one of the earliest investments for Valley Forge was said to have been bought in 2009 during the Great financial crisis according to his interviews. But we don't have 13 Fs only going back to 2016. So if you look at the 13 F, it's going to say 2016, but he was investing much earlier. It is S and P Global. Ryan, take us through this case study in one of the longest running holdings of the Valley Forge Fund.
- [37:56]
Ryan Henderson
All right folks, if you are a regular listener to Chit chat stocks, then you know that we use Fiscal AI formerly known as FinChat daily. Fiscal AI is our complete stock research terminal. It's where we have our investment dashboards, it's where we create financial charts. It's where I read all the transcripts for conference calls, sell side events, shareholder meetings. And it has Morningstar's high quality reports on more than 1700 companies. It really is the complete research platform for stock focused investors. If you use our link Fiscal AI Chit Chat, you will automatically get two weeks of Fiscal Pro for free. And if you find that it's worth upgrading, which I think you will, you'll get 15 off any paid plans with our link. Again, that is fiscal AI chitchat. The link will be in the show notes. Yeah. So quick one liner on S and P Global for those totally unfamiliar. S and P Global is one of the leading credit credit ratings agencies and they also sell a variety of different financial data software services. Today, software is actually the largest revenue contributor, but throughout most of its history, the credit ratings has really been what drove the business. So you mentioned it. Kantessaria first started buying S and P Low S and P Global in 20082009 time frame following the fallout of the great financial crisis. At the time, S and P was undergoing a ton of pressure and I think most people would argue rightfully so for its misleading ratings on mortgage backed securities and maybe some I don't Know if collusion is the right word, but.
- [39:37]
Brett Schaefer
Yeah, that's probably the right word.
- [39:39]
Ryan Henderson
Collusion in the industry as well. Not only were they suffering from the broad market sell off and just generally weak investor sentiment, but investors were worried because Congress was considering making some structural changes to the industry overall. Not to mention revenue had fallen off a cliff for S and P Global. So just this like triple whammy effect. And as you can imagine, this led to a major sell off in the shares. At its worst during the great financial crisis, S and P Global dropped 75% from its highs and was trading at a single digit trough trailing earnings multiple. So very cheap. Obviously there was a lot of uncertainty around the business at the time. But here's what Cantasaria was thinking. He says beyond the noise, these companies, he's referring to S and P and Moody's. These companies had among the best business models in the world. Rating debt. An issuer could try to use another rating service, but would have to pay 30 or 50 basis points more in interest rates. Effectively, there is no way to undercut Moody's or S and P on price. And because no one can really compete with them, Moody's and S and P raise their prices pretty much every year at slightly above inflation, whatever rate that is. So if they want to, if inflation jumps 10%, Moody's and S&P can raise their rates 13%. If inflation's 2%, they can raise it 4%. They basically can do what they want because the cost of paying 30 or 50 basis points more in interest rates is way more expensive than just getting the your debt rated by S and P or Moody's or whatever that fixed fee is the willingness to bet on these businesses at arguably their most difficult period ever paid off. So S&P's revenue has grown by 10% annually since 2010 and operating margins have expanded from 28% to 40% over that time frame. This has been a recipe for fantastic returns. As you can probably imagine, S and P Global is now more than a 40 bagger off of its 2008 lows and Cantos. Arya initially bought shares at $17.50. Today shares stand at around $550. So his return specifically would have been a 30 bagger off of that initial purchase. However, his returns are probably a bit lower because his that 1750 was his initial cost, but that is far from his cost basis. So he's probably bought. I mean he has added more shares over the years. You can another shout out to Fiscal AI here. If you're on Dev Cantosaria's page, you can go over to companies, you can hit S P Global and you can see how many shares he's owned over time. And in 2016 he owned 300,000 shares. Today he owns over 2 million. So he's been buying on the way up over time as well. For most, this kind of is a separate thing that we should talk about. But and and you we're going to talk about his returns in a second and it plays into it. But for most fund managers the capital raising process is kind of counterproductive because the easiest time to raise money is when the fund has been doing really well. But when the fund has been doing really well, that also coincides often with lower future returns assuming you own the same companies. However, when you are buying these compounding machines that have such unstoppable pricing power like S P Ratings Business or FICO Scores Business, the growth is so durable over 5 to 10 year time frame that most days are a good day to buy shares. So timing doesn't matter quite as much in my opinion on a company like this. Now you can Cherry Pick individual 5 year periods where it may have underperformed, but on average, if you would have bought S P Global probably any day between 2010 and 2015, you probably would have had pretty dang good returns by 2020 or by today. So that is just to say the capital raising process maybe doesn't affect Dev Cantosaria as much as it would a.
