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- [00:01]
A
Welcome to Chit Chat Stocks, the podcast that helps you discover your next great investments. We are joined today by recurring guest at this point, John Roton. He is the portfolio manager of the Bastion Industrial and Infrastructure Portfolio. I think you've been on the podcast maybe more than five times at this point. So thank you again for joining. You launched the portfolio, I believe, just over seven months ago. Take us through it. How have things been since the start, Ryan?
- [00:33]
B
Thanks for having me. Always love coming on. It's an honor. It's. It's been great. The portfolio launched on January 23rd of 2025. I've been at Bastion almost a year. I joined Bastion August 1st of 2025, and I spent, I'm sorry, August 1st, 2024. And I spent all of the, all the time in 2024 just researching companies and putting my, my watch list together, my universe of stocks, which is, which is only 60 stocks, Ryan. And so my entire universe is about 60 stocks. And I launched on January 23rd. The portfolio had 32 stocks in it and a big cash position, really big, like more than 30%. It was 40% on day one because I just wasn't done building out the portfolio. And then a few days later, January 27th was when deep Seek was sort of announced in the US and, you know, had had stocks that day in the portfolio, a handful that fell anywhere from 10 to 30%. And so kind of, kind of like a gut punch two day, I think it was two or three trading days after I launched. But, you know, saw that as opportunity and, you know, I was in the market that day for sure. And, you know, those. This is not an AI portfolio and happy to talk about that. Happy talk about what the portfolio is. But it's definitely not an AI portfolio that I can say emphatically. But a lot of the, A lot of the companies that I own sell into the AI data center and so they get caught up in that AI trade. Even if, like only 15 or 20% of their overall revenues come from AI and data centers, they still got caught up. Stocks fell, like I said, anywhere from 10 to 30%. But that was an opportunity for me to put some of that cash to work. I told my clients going in, I don't plan to always have 40% cash now. I also don't plan to be fully invested, Ryan. That's something that my clients understand. For me, fully invested is probably 10% cash. I just never, ever want to have to sell something that I love at a temporarily depressed price to buy something else. That's on sale. So for me, fully invested is probably 10% cash. But I was able to put a lot of that cash to work three days in, which was exciting. And then the portfolio was just kind of chugging along and then tariffs hit and so, you know, we got another downdraft there. But overall it's only been seven months and so performance is, it's not something I would talk about even ahead if, even if it was longer than seven months. By the way, something else I don't do. I don't benchmark, I don't benchmark and I don't publish my performance in any of my writings. Any of my writings. I just think that takes away from our long term generational outlook. The goal of the portfolio is not necessarily to beat the market. The goal of the portfolio is to raise, help, help build generational wealth for my clients. And so we're looking out 10, 20, 30 years or more. And that's the goal of the portfolio.
- [03:56]
A
Yeah, it's a great summary and it's interesting to have deep seek happen right at the beginning which a lot of companies were impacted by that people kind of think of it as the day Nvidia got hit. I feel like that's kind of how most people remember that deep seek moment. But there were so many companies tied to data center and infrastructure build out that were benefiting from this tailwind and still are today that got, like you said, hit or impacted by it. Yeah, I do want to talk more about data centers, but I also liked what you said there about not mentioning portfolio returns. A. Because you're measuring yourself on a longer term horizon. Even if first seven months are good type of thing. But it also, I found that it changes the way people view content. Like if you are doing really well, people are like, oh, this makes so much more sense. And if you aren't doing well, it's like, ah, why would I listen to this guy? And I, I just think I actually kind of like that approach of focus on the content, focus on the long term.
- [05:08]
B
My clients, to be, to be clear, my clients can check their portfolio performance any minute of the day they want. They just log into their account and they can check their performance so they, you know, full transparency to my, to my clients. I'm just, it's not something that I'm going to publish in my letters, in my J. Rose notes, in my newsletter. Just doesn't, it's not how I think about it. I'm general, I'm, I'm solely focused on trying to build generational wealth for My clients.
- [05:40]
A
I like that approach.
- [05:41]
B
So, you know, putting a chart of month to date, year to date, you know, sorry, month to date, quarter to date, year to date, one year, three year, five year. Like it's just very distracting and I think it could send the wrong message.
- [05:58]
A
Yeah, I think that's, that's very true. Let's jump into some of the topics. There's a lot that we could get to, especially considering it's been a while since we last spoke. I think we can talk data centers, but I guess I want to get your take overall on just the sheer boom in AI spending. It feels like right now we are seeing almost a competition between big tech executives with who can say the biggest number on data center spending. So I guess I'm just curious, what's your take on all of it? Do you think we are in any sort of an overspending period or do you think this is still early innings and five years from now we're going to be spending even more?
