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Excess Returns
The Single Most Important Metric | Matt Reustle on the Patterns That Separate Great Businesses
01:07:52
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Matt Russell
Great businesses find a way where once they make that initial sale, there is an increased likelihood that they are going to make future sales. I look at just a very simple thing. It's understanding how a business makes money, how they generate sales. You take an aircraft engine manufacturer and you would think that their business is selling engines to Boeing and Airbus, when in reality what they have pushed into and what is a much larger percent of their revenue mix is the aftermarket services. There are several examples of what I would call kind of the suburban business that you see everywhere across America that you would never appreciate that this business has actually been an incredible stock. It's this combination of taking the individual micro work and then pairing that with the broader lessons. And that's where you switch from saying that you had a gut instinct about a certain name to it was the pattern recognition that drove your appreciation for it.
- [01:55]
Matt Zigler
You're watching Excess Returns. This is our latest installment of Teach Me Like I'm five. I'm Matt Zigler, your host and resident five year old. Today my teacher that's the host of one of my favorite podcasts, Business Breakdowns where he showcases not just his curiosity about all sorts of storied businesses, but as this 10 years worker at Goldman Sachs, the handful of years as a private credit hedge fund analyst, his time more recently building and scaling a media company at Colossus. He just has so many thoughts that I come across and think how do you know to ask that? So that's why he's here. Ladies and gentlemen, Matt Russell. Welcome to Access Returns.
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Matt Russell
It is a pleasure to be here. I equally enjoy learning from you and everything that you put out. So it is a mutually shared feeling that it would send right back at you. It's great to be back, Matt.
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Matt Zigler
All right, well you're gonna teach me like I'm five. The all Matt. You know, Power hour here continues. We're gonna go into this is about business breakdowns. This is where I want to take this. Because you study businesses at a level that I see few people do. You'll meet an analyst, you'll meet somebody who's covered a company for, you know, more than a quarter years, sometimes multiple, multiple years. Sometimes as an owner, sometimes not. And you go, wow, you must know this business better than the frigging cfo. Business breakdowns is where I go when I want to understand all the economics of a business. How they think they fit into the world, how the world thinks they fit into it. How do you start your homework on a company that feels like too big of an assignment?
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Matt Russell
For me, yeah, it's. It all stems from that previous experience that you mentioned. It's something that I viewed as the most enjoyable part of my job. When I was a sell side analyst, when I worked at the private credit fund, you have all these tasks to do, but the most enjoyable thing was learning about a new business, getting to study it. Kind of dive into the secret sauce of what makes it special or why it is in the place that it is. And I think most people have different processes. Personally, as I approach this, I look at just a very simple thing. It's understanding how a business makes money, how they generate sales. Even I start just at the top line. Are they selling something one off, are they selling contracts? Do they collect the cash upfront? Do they collect the cash slowly? Who are their customers? Is it big industry players? Is it a bunch of small consumers? Those are the like very, very simple things that I'll be honest. Like the first four years I got into the stock market, I didn't actually appreciate it. And if you had asked me some of the companies that I was talking about, how do they actually generate sales, I would have given you an answer that wouldn't have been that close to the reality of what the case was. So that, that is honestly the thing that I'm after. And to do that I really start with investor presentations that they will produce some of the materials that are sent out there. Then I'll work my way through the system in terms of understanding more about the industry, digesting all of that. But the sources that I'm relying on to do this are the investor prescience that they release, the investor write ups that you can find on value investor club on Twitter, and then just some sleuthing around other sources that I might have access to in terms of getting just a simple understanding of what I'm looking at with the business. And I would say I'M aiming at, you know, spending an hour to two hours of time to do that.
- [05:34]
Matt Zigler
Okay. And I love this because it's not, you're not reading just K's and Q's. You're not like doing, I don't want to call it the traditional way that I hear people talk about this. Those investor presentations aren't usually the top of somebody's reading list. Can you give me an example of like just answering the. Where are the sales, where do they come from and who are the customers? Can you give me anything with that?