- [44:12]
CD Lamb
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- [44:46]
Ryan Henderson
So you're about to make a trade based on a friend's text, but which you do you listen to is it we could buy a house in Tulum.
- [44:56]
Get optioning those options.
- [45:00]
We could lose everything. Or let's do a little research, get your head in the trade and make the investment decision that's right for you. Learn more@finra.org TradeSmart yeah, perhaps.
- [45:16]
Brett Schaefer
Sorry to read through the tea leaves sometimes, but that is something that can affect them. Let's estimate its forward returns according to a Barron's article Valley Forge has compounded at around 15% annually since 2007. This compares to a total return around 10 to 11% for the S&P 500. While this is great performance that puts value forging, you know, on the 99th percentile of active management. I was expecting better returns, frankly, given what is in the portfolio. You know, you have Fair, Isaac Corporation FICO annual total return 33 since he's bought in just 2018. S P Global 24 MasterCard 20 probably along with Visa around when they bought. Really there's a lot of different periods you could have bought Visa MasterCard to get 20% except for the last few years it's been a bit lower. Moody's would have been to be 22% if they bought around the same time as S P Global. So this makes up the majority of the portfolio and has for years. Even if you bought some of these companies later than that initial period when he just had a little bit of Aum, you would have done well. And it seems like, you know, even if we look at Fico, when he loaded up in 2021, the returns there were, you know, above this 15 level. So I'm kind of keeping curious. What do you think is brought his performance down to only 15% a year instead of that Buffett level? Two decades of 20% compounding which Buffett is 60 years, I think, but most people can't do more than 10.
- [46:47]
Ryan Henderson
Yeah, I think a lot of it, a good chunk of it probably just has to do with capital inflows, the fund growing and him having to pay like him having to raise his cost basis. So maybe the annual returns for those early investors is closer to that 25, 30% mark. But for if they got a whole bunch of money in 2020 and Visa and MasterCard made up a good chunk of the portfolio, potentially there might have been some underperformance there. So I do think big capital inflows are going to affect the total annual return, especially when it's coming off the back of him of good performance. Does that make sense?
- [47:35]
Brett Schaefer
Yeah, I think that could it. Some of it just seems way worse than it should be. Even with that. Maybe there's. There's, you know, not everything's a home run. He invested in Adobe and Autodesk, which were losers Amazon is investing in, which I think would have been a winner looking at his 13 Fs. But. But perhaps there was some companies that weren't. You know, not everything can be a winner, so that could be dragging down returns. Hard to tell though. Hard to tell. Though maybe there's a larger cash position than we think. When new investors come in, they're waiting for a few years. But I would think given the stocks here and the multiple expansion enjoyed by these type of companies, that it would be better than 15%.
- [48:19]
Ryan Henderson
Do you know what the fee structure is?
- [48:22]
Brett Schaefer
No clue. No clue.
- [48:24]
Ryan Henderson
It's not maybe that 15% was net fees.
- [48:27]
Brett Schaefer
Yeah, maybe gross is 20 to 25%. Either way, 15% for any investor, any outside investor is quite good. Now one thing to add here, I think a fun thing for the podcast is what is he buying now? Since 2023 he has purchased ASML Equifax, which is actually a customer of fico, one of the credit bureaus, and msci, which Ryan knows better than me and I know ASML a little bit though. What are your thoughts on these purchases? Do you think this is an indicator for investors, given his long term time horizon, that these are potential buys or something to add to the watch list?
- [49:10]
Ryan Henderson
Yeah, I find the ASML transaction probably the most interesting of them all. So I believe he doubled his position in ASML at some point in the last. Yeah, it looks like four quarters ago he doubled the amount of shares he owned. Hasn't done much with it since, but it's for someone who does so little like management of his positions. So for example, FICO has dropped like 40% or something in the last couple of months around basically pressure from politicians that they need to stop raising prices as much as they are. He, as of his latest quarterly update, has not added any shares to it whatsoever. He actually didn't add to anything. From what I can see, he only sold some shares of Intuit. So ASML is one of his biggest recent additions. I really like that. And the other part that I find interesting is it's sort of not his typical bread and butter. I think his bread and butter is like software and financial services where there's just so little cost required to grow. ASML obviously has big machinery and there is going to be some level of capital expenditures, although it's lower than I thought. So that one probably interests me the most. MSCI as well. That's kind of more a traditional pick I'd call it for him. But it kind of weirds me out that that's a business that's totally in his wheelhouse. Super Capital Light Financial Services embedded in the financial industry and it's such a small percentage of his portfolio.