- [06:44]
B
We're definitely, I think everything I need to say, these are all my opinions. Like nothing is certain. Right. Like I think that we are early in the AI build out. There's definitely a race going on. There's no question about it. I mean everyone saw the news yesterday with Meta basically guiding to 100 billion in CapEx for 2026. Actually 100 billion plus in CapEx for 2026. Amazon's going to do 100 billion this year. Alphabet's going to do 85 billion this year. Microsoft 80, 80 billion, whatever it is. Well, like you just said, there's this one upmanship. There's no way in my opinion that Microsoft and Alphabet are going to let Meta spend more than them next year. I just don't see it. And so that takes Microsoft to 100 and sorry, Microsoft just guided to 30 billion for Q1. Okay. Because they just finished their fiscal 2025 and so they just got for 30 billion. If you annualize that, that's 120 billion. So let's just say they do 120 billion. Meta is at 100 billion plus for next year. Amazon's going to be over 100 billion because they're 100 billion this year. So you have Alphabet at 85 billion this year. They're going to be at 100 billion. That's four companies sum up over $400 billion. They're chasing something that they believe is going to fundamentally change the way that we work and live. And I think that's true as well. If you think about the impact that the Internet had on everyone that has access to the Internet. Not all of humanity because not all of humanity has access. But if you think about the impact the Internet had on the world and society and civilization and everything, AI could be that much or even bigger. And they're announcing these numbers, but to the data center part of it. You don't just announce you're going to build a data center and start building it the next day. It could take years to even get approved for power access to that site. Years. Then once you start building, if you're Elon, then you can build it in a year. And you know, Jensen Huang said that Elon was like superhuman in how fast they put up that Memphis facility. But other companies, it could take a year to two to build it and to move all of the equipment and GPUs inside of it and actually get it running. So it's a multiple year process. There's at least 10 years of backlog build from just announced data center CAPEX in the US 10 years to build it out at current build rates at least. And then you look at some numbers like Morgan Stanley just put out a note. These are estimates obviously, but they're estimating 2.9 trillion in global data center spend just through 2028 and 900 billion just in 2028. $900 billion in 2028 globally. But these are really, really big numbers. And the last thing I'll say to answer the question is mega cap tech capex almost never goes down. Ryan in 2005, Microsoft spent $800 million in capex in 2005 and like I just said, this year they're going to do about 80 billion in the calendar year. So that's 100x increase in 20 years for Microsoft. Google also did $800 million in capex in 2005. This year it's going to do 85 billion. So that's another 100 increase in capex in 20 years. Microsoft went from 800 million to 80 billion. Google went from 800 million in 2005 to about 85 billion. Amazon in 2005 only spent $204 million in capex. This year it's going to spend 104 billion. It's a 500x in 20 years. So this is a long term trend of Capex growing in the largest technology companies in the US. It's not just AI. This is going back to 2005, which is the earliest information that I have. So long term trend and if you look at it year to year, it very rarely Goes down now, it may not continue to grow at these rates, But I think CapEx continues to grow.
- [12:00]
A
You raise a good point, which is a lot of people are looking at these, the commentary out of big tech like, oh, they're just trying to one up each other and spend as much as they can and they don't want to be left behind. But it's like the management teams, they're not only just spitting out these CapEx figures, they're actually hoping that they can spend that much. Like they might not be able to.
- [12:26]
B
Yeah, they all feel capacity constrained.
- [12:28]
A
Yeah. And I, you know, that leads to a whole world of other companies that are likely benefiting that people don't even think of the picks and shovels providers to the industry.
- [12:40]
B
Well, Ryan, 30% of an AI data center. So there's traditional data centers and there's AI data centers. The equipment's a little different. The, the layout is definitely different. But 30% of an AI data center is electrical components. So you're talking about picks and shovels. Little, sometimes bigger, but low cost relative to the, to the overall cost of the project and definitely relative to the cost of those GPUs. Okay. Small electrical components, wiring, things like that. Back planes which are just basically circuit breakers and connectors that connect GPUs to each other. 30% of an AI data center is just electrical components. Yeah.
- [13:28]
A
It's amazing the different companies that are actually benefiting from this. The logical beneficiary here is Nvidia. Everyone thinks of Nvidia Taiwan Semiconductor, keep going down the value chain, ASML and the people providing the chips to these data centers. But there are, like you said, the electrical providers, the wires, there's, there's probably ones we don't even think of. The door stoppers that providers to the data centers. Air conditioning companies are seeing a huge boost.
- [14:03]
B
Absolutely.
- [14:03]
A
Across the board.
- [14:05]
B
So land, right. Start starts with land and power. And then you know, the, the physical structure is concrete and steel. But then like, like you said, then you've got all of the cooling equipment and that's both air cooling and liquid direct to chip cooling. You've got all the wiring, copper and fiber optic. You've got massive clusters now of GPUs which are, you know, stacked in these racks. Tons of connectors and sensors and networking gear. Switches and routers. Yeah, just a ton of stuff. Backup power generators. Yeah, just a lot of stuff.
- [15:01]
A
So the spending is one thing and it's creating. Well, maybe this is, it's kind of the chicken or the egg here, but the spending's creating demand, demand's creating more spending, so on and so on. But we're also seeing valuations for a lot of the tech companies. Not all of them, but I'd say, I guess some of the Mag 7 I'll just leave it at that because everyone can kind of do their own work on each company getting to what seemed like historically high multiples for those companies. And they make up a huge chunk of the indices. I think it's at, I want to say 37% of the S&P 500 is now comprised of big tech.
- [15:50]
B
That's misleading. It's over 50% because Amazon is consumer discretionary. Amazon is without a doubt a tech infrastructure company. Even though, look, Amazon.com is a larger percentage of revenue than is AWS. But you can't argue that Amazon is not a tech company and that's not included. And Alphabet and Meta are not included because they're communication services. It's insane, but it's true. They're not included. And so it's over 50% of the S&P 500 is, is mega cap tech.