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Matt Russell
Yeah, I think, you know, you have these businesses today that you take an aircraft engine manufacturer and you would think that their business is selling engines to Boeing and Airbus, when in reality what they have pushed into and what is a much larger percent of their revenue mix is the aftermarket services. So that's maintenance related and aftermarket parts that are sold to support whether it's the engines, parts of the engines, other things that they do with the aircraft. And not only is that a bigger chunk of revenue for most of those businesses, it's much higher margin revenue for those businesses. It's contracted rather than a one time sale. So those are some of the dynamics that I'm looking for. It is the, what is the non obvious thing that might be happening here that I don't appreciate and there's many examples of that. I think the idea of the equipment and attaching some type of service to it is one of the most common ones that I see as I do work.
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Matt Zigler
So in this initial phase of discovery, is this really, is that what you're looking for? Just do I actually understand where the sales come from, who the customers are and what's unique about why there's even a penny of profit inside of this? Is that a fair way to put it?
- [07:21]
Matt Russell
Yeah, I would say before I even get to the profit dynamics, it is, it's understanding just how the cash moves through the value chain. So it's who's paying who, who's the end customer, what is the end product and how does it work its way through the system. So once I've kind of figured out, you know, where a company fits, you know, who is their supplier and who is their customer, how do they generate sales? That's when I'll start to move up and take a broader image or snapshot of the industry value chain and that reveals, I'll just stay with the whole air aerospace segment as, as kind of the example here.
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Matt Zigler
I mean, it's so fun and exciting. Thank you for appealing to my 5 year old that wants to talk about planes and trucks, literally.
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Matt Russell
Well, you would assume, you know, I think if you asked most people who didn't know much or weren't stuck with the baggage about airlines would assume they were probably good businesses. You know, it's capital intensive. You and I just couldn't start another airline business. Right. There's only a certain amount of slips you gotta get up into the air. You know, there's different dynamics. But then you realize airlines are terrible businesses, particularly within the value chain of aerospace. And you move back and you look at, okay, well, why is that the case? Okay, well, we have this duopoly of Boeing and Airbus that supply the airplanes. Those airplanes are really probably the most challenging piece of what's going on in that value chain. Designing something that could fly in the Air Force however many miles with all these people and take into consideration all the physics. And then beyond that, you know, you have the engine suppliers, you have union dynamics going on at the airlines. So those are the questions that I would seek to answer next, which is just, you know, how does this business exist in its ecosystem or its value chain? And then I start to work through, okay, what does that result in in terms of profitability and all the important things that we care about from a financial perspective.
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Matt Zigler
So I think this is fascinating because the cash flow component at the industry level precedes the cash flow component at the company level.
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Matt Russell
Yes, I think, at least in the framework in my mind is, you know, who is capturing most of the value through the chain. Just to use another example, you could take an industry like oil and gas, and if we say oil sells at $60 a barrel, well, you have the producers of the oil who are in theory producing that oil and then selling it at 60 to a refinery. But they have to pay someone who owns and operates the rig. How much money of that barrel of oil do the rig operators get? They also have to pay pipeline companies to move the oil on the pipeline to get to the refinery. How much money do they have to pay? And you kind of work your way through the chain. And that sometimes can reveal if you have a big downturn like we had in 2015, 16, when oil was at 100 plus dollars per barrel of oil and it dropped all the way into the 20s. Pipelines had these contracted revenues that basically equated to, let's say, $3 a barrel. It's a lot different when it's 3% of the end customer sale price versus now being.
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You know, 15%, whatever it might be, you know, five times. So that that's where you can have some interesting things come out by understanding that value chain. And that gives you a framework for thinking about, you know, once you go into the company, what couldn't be the impact or ability for them to change? What is the current state of margins, profitability and all of that.
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Matt Zigler
Give me some companies or themes that as you've done. How many business breakdowns have you done right now on the pockets?
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Matt Russell
I think it's over 150. I don't know exactly how many. It could be close to 200. But yeah, it's quite a few.
- [11:21]
Matt Zigler
I knew we were well north of 100. Give me some surprising themes or areas or companies. What are some of the things that you went, holy crap, I had no idea.