- [50:58]
Brett Schaefer
Yeah, I agree. Maybe just waiting for a better price, something like that. Maybe they got there. Yeah, earlier this year. Could have been not that bad. Looking at the valuation here, I agree on ASML though. It's got a lot of pricing power Monopoly player and it's a small but valuable part in a giant supply chain. We have two sections left to tease the listeners to listen to the whole thing. Our takeaways from studying Kantosaria and I think to close out a quote that I thought was quite provocative from him in December 2024 on investing in AI Ryan, why don't you go first? What were your takeaways from studying Cantos?
- [51:36]
Ryan Henderson
Ari yeah, I've got a couple and he's a really fun investor to look at just because the unique focus on certain companies but so the first one is even in slow growing industries, monopolies or duopolies tend to deliver double digit annual earnings growth usually due to pricing power. So you can as mature as a business might feel say you're looking at the Moody's or the S P Globals of the world or MSCI companies like that. It can feel so mature like I'm already I'm buying a 200 billion dollar business. Like how much can it grow? When you're a monopoly or duopoly you've got the ability typically to grow at an above market rate. Second one often the best action is inaction. So he does so little with his portfolio that but yet he still produced 15% annualized returns. And my note here is either if you are buying what you consider these compounding machines and that's not the only type of company I'm looking for in my own investment strategy. But if, if it is, if I group a company into sort of that bucket like this is a compounding machine, I want to own it for a long time. Oftentimes the best thing to do is just nothing or maybe just buy more if if you get a big stock drop over controversial news. And the other part is he doesn't really implement this because he has more money coming in each, you know, with new investors and such. But it kind of goes back to I think it's like the Munger quote which is like be I'm going to botch the quote. So I'll just paraphrase be valuation disciplined on entry price but be valuation lenient while you own the security. That's kind of the approach I think is worth taking. Like be opportunistic, wait for a good price to get into it but then be willing to let it run even if the valuation starts to get a little stretched. I think Munger says it's like picking A wife like you need to have, you need to be as aware as you can be of all the flaws before getting married. But after you're married, you can just squint through them. A couple other ones I'll mention here. Pricing power is so helpful. He has a quote here. Pricing power is the hallmark of a great business. If you can raise your prices above the rate of inflation consistently, you have a phenomenal business model. I think that kind of speaks for itself. And then the last one, this is sort of a Investment approach type 1. Be a quote, business historian. He kind of describes himself as that. Like he's trying to be a business historian. He's going all the way back. When you know the history of a business, you know the difficult periods that it's been through, it makes it easier to weather the next storm. So I think that can be a really helpful thing to do for me personally is when I'm looking at an investment, go all the way back, go back to the founding, go back to some of the difficult periods, see if there's any standout things that happened and kind of how they weathered that or how they managed. And it can be useful when stuff in that inevitably hits the fan in the future at some point.
- [55:00]
Brett Schaefer
Okay, my lessons were pricing power. But to add on there untapped pricing power that can lead to predictability, weathering inflation. He uses something that we use specifically for restaurants or retail operations before, but can be applied to all businesses, which is you need to have a very easy time matching or raising prices or just raising your revenue overall. If it's a slightly different business model to counteract potentially inflationary input costs, which has been a huge lesson that investors maybe are learning the hard way over the last five years. So having that pricing power, untapped pricing power, or just a business model that allows you to grow along with inflation, which a lot of this business. The businesses he owns are Visa, MasterCard, S&P Global and Moody's. Can I account for there? Because the larger the debt, you know, expansion goes, the more that those ones are going to take their fee off of everything. Another one is just letting your winners ride and letting it become a huge percentage of your portfolio. And even if, for example, FICO, I think it was for probably 40% of his portfolio or not, if not larger, even if it was priced to perfection, 89 times the earnings and it has a drawdown, you still have great returns. It went from 90 times earnings down to 40 times earnings. And the company has still been a great investment for him. Now he trimmed along the way. And I think if it got to a what we might call the Palantir level earnings ratio of 200, 300, 400 times earnings that has gotten a few companies to extreme levels in recent years, I would be interested to see what he would have done with fico. But even a company you know that good, you have, you have the tax hit, what you're going to invest in, stuff like that, even if it's at 80 times earnings, that is an extreme price to pay. But as Ryan talked about, you can have discipline on the buy price, but lethargy wiggle room on that sell price. And extreme wiggle room can help because will FICO be higher than its near term peak before this huge drawdown in 20 years? I think probably. But the returns from 90 times earnings aren't going to be that great. But from Cantos Aria's buy price, they'll probably still be fantastic. All right, you want to talk his quote on AI to scare investors? Ryan?