- [16:28]
A
What do you. I guess when I look at the S&P 500 as a whole and I. It's weird because you can look at every big tech company individually and now I'm kind of grouping the S&P 500 as just big tech because I guess it's going to dominate the returns for the overall IND index. But you can look at each one and you can make a case for, oh, this will provide you decent returns. Now some, you might have to be a little more optimistic than others, but you can make a case. But when you look at the S&P 500 as a whole, the earnings yield is trading at historically low figure. I think it's like 3.3% earnings yield on the S&P 500 overall. Meanwhile, I think Treasuries are at like 5%. So you've got this big difference right now. So I guess what do you make of valuations broadly? And is. Is this just sign of the times or is it people saying growth will accelerate for the biggest companies?
- [17:38]
B
I. So two questions. What do I think about valuations and what does it say? I think that. I think that The S&P 500 is very rich from a historical multiple basis on a trailing 12 month or a forward 12 month, next 12 month. It's in the 95th to like 98th percentile going back in history, meaning markets have basically only been more expensive in the dot com boom. That's the only time and then in the universe that I look at my 60 stocks, which are, it's a quality universe based on the way that I look at quality. Quality is obviously in the eye of the beholder, but these are what I consider to be the best of the best companies. Something I should mention really quick about the portfolio is there's an uncompromising quality that's the number one North Star and Guiding Light is uncompromising quality. So my 60 stock universe is, is, is, is also rich, you know, high side affair or a little more. And you know, I spend most of my time in those 60 and following those 60 and you know, quality is as expensive as I've ever seen it, let me say that. And as you know, I've been a quality investor for a long time, been following quality stocks for a long time and quality is as, as expensive as I've ever seen it. So I do think that you've got historically very rich multiple at the index level, at the S&P 500 level. And I think the companies that I look at are also quite rich. What does it say? I think it says that, you hear this term US exceptionalism. I think it says that the US when it comes to businesses is exceptional. We have, we have the best businesses in the world. We have more leading edge innovative, disruptive tech companies than anyone else in the world. And we have the, you know, we have the biggest companies in the world and they have a lot of capital to throw at things, to invest at things. So I think this is that, I think it's also says that, you know, the, the, the market doesn't currently think that we're approaching a recession. So I think that's something else that it says and then I think that it says that AI I think the market is saying that they, they believe, the market believes that AI has a, a long Runway of growth.
- [20:27]
A
In a world where like you just said, quality companies. It's, it's hard to argue that some of these businesses are high quality, like no doubt about it, especially the biggest ones today. But like you said, the valuations are maybe as rich as they've ever been at the largest size they've ever been. What do you do? Does that just when you get kind of that sense, does it just mean let's be more conservative on my cash balance or do you start looking in pockets of the market where hopefully less people are looking?
- [21:06]
B
I, I do both. So we only have, we only have two of the Mag 7 in the portfolio. That's the first thing I'LL say. The second thing I'll say is we are. The model portfolio is 22% cash right now. And, yeah, and, and I haven't, and I haven't been buying. So I'm just waiting to see what the market offers. Hopefully something soon. You know, like I said, I don't want to be at 20% cash forever. I'd like to, I like to deploy at least 10 points of that, get down to 10% cash. Now if the market gives me a 2008, 2009 type of situation, down 40 or 50%, I'll go all in. But other than that, I'm going to keep about 10% cash. I will say the S&P 500, we should point out, is if you think about it as one company as a whole, that's a very high quality company. The return on equity in The S&P 500 a decade ago was 15% and now it's 21%. And the return on equity of the S&P 500 compared to the rest of the world is much higher. I think the rest of the world's at 12% and the S&P is at 21. But they've been going in opposite directions, sort of the S and P's. The return on equity has been rising and the rest of the world's kind of actually ticking down. So the gap between the return equity spread between the US best companies, S&P 500, and the rest of the world is actually getting larger. So, you know, I'm just trying to say some of that is justified. You know, profit margins are near, near, near records. There's a lot of innovation happening. There's a lot of investment in future growth happening. These are generally very good companies in the S&P 500. So some of it's warranted. I just don't know if all of it's warranted. But the other, the other thing I'll say is outside of The S&P 500, Ryan, there's a lot going on that is very speculative. I don't want to say concerning, because to be clear, I would like to see stocks fall. Like, I'm not scared to say that. I would like to see stocks fall. I want to get the best prices I can get for my clients. But, you know, Richard Bernstein put out a note yesterday, by the way, I love reading Richard's stuff. I'm just going to read one sentence. I think it's the opening sentence. He says, quote, there have been two times in my career when speculation ran rampant, markets got frothy and financial bubbles formed. One was the tech bubble and the other was the housing bubble. The current environment seems very much the same as those two periods, if not bigger. It's strong words, you know, that jives with what you know. Goldman Sachs has a speculative trading indicator. It's a composition of a bunch of things, but they call it their speculative trading indicator. And as of earlier this week, July 24, it was the highest level it's ever been other than the dot com boom and the mania of 2020 and 2021. On July 10, I wrote a note to my team internally. So this is before Richard Bernstein put out his note, which was yesterday, July 