- [11:33]
Matt Russell
Well, I think there are several examples of what I would call kind of the suburban business that you see everywhere across America that you would never appreciate that this business has actually been an incredible stock. So examples of that would be Sherwin Williams autozone. I would even put something like Planet Fitness. And with each of those, they're somewhat unassuming from the outside. And it's only when you dive into whatever they do that's unique in each case, the management teams that have implemented that strategy and evolved over time to look different than the competition that you come to appreciate. Okay, it's not just software business, which in terms of just a pure business model is one of the most beautiful things because you build it once and you sell it infinite times and you get this 90% plus gross margin. There are other ways to build incredible compounding businesses. And some of the most interesting things I think I've come to appreciate are we went from this huge wave of industrial conglomerates where they were very capital intensive and there were massive barriers to entry. We kind of flip flopped into this era where everything was capital light and software like and technology driven. And it's easy to overlook the competitive advantage that exists with some of these, you know, brick and mortar, traditional capital intensive businesses that have been coming back to life. And, you know, it's good to reappreciate some of the dynamics that drive that.
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Matt Zigler
Something I've noticed from listening to these is when they give.
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The bull case, the bear case, when they break down these things, it tells you a lot more about the macro environment on how this fits in too. I feel like one of the sleeper things about your podcast is I come to get from 0 to 6 of an understanding because I'm just interested in how businesses work. But then you actually get this beggar backdrop of how does the world actually work around these businesses?
- [13:46]
What is that? I mean, that's an unintended consequence, I assume. But what is that?
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Matt Russell
No, it's interesting. As much as we try to make them evergreen in nature, the reality is if we cover a name that's in the power industry, you can't talk about these power businesses today without AI and data centers and this massive demand for power. Whereas if we did that in the very beginning of the show, that probably would have only been mentioned as the third thing in the, you know, potential.
- [14:18]
Matt Zigler
Growth footnote in some abstract future scenario.
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Matt Russell
Maybe when AI is here, kids 100%. So I think, yes, it gives you some perspective on the industry. What I often like to do is just to get some sense in a normalized environment. I try to, you know, in terms of trying to understand the business. It's like, what is the financial model for a company? Is it. Does it grow with gdp? You know, and I think that's like where I always start as a starting point is, you know, there's going to be price plus volume. And you are usually, you know, for the default company, going to be around GDP for that. But certain companies are exposed to industries where there's a secular growth tailwind. And it was, you know, anything exposed to housing for a very long stretch of time was actually growing north of gdp. And there's all different trends that reveal themselves where you have to. Obviously if you're going to make the investment, take a view on how long that trend is going to exist for. But if you can find businesses where the secular tailwind exists, where it will grow north of gdp, where they can actually flow that through into stable or even higher margins, that's when you get some of the interesting business opportunities that come out of it. And I look at it more from a framework perspective than I do necessarily for the individual company that we're talking about.
- [15:37]
Matt Zigler
Okay, framework perspective, specifically, because I'm thinking about it. You listen to an episode you get from. You get this awareness of this company, how it fits into the world, how the world fits it back into it. You go zero to six, all of a sudden you're like, now I'm dangerous. How do you actually maybe speak personally on this? Because I'm not asking you to project this on me. What then do you do? Because now, again, now you're dangerous. I understand power. These power companies, I get with this. What is the next step? You implied that earlier. Like now you should know what to do with it. Explain.
- [16:14]
Matt Russell
Yeah, I Think if the business looks compelling to somebody who is a listener and this, you know, in some cases, this is me. I'm usually walking away with.
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Two or three things that to me are the most important drivers of this business over the next one to two years. That might be the ability to reprice contracts higher and their ability to have success and execute on that is going to be telling in many ways that will materially affect the stock more than anything else. So that's where I would spend the majority of my time. Or maybe it's, you know, they talked about competition, but I didn't really get a deep understanding as to why they have this competitive advantage. So somebody just sent me an email two days ago. You know, you talked about them having 80% market share, but what is the true competitive advantage? That to me was like a perfect follow up question, a perfect example of where you go next. And then the third thing was, which I always think about is just like, okay, what were the takeaways? We have this closing question of what are the key lessons that you could apply elsewhere? And looking for the commonality in those answers and then keeping in mind, okay, let's say this business has gone up 5x over the past 10 years. Maybe you're not getting in in the early innings, maybe you still are. Plenty of businesses compound way longer than you expect. But if you've heard the same theme from them and from multiple others who have had that same story, now you kind of keep that in the back of your mind anytime you're looking at a new business that doesn't have that narrative around it but might be showing signals of it. So that's what I would say is kind of like, it's this combination of taking the individual microwork and then pairing that with the broader lessons. And that's where you switch from saying that you had a gut instinct about a certain name too. It was the pattern recognition that drove your appreciation for it.