- [57:33]
Ryan Henderson
Sure, let's do it.
- [57:35]
Brett Schaefer
Okay, so this is from the investors podcast. He was actually on that show in December 2024. So if you want to hear it from the horse's mouth, go listen to that show. You'll be able to find it quite easily if you search either Google or the podcast players. Just search his name, you'll be able to find it. It's a long quote, but I'll read it and we can react to it. Quote, big tech, they are above quality business models. Google search is an amazing business model and a high has given the big tech companies another growth driver for the next few years. So I expect the Nvidias and the Googles and the Microsofts and the Amazons of the world to do well for the next few years. The concern is that I have is what happens in after that. And it's our view that AI becomes commoditized and then it becomes difficult for these companies to monetize their AI offerings. We can see today that in terms of R and D expenses and capital expenditures, these are going up exponentially because these companies are fighting each other ruthlessly to stay ahead of the others. So a few years out and if an off the shelf AI program can do 98% of all the tasks, the human tasks in the world, how do you differentiate yourself? How do you monetize that? And so as we look at five years from now, seven years from now, 10 years from now, it's very difficult to know who the winners will be in AI from both the hardware perspective and the software perspective. So we can argue with what they've been able to deliver and the earnings they've been able to produce. I think that the transition was off there. There will be a bad ending. Here's kind of continuing the quote. There will be a bad ending for most people because it's very hard to predict the one or two companies that are the real winners here. Thoughts? Ryan? As I catch my breath, I don't.
- [59:14]
Ryan Henderson
Know if I agree with all that. I certainly don't think I agree with the there's going to be an off the Shelf AI program that can do 98% of all tasks. The other part that's important here with all these businesses, Microsoft, Google, Amazon, those three specifically, I can tell you they're going to be winners from AI spending because the benefits it'll produce for their cloud businesses. But the other part is they have moats in other ways. So yes, there could be sort of a bubble in the spending and maybe the return on invested capital is not as high as people are projecting. But it's not like they're, it's. They're all going to become commoditized businesses like Microsoft is deeply embedded within the business world. I don't see that being disrupted because Google has some new sort of AI offering. On the flip side, YouTube has a huge data advantage. I don't see that being disrupted just because of some AI offering from Microsoft. I think each of these businesses will still have a solid moat in five years for reasons beyond AI. But I could see the argument that the AI spending is potentially going to diminish the returns on invested capital.
- [60:31]
Brett Schaefer
Now, I think this is what Cantosari would say, is that your argument could be right and I think your argument's probably right, I'm not sure. But it's that uncertainty that he hates with investments he wants. And he said predictability matters above all else. He wants near certainty as best as possible in buying stuff. And AI has added uncertainty, which he despises.
- [60:55]
Ryan Henderson
Yeah, with, with his companies he doesn't really have to worry about it too much because I think a lot of the businesses he owns sort of have like a regulatory moat in a way where maybe regulatory is the wrong word. But FICO is the industry standard and it's a risk to move off of them. S and P Global's ratings are the industry standard. It is a risk to move off of them. It's more costly. I don't see AI replacing those. So in that sense, yeah, I think he's probably more insulated from any sort of AI. Worries than potentially the big tech companies.
- [61:32]
Brett Schaefer
And that's the lesson there. And maybe ASML will be a true beneficiary there if he sizes up that position. And I guess looking at his visa and MasterCard holds, he's not concerned about crypto stable coins disrupting that entire operation. Okay, Ryan, anything else you want the listeners to know before we get out of here?
- [61:54]
Ryan Henderson
No. Shout out to Fiscally I, because they helped a lot with the research here and they've got some good investor super Investor resources on their platform as well.
- [62:04]
Brett Schaefer
And shout out to our other sponsors, thank you for, you know, helping us with this episode. And for anyone that wants to listen to these. I know we have new listeners, so maybe just reminding everyone we have a Wednesday morning episode that we do prerecorded. It could either be Super Investor series interview, a stock research episode, maybe a portfolio update across our personal portfolios, which is going to come up shortly. Next week we have Ryan doing a research report episode. I won't spoil it yet, but it's going to be a fun one and it is a very popular company. And then on Thursdays we record the Investing Power Hour live on our YouTube channel. But Friday morning it comes out on the podcast. Go listen to those for some more fun, hopefully entertaining and quicker conversations. Let's hit the disclosure and get out of here. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan I earning podcast guests may hold securities discussed in this podcast, may have held them in the past, and may buy, sell or hold them in the future. Thank you everyone for tuning in and we'll see you next time.