30, before this Goldman note that I'm talking about, which was July 24th. On July 10th, I wrote a note to my team saying that I'm seeing a lot of rank speculation in the market. And I think I listed 10 or 12 bullet points of what I'm seeing. And you know, just looking at this note right now, some of the ones, I'm not going to read them all, but some of the ones I pointed out. Bitcoin fundamentalists. I have nothing against bitcoin, okay? And I own a little bitcoin personally. Not in the portfolio, but personally. But bitcoin fundamentalists are now tweeting ad nauseam. Everybody gets the bitcoin price they deserve, quote unquote. Well, if you remember their Slogan Back in 2020 and 2021, it was have fun staying poor. And you know, it's just, it's this, it's this mentality of superiority in some sense, you know, by, by certain crowds in the market. Something else is there's been massive flows into levered ETFs and there was a launch of the first ever levered CLO ETF collateralized Loan Obligation etf. A firm filed with the SEC to launch something called the Penguin Penguin etf, which if you read about it, it combines a Penguin meme coin and a Penguin nft. As far as I can tell, the FHFA has asked Fannie and Freddie to consider crypto as collateral for mortgage loans. When I wrote this on July 10, Ryan, there had been massive complacency in the market as seen by a 70% crash in the Vix in 13 weeks. And then I close with this sentence, I said, despite all of these signs, all of the 10 or 12 that I listed, I think when we look back after the bubble pops, which I don't know when the bubble will pop, but there's definitely a bubble forming in AI as well. I want to be clear about that. A bubble is forming in AI. I just don't know. I just think there's a long Runway. But what I said was, despite all these signs, I think when we look back after the bubble pops, it will be Zuck stealing AI engineers by paying them 100 million to 300 million. That will be memorialized as the clearest sign of the times. I'm not against what he's doing. He's a savage. He's an absolute savage. But you know, I even heard of one pay package was offered at a billion dollars. A billion dollars for an AI engineer. I do think that will be the sign of the times.
- [27:24]
A
I. Yeah, there's a lot to unpack there. Some of it. There's no doubt there's areas of froth again like this feels reminiscent of 2021, maybe.
- [27:39]
B
You're so polite. Froth. This is rank speculation in my opinion. But like I said, I'm all, I'm here for it because if it. If it gives us better prices, it gives us better prices.
- [27:49]
A
It's kind of an awkward place to be in for long only or long focused investors where because companies, especially if you're skewing larger, you kind of don't want to be sitting on cash all the time. A, it's not fun, but B, you're kind of worried about not participating in some of the gains. But on the flip side, stuff's too expensive and even if your company is performing well, it might have some correlation with the index and you could experience a drawdown. So it's kind of this awkward place to be.
- [28:29]
B
There are reasons to be bullish really quickly. So just because I think there's rank speculation taking place doesn't mean I'm bearish. I'm just pointing out what I think is speculative behavior. And like I said with The S&P 500, I do think some of the high multiple is justified because these companies are objectively getting better. They're really good companies in the S&P 500 on average. But there's reasons to be bullish. Consumer confidence has recently been near record lows and that historically has been a very strong bullish indicator. It's a contraindicator. The one big beautiful bill act. Oba. It's a massive stimulus bill. Massive stimulus bill. It's going to increase the debt by over 3 trillion at the same time that the Fed may start cutting rates at some time in the next several months. Jim Paulson recently said there's over $15 trillion in household dry powder on the sidelines. Not total dry powder, just household dry powder. Fifteen trillion. Yeah. And then just the most important reason. I think I'm bullish now and will always be bullish. Ryan, if you want to call me a permeable, that's fine. It's just math and statistics, which is the US economy has a very long history of growth because of capitalism, democracy, entrepreneurial spirit, technology driven innovation, whatever you want to call it. So I think that US GDP will be higher in the future. I don't know at what rate we grow, but I think US GDP will be higher in the future. Stocks have historically gone up three out of every four years. And there have been more. This is the one that gets me. There have been more 20% up years in the S&P 500 then total down years going back to 1950. Going back to 1950, stocks were only down in 16 out of 75 years. And I think there were 29 or 30. Yeah, 29 or 30 years when the S&P 500 went up more than 20%. So more 20% up years by a lot, by almost double. Then there were total down years. And the last one I'll give you is this is from Datatrek and this is another one that gets me, Ryan. Going back to 1928, now the stock market has only finished the year down by 10% or more in 12 years. Now intra year drawdowns are more than 10%, but going back to 1928, that only been 12 years when the stock market has finished the year down by at least 10%. So it really takes, it really takes a throat punch for this, for the stock market to finish down more than 10% in a year.
- [31:35]
A
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- [33:21]
B
Absolutely.
- [33:22]
A
The average age is way higher. Of death, there's way lower. Like infant mortality rates been just drastically improved. Like the list goes on of quality of life improvements if you compared today versus a century ago. So it's not just like historical performance means future returns, but these are showing up in people's lives as well. I do want to go back and unpack some of the stuff you said earlier. We have a comment from someone in the chat that says I'm very anti crypto because it doesn't produce anything or have intrinsic value. So I admit I am biased against it, but I've heard people make arguments that to be diversified I should have 5% of my portfolio allocated to Bitcoin, either an ETF or gold hold. You mentioned in your personal holdings you have some Bitcoin. I'm curious, what's the rationale?
- [34:19]
B
I guess fomo.
- [34:22]
A
That'S fair. I guess that's fair. I mean I, I don't. I think that's the rationale for everyone in, in some way because it's not like increased utility or productivity most likely. So yeah, that's the reason.
- [34:37]
B
Just being, just being honest.
- [34:40]
A
That's a fair answer.
- [34:42]
B
I was going to answer this way, but it's the exact same thing. But if you know, I could be wrong about crypto and so I also don't have, I don't have a positive view on crypto necessarily, but I could be wrong. And so FOMO is the reason that I own a little bitcoin.
- [35:02]
A
Yeah, I don't own any and I actually one of the best Arguments that I've seen around just the price of bitcoin in general, like, what makes it worth. What it's worth is obviously just whatever people think about it. And I hear some people say, like, well, that's not that different than stocks, but it's like if.
- [35:27]
B
No, it is because stocks generate cash. There's an intrinsic value. There's a stream of cash flows that you can discount back.
- [35:36]
A
Exactly. And if a stock drops 50%, the likelihood of positive returns, all else equal in the business, are higher because the business can then repurchase its own shares, return more cash to shareholders, whatever it is. If you. With crypto, it. I think the returns, the likelihood of positive returns don't change based on price going down. Like if it, if crypto drops 50%, whatever that holding is, when it's just a trading token and it's just about what people believe, the likelihood of it continuing to go down, I imagine would get higher as it goes down, if that makes sense. I know that's kind of a roundabout way of saying that it lacks intrinsic value.
- [36:26]
B
Yeah. So not an expert here, but it has fallen. I think so. Bitcoin is a 16 year history. 16 year brand. It has survived, definitely 2, maybe 3, 80% drops, Ryan. But it always recovered to a new high. So, you know, you make a good point. But it has historically recovered to new highs. And right now there's a lot of tailwinds coming from the administration. The administration is more favorable to crypto than previous administrations. And so that could be a strong tailwind. Most people don't own any bitcoin yet. And so this, this viewer, you know, asked the question if it should be part of a diversified portfolio. By the way, I don't answer. I'll get to this a second. I don't answer any questions, not even for my own clients. Like, all I do is manage this portfolio for them. If they have questions like that, I send them to our planners. I don't do any of that stuff, Ryan, but. So I don't have an answer to that question. But if that's a question that broad parts of this population start to ask themselves, should bitcoin be included as part of a diversified portfolio? Well, very few people still own bitcoin today relative to the size of the adult population. So there are some potential tailwinds, but it does not have an intrinsic value in the way that cash generative assets have intrinsic value. By cash generative, you know, businesses have the potential to generate cash. A lot of them don't. 40%, you know, of the Russell 2000 is not profitable. And I understand there's a difference between GAAP profitability and cash flow. But you know, some businesses don't generate cash, but businesses have the potential to, you know, real estate has the potential to generate cash flow and if you, you know, rent it out to tenants, farmland has the potential to generate cash flow. You know, because you plant crops and you harvest them, you take them to market and you generate cash that way. So those are cash generative assets. Other things have been fantastic investments for people, but they're just, they just don't have intrinsic value. Crypto is not the only one. People collect art. No intrinsic value. Trading cards, wine. There's wine collectors out there, you know.
- [39:02]
A
So luxury real estate, any.
- [39:05]
B
Exactly. That they're not going to rent out. Exactly. So there's, there's lots of things that don't have a stream of cash flows that you can discount back to present value and put a, and put an intrinsic value on that are, that can be and have been for other people, successful investments.
- [39:22]
A
That's fair. I want to ask because you sent me over this report yesterday, I believe maybe two days ago of the alchemy of multi bagger stocks which goes into, I believe they studied, I think it was 400 something stocks that were greater than 10 baggers from 2009 to 2024. Let's dig into it a bit. What were some of the commonalities that they found in multi bagger stocks?
- [39:53]
B
Yeah, it was a good report by Anna Yartseva from Birmingham City School of Business dated February of 2025. So a new report, it looks at multi bagger returns. Multi bagger stocks in that. So it was 464 stocks that achieved at least 10x and maintained it. So there were like 500. She, she, she goes through the, the whole process. They're like 500 stocks that hit 10x Ryan but then they didn't hold it. So These are the 464 stocks that from 2009 through year end 2024 were able to maintain 10x returns. Lots of, not lots, but you know, several common commonalities. I'll say that she said the most, the strongest, the strongest predictor. And this is not going to surprise anybody. It's probably going to excite some people. The strongest predictor, the strongest single predictor of multi bagger returns was high free cash flow yield. So that's like, you know, kind of exciting. There's I, I've shared some other research on, on X in the past and you know, I'M happy to send it to you, Ryan, again if you want to put it in show notes or something. But there's been a lot of research that say that high free cash flow yield is the best predictor of forward rate of return. And so this verifies that in a way. Some sort of classic traditional ideas of outperformance also survived this statistical analysis. So small caps do better than large caps when it comes to achieving multi bagger status.
- [41:42]
A
That was interesting to me. Yeah, you highlighted that and that was interesting to me because we just talked about the success of mega camps over the last decade, but we've still, like you said, they found that being smaller still did help.
- [41:57]
B
It did. It's easier when you're coming off a small base. But yeah, there's no question there's been mega cap dominance, profitability, unquestionable. So you have to be profitable. The one that. The two that were most surprising to me, one is actually fascinating. Not fascinating, but I understand why. Historical growth rate of any metric you can think of, completely statistically insignificant. So sales growth, gross profit growth, EBITDA growth, EBIT growth, net income growth, earnings per share growth or free cash flow per share growth, statistically insignificant over the last year, over the last five years cumulative growth rate or over the last five years cagrade growth rate, compound annual growth rate of five years, statistically insignificant. Now that makes sense because Mauboussin has written about this a lot. He's, you know, he put a whole 60 page book out called base rates white paper. But McKinsey has written about it in their book. Very few firms, very few firms can maintain above average growth for a long period of time and actually growth starts to fade. The decay rate or the fade rate is actually like year five. So historical growth rates completely statistically insignificant at identifying which companies are going to be multi baggers going forward. Then the other one that is really interesting to me, I know that growth rate one makes perfect sense to me because I've read the research, I've read base rates, been following Mobison forever. But that growth rate one is going to blow some people's minds.
- [43:57]
A
It's fascinating because it's what so many people track. What has growth been like historically? Yeah, and you always hear about the companies that are able to sustain above market growth rates because those are the.
- [44:09]
B
Ones that do it. So it's like survivorship bias.
- [44:11]
A
Exactly. Yeah. Reading that was kind of sort of a big realization moment for me in that it doesn't matter what happened over the last five years. All that Matters is what you believe.
- [44:25]
B
Happens from here which could indicate that turnarounds are, are a good fishing ground, a good fishing pond. You know, companies that weren't growing or that were in a cyclical, you know, trough when, when, when earnings turned down or something. Now it could also just mean that, you know, companies improved. It could mean a lot of things. But maybe, maybe it's an indicator to look at turn. I'm not going to be looking at turnarounds because I have an uncompromising core quality Northstar. But you know, there, that's probably one place to look. The other really interesting one for me, Ryan was strong correlation, strong correlation, very statistically significant between companies that are aggressively investing in growth as measured by growth of total assets on the balance sheet. But, but it must be accompanied by profit growth. It must be, in other words, fast asset growth. So investing rapidly in growth as measured by growth of total assets on the balance sheet. But if returns on assets are declining, that is a red flag. That is a red flag. Rapid asset growth, rapid investment in growth and declining assets does not lead to multi bag returns. In fact it leads to really poor returns and Mobis has written about that. Actually there's already been research saying that rapid asset growth and declining return on assets leads to poor returns. But if you can get rapid asset growth and profits keep up because you remember return assets is net income, some profit metric over total assets. So if ROA stays stable or increases massive, massive green flag for multi baggers.
- [46:24]
A
Can you think of any, you don't have to name any names but can you think of any situations in today's world where. Well, I guess maybe the data center spending is potentially assets growing faster but who knows what it looks like in the future. Can you think of any other situations where asset growth, they're investing a ton into assets but the return on assets is potentially declining.
- [46:56]
B
In the past, Under Armour and I never had a position in it, but Under Armour was just investing in growth so rapidly and return on assets was just deteriorating year after year. This was like before the founder came back to be CEO and all this stuff. I'm going back five, six, seven years and the stock fell into, I didn't follow it closely but it fell into single digits or something. But someone pitched it to me and at the time I'm a return on invested capital investor. I spent a lot of time looking at all the return metrics and I just saw almost straight line down across the board return on invested capital, return on equity, return on assets. But if you looked, it was Investing very heavily into assets. Its invested capital is growing quickly. Its assets were growing quickly. It's a picture perfect mirror image of that.
- [47:50]
A
I imagine retail and apparel generally is probably one of the industries or categories that has the highest possibility of investing heavily into your assets. And suddenly the return on assets can change pretty quickly or can decline.
- [48:09]
B
I think that's fair. Yeah, it was a good read.
- [48:14]
A
What's that?
- [48:14]
B
It was a good read. I enjoyed reading it.
- [48:16]
A
Yeah. The other thing I was thinking about was with historical growth rates, it's probably tied at the hip a bit to the entry free cash flow yield, which is when you've got five years of strong historical growth rates, you're probably, it's probably at more of a premium, which means for investors you're getting a lower entry free cash flow yield. So I guess it would kind of make sense that those two that go.
- [48:46]
B
Together, that makes sense. And then she also, you know, I didn't mention this but one of the takeaways was close to a 52 week low. She called it a 12 month low. But so yeah, and she stresses that entry price is very important. High free cash flow yield is important, but also close to a 12 month low is what she called it is very important. Another really interesting One, Ryan, is 57 of the companies paid a dividend. And by in 2009 and by the end of the study, so 2024, 75% of the companies paid a dividend.
- [49:20]
A
I have always, I've always thought that dividends, because when you get started you start to think dividend kind of means like mature, maybe saturated business. They can't think, they can't find other things to do with their cash flow. But now in my experience, dividends are a good forcing function to stop management from doing something stupid. Almost where it's like you have to return some cash and you got to be more resourceful with the remainder of the cash flow you have because buybacks people you can flip flop on buybacks pretty quickly. You can just put out, okay, here's our total share repurchase program that we can use. Whereas a dividend you kind of got, once you say we're going to pay this, you got a shareholder base that you need to satisfy with that dividend that's 100% true.
- [50:16]
B
It shows that you have a management team, first of all. It shows that you have a management team that thinks and acts like owners. They're economically aligned. Two it if, if it's a high quality business, there are some lower quality businesses that try to pay dividends and they shouldn't. But if it's a high quality business, it means that the company is generating excess free cash flow and buying back stock. There's only four. There's only four things that you can do with free cash flow. You can make an acquisition. Now some people take free, take acquisitions out of, out of operating cash flow and so, and so that's not even an option for free cash flow. But assuming you don't subtract acquisitions, the only four things you can do is make an acquisition, pay a dividend, pay down debt, or buy back stock. That's it. Fifth, you could let it build up on the balance sheet and do nothing with it. That's it. You cannot invest in growth. Free cash flow calculated correctly is after all of the investments down the income statement and all of the investments down the cash flow statement, working capital capex and acquisitions if you want to take it out. So yeah, it shows that if a company has free cash flow, by definition that means excess cash flow that it did not find a place to reinvest at a high return. It shows that they want to return some of that because it belongs to the owners. Secondly, as you said, it instills forces as a force and functioning for discipline in capital allocation. But the third thing is it's also the silliest notion in the world to think that a. And I know you don't believe this, but it is a notion out there that you mentioned to think that a company has gone X growth because it pays a dividend, it's madness. It's insane. Costco pays a dividend. Now, I need to tell you, I personally own shares of Costco. It pays a dividend. Has the company gone X growth? Microsoft pays a dividend. Has it gone X growth?
- [52:12]
A
Obviously not if you read their earnings yesterday, obviously not.
- [52:15]
B
I own shares of Microsoft, by the way, personally as well. I mean, it's an insane, it's an insane concept. But things on Twitter X now, they take off and they blossom and they take a life of their own. Someone with a lot of followers can say something, Ryan, and as you know, it just takes off. It's an insane concept to think that companies that pay a reasonable and prudent dividend have gone X growth.
- [52:44]
A
Do you use any screeners at all? This study on the alchemy of multibaggers kind of got me thinking of what screening criteria should I use? Do you use them at all? And what are the criteria that you use if you do?
- [52:59]
B
I don't screen. I honestly don't screen in My life, I've probably run like literally hit enter on a screen like two dozen times in my entire life, like 25 years doing this. But I will tell you some common characteristics of companies in the portfolio. There's 28 companies in the portfolio. Most of them have already achieved scale. They have very healthy balance sheets, sometimes with net cash, they have high and or rising returns on invested capital. So like high and stable or rising returns on invested capital, they have stable or growing free cash flows. And most importantly Ryan, is they have and this you can't screen for. We just learned about this. They have what I believe to be a very long duration of per share growth, earnings per share, free cash flow per share, whatever metric I think is most important. A long duration. I care much less about the rate of growth as long as the valuation is reasonable relative to that rate of growth. I care much less about the rate of growth as long as I think there is an extended much longer than normal, much longer than average Runway of earnings per share growth. That's everything else, Ryan. I'm an ROIC investor for the most part, but that's because it drives earnings per share growth, it drives free cash flow. Companies with high ROIC by definition generate more free cash flow per dollar of net income per dollar of earnings. And then if they allocate that free cash flow intelligently to buying back stock when appropriate or reinvesting or making acquisitions and at good prices, that will drive long term free cash flow per share. So everything that I mentioned, scale and healthy balance sheets and quality management is so important to what I look at. Everything just comes down to one thing and that is a what I believe to be extra long duration of per share growth. Some other commonalities is, you know, a large. Someone on, on X the other day posted this really great sort of chart of oligopolies, duopolies and monopolies across industries. And I joked to myself in my head, I was like, I was like this dude or dudette, I don't know if it was male or female, just inadvertently like gave away my strategy. I invest in a lot of monopolies, duopolies and oligopolies a lot. I don't like competition. I just said I like stable sort of high roic, you know, rational industry structures, rational pricing, hard to screen for for those things. But so there's a lot of monopolies and oligopolies. And last thing I'll say is if, if it's not like an earned monopoly or a duopoly or an oligopoly then it's in those cases, Ryan, there's stable market shares. There's not a whole lot of share shifting happening. I love that you sleep well at night. And we could talk about the railroad if you want, because that's an example of that. But the other category is companies that have leading market share but in a very, very fragmented industry. And so they could have leading market share, but Maybe it's only 12% and maybe there's 1,000 players in the industry, mom and pops. Right. And so in that case it's not stable market share. They're constantly growing their market share if they're good at what they do organically, but also through consolidation, making acquisitions. And so I have a handful of companies that are duopolies, oligopolies. And then I have a handful of companies that are leading market share but in this massively fragmented industry and they're just chipping away at share and gaining share every year.
- [57:06]
A
Let's talk about those rails. There have been, it seems like this has been the most exciting time in the last five years for Rails because there's rumored acquisitions, maybe go through some of the rumors. But I'm curious, what implications does this have? What like could this, how does it benefit the company, the, the companies if the consolidation occurs?
- [57:34]
B
So just to get, just to frame this really quickly, there were 120 Class 1 railroads in the US in 1950. 120. There's now four US based Class 1 railroads. Two on the West coast, two on the east coast. I own one in the portfolio for Bastion. It's a west coast duopoly. I own Union Pacific. The other West Coast Class 1 is Burlington Northern which is owned by Berkshire Hathaway. I own Berkshire Hathaway, my personal portfolio. The two east coast railroads I don't own, those are Norfolk Southern and csx. Union Pacific has actually now announced, it's in my portfolio, Union Pacific, that it plans to acquire Norfolk Southern, which would create the first modern day transcontinental railroad west coast to east coast in the U.S. i think the implications are twofold right now. First of all, let me say this is a announced acquisition and it may not go through. These are approved by the Surface Transportation Board. And the Surface Transportation Board in 2021 put some new language on what they will allow. And that new language actually says that any rail mergers going forward from 2021 forward must enhance competition. That's a key word. Not just not stifle competition. It actually must enhance competition. So there's, you know, pretty high hurdle to get this, getting this approved. I think the last merger, railroad merger in the US Took two years. So we could expect two years. Union Pacific won't even file with the Surface Transportation Board for six months. So it's six months and then they'll take another year and a half probably to approve it.
- [59:24]
A
Just to pause. That is a hilarious concept that to get the approval over the hurdle here. They have to convince. They do, they have to convince them that this, we are making this acquisition to better our competition.
- [59:38]
B
Yeah. And so the way that, why would they do that? The way that they're going, that's, you know, they, they thought that four was enough. I guess they didn't want any more consolidation. And so the way that Union Pacific has to do that is convince the regulators, the stb, that they're going to take market share from trucks. They're going to take trucks off the road, improve our highways, improve traffic, improve traffic safety, take trucks off the road. Currently, trucks move 70% of cargo in the U.S. so trucks move the vast majority of cargo in the US Trucks are more efficient and more timely. You can imagine trucks can go anywhere, right. Roads go anywhere. Rails have to be on the rail. The other problem is that rails, we don't have a transcontinental railroad, so rails have to interchange. The west coast railroad has to move the cargo over to an east coast railroad or vice versa, in these interchange hubs in the middle of our country, in places like Memphis and Chicago. That takes money and time slows it down dramatically. So the argument that Union Pacific is going to make is probably twofold. It's that we are going to improve the value proposition for the customer, for the shipper, because we're going to speed up the process. We're not going to have to slow everything down during these interchanges in the middle of the country. And then the other argument they're going to make is we're going to take some trucks off the road by. Because rail is already cheaper than truck and four times less carbon intensive. Ryan. Cheaper by. I've read estimates 10 to 15 to 20%. So it's more affordable and less carbon intensive. That's the value proposition as it stands today. The other value proposition is there's. There's certain things you can't move by truck. You can't move grain, you know, heavy, heavy steel, big carloads of autos, coal. You can't move that by truck. In massive scale. Right. So some things, there's a captive customer base. So the value proposition is cheaper and better for the environment. Four times better for the environment. Value proposition for trucks is we're much faster, we have much better customer service. So they're going to try to say we can improve customer service, we can improve the value proposition and we can take some trucks off the road. I don't know if it'll get approved if it does. So the first implications, this is the first transcontinental railroad and it could improve the value proposition. Could. The second implication is Berkshire Hathaway may. I don't want to use the word force because they do what they want to do, as you know, but they may strongly have to consider making an offer for csx. I know that they don't abide by the institutional imperative, peer pressure and they never have. But if this gets approved and Union Pacific is successful at improving the value proposition to shippers by either lowering cost or speeding up deliveries, Berkshire may not have a choice.
- [62:59]
A
That would be from, what do you say? 120 class one rails to two down.
- [63:04]
B
To two US based. There's two Canadian in the US that, that run kind of north, south, like from Canada down into Mexico. But yes, from 120 down to 2. Interesting. Ryan, there's a natural tendency towards consolidation in the U.S. there's no question about it. It's not just railroads. There have been multiple periods of consolidation in semiconductors in the US which you and I have talked about. And by the way, when you go from 100 players to 2, rationality enters the market. There's no longer these price wars, right? There's no longer these massive cycles of boom and bust. And so I think it's good from investor standpoint because you get more rational pricing and you, and you moderate the cyclicality somewhat. Right. But you know, we've seen massive consolidation in railroads, massive consolidation in semiconductors, massive consolidation in airlines, autos. Home builders are consolidating equipment rental companies. The top 10 equipment rental companies, very fragmented industry by the way. But the top 10 share of equipment rental companies every year increases because those top 10 scaled people just buy the mom and pops. It doesn't, it almost doesn't matter. The industry, pest control. It almost doesn't matter. The industry. There's a natural tendency towards consolidation in corporate America.
- [64:35]
A
Okay, we are running just over an hour. I feel like I could talk forever with you but we, we got to turn it off at some point. We have a comment here from John says make sure you sign up for J. Rose notes regarding the companies he follows. I couldn't agree more. Do you want to give a quick plug to where that is how people can read your stuff.
- [64:55]
B
Thank you. Yes, please. My newsletter is my My Second Baby. My portfolio is the First Baby, the newsletter the Second. It's J. Rose Notes, and you can subscribe@LastBillion.com and yeah, it's My baby. I love it. I love writing and sharing and. And trying to educate.
- [65:16]
A
All right, that is going to do it for today. Thank you, everyone, for tuning in. We want to remind listeners that nothing we say on this podcast is formal advice or a recommendation. John or myself may buy, sell, or hold any of the securities discussed in this podcast. Thank you all for tuning in, and we'll see you next time.