- [18:19]
Matt Zigler
Ah, that's when the pattern recognition comes in. So.
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In the tradition of teaching me like I'm five, in the tradition of obviously this is not for a five year old.
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Matt Russell
Yeah, I was going to say, yeah, hopefully high school is, is reasonable.
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Matt Zigler
It's like a Doogie Howser five year old. Okay, yes. In this scenario, really starting just with the time to understand the company. And like you said, when you were doing this at Goldman or at the hedge fund, like you would spend like an hour, two hours at a minimum of just trying to understand that value chain first.
- [18:57]
Matt Russell
It would be significantly more while I was There because I can rely on the guest for these episodes. But yes. Yeah, it. That can take a lot. And how much time you put in totally depends on, you know, your interest in. In making individual investments. Yeah.
- [19:13]
Matt Zigler
What you're going to do with it in the end. I think in an era of social media reviews of companies and figuring out stock tips and whatever else, not only is this rare or more rare than it used to be, but it's also underappreciated with how much elbow grease, how much effort this process takes. Do you feel like in talking to this many experts over this, this amount of time now, do you have a. Do you have a different appreciation for it than when you started?
- [19:43]
Matt Russell
I would say I have a greater appreciation for just how big the market is.
- [19:52]
I was often frustrated looking at social media and the analysis or lack thereof that was used to explain why certain businesses were good or not. Having known some of the rigor that goes into true work. And not all rigor is good rigor, but I think to me, I often have this conversation with somebody else who's very close to the show that, you know, we're sometimes flabbergasted at, you know, certain personalities, inability to answer questions that for us, we were trained. You're going to go into a meeting with a bunch of investment committee ads and get absolutely torched for an hour and a half. And you need to know every small detail of the business and details that really don't matter. But, you know, they're probably going to ask about their FX exposure if we're to see some, you know, outbreak over here. This.
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Matt Zigler
Because if you don't know this, what else don't you know is like, what it reveals?
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Matt Russell
Yeah. So I think that rigorous, which again, I don't think it is all 100% necessary or actually drives the alpha. But it's like that marketing saying, you know, 50% of my marketing spend is a waste. I just don't know what 50%. It's like 50% of the work that you do will probably be wasteful. You're just not going to know what 50%.
- [21:18]
Matt Zigler
Well, as. As two men named Matt, who Mary. Waste a minute of their time in a given day. I'll take that one to heart.
- [21:29]
All right, so we were having this conversation and we thought this was going to be. Just teach me like I'm five and we're going to stop there. And then we kept talking about it and we went, I think there's more to this and we shouldn't make people hunt for another episode so we're just, we're just going to keep going with this conversation. I want to dive right in on these like recurring characteristics in these exceptional businesses because this is, this is a pattern matching job. Let's search just like what to you separates great companies from merely good companies.
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Matt Russell
Yeah, it's a question that could go on for hours. And there's a lot of episode if we wanted je ne sais quoi to this. But if I were to isolate the most important things that stand out to me, the first is self reinforcing sales model. And most people will talk about, I want to see reoccurring revenue or that gets simplified into contractual revenue rather than transactional revenue. But ultimately great businesses find a way where once they make that initial sale there is an increased likelihood that they are going to make future sales and that could be just contracted revenue. You know, the sales are going to continue next year because it is literally legally binding. But it could be something like the Apple iOS software where once you have a Mac or an iPhone, getting the AirPods and anything else that's attached to it just becomes so naturally easy. It makes your life better. It combines everything that you're doing and you ultimately want to spend more inside the Apple universe. And that's a very transactional revenue business. They've attached certain things subscription wise, but in, you know, the basic sense it is, you have Amazon who's done that with prime and once you make a order on prime and you realize, okay, this is reliable, it's easy, you stop searching around for best cost oftentimes. And Amazon really isn't the cheapest that often anymore. So you could see how that works. It could also be something like a regulatory barrier to entry where Transdigm or Heiko have these parts for aircrafts and they are the ones that have gotten approved by the faa, they are the ones that have them in the catalog that they can deliver them to you. So the top line having this sales model that, that is reinforcing on itself is number one, number two is financial hygiene. And it's rare that you get these two things married together. So if I were to boil it down to two things, it's, it's that sales model plus financial hygiene. And that can mean in the simplest terms having cost discipline, focusing on margins. But I think it, it goes even beyond that. It's understanding the cash economics of a business and it's taking a business that could seem great from the outside. I just did a breakdown on GE Aviation which sells jet engines, which are some of the most complicated things in the world to manufacture. And when you think about all the different things that you have to take into consideration with a jet engine, it's obviously a really important thing. But the business model itself, the jet engine sale does not produce much in the sense of profits up front. In, in fact it was cost lo, you know, was a cost loser in many ways. And, and it was a razor, razor blade model where the service contract attached to those jet engines, the maintenance that went on it. So having a, a management team that stepped in, Larry Culp understood this, really leaned into the services side of the business, really tried to get better penetration, more market share of that understanding how to price those contracts. And then also had the discipline to say, hey, when we get a new engine order, let's make sure that the cash economics are set up in such a way that we're getting paid at milestones, maybe on the contract signature. I think this often gets lost in the sense that okay, how much did you pay for that engine? Let's say we paid $100 million for an engine. Well, when did you get paid? And that can make a material difference in terms of the performance of the business. The ability to reinvest that cash into other things. So those two things are, I think are the most important. And then the third thing is the ability to evolve over time because you can have a great business for a particular moment or cycle or period, but if you can't evolve, then you don't have that same durability that I think makes up some of the, the best businesses in the world. So if I were to simplify those three things, it's the self reinforcing sales, the financial hygiene and then that evolution and adaptability that really separate good businesses, which there are many from great ones.
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Matt Zigler
Okay, host, host level question. How has that awareness, the ability to answer the question, the way you just answered it, how has that evolved over time? Did you understand this at the beginning of this series?
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Matt Russell
No, I think what I would say is.
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Being able to see how those things connected. I think I, what I said at the end of that answer there about being good business in a particular cycle, a great business perhaps, or a great stock in a particular cycle certainly was obvious to me. But to see how intertwined those things were for some of the best, most durable, most impressive businesses, to me that is something that, that really changed as I started to see the best run companies, the companies that had been around for, you know, 50 years, 100 years, and continued to perform incredibly well. It was the marrying of those concepts together. So I think it's something that you mentioned early on in terms of pattern recognition. It's where the patterns emerged about that ability to do all of those things at the same time that really, you know, started to present itself as I hosted more and more of these.
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Matt Zigler
Okay. And as I think of the sales model, financial hygiene, the ability to evolve, I can't help but think about managers. And I think about this at all the levels. I think about this with the Fortune 500 massive company. I think about this with the small mom and pop thing because like people still have to implement those three very, very interwoven patterns. How do you think about management teams? How do you even approach like the people responsible?
- [28:16]
Matt Russell
I think it's incredibly important. It's almost cliche to say, you know, you're investing in a management team, but I do think it's the truth. And I, I think it was Munger who said, like, find a business that's so great that an idiot could run in and it would still do well. It's very hard for me to find those businesses that, that look like that. And I think you can more often find a management team that understands their industry shareholders, which I think is incredibly important. And something I've gained appreciation for is not only what's going on inside the business, but also how to communicate that to shareholders. And you can expect that they often know how to communicate that to their teams as well. And I think it's going to look different in different industries. So the founder of a tech company that is scaling at abnormal, insane rates of growth is going to look different than the industrial CEO who is operating in this incredibly mature, competitive, low margin business. But they, they certainly have some of the same characteristics in terms of steering a ship and keeping, you know, focus on the things that most is most important and then communicating that to the shareholder base as well. The only other thing I would mention is one of the first things that I said about a sales model. I have come to appreciate that even the best management teams can't get over an industry that isn't growing anymore. And I saw this up front with offshore drillers where there were some really good management teams, really thoughtful about capital allocation. But when nobody's drilling offshore anymore, it's incredibly hard to run that type of very high fixed cost business that is just getting, you know, no matter what you do, there's not much you can do to save that, that stock, the shareholders and everything that goes into it.
- [30:10]
Matt Zigler
Okay. And especially because you just brought it up with no slights to TED cites, but I want to talk about capital allocators and capital allocation. How has that. Just talk to me about capital allocation, what you've seen in the great businesses. And I'm really interested how this evolved over time too for you.
- [30:28]
Matt Russell
Yeah, I think one of the most underappreciated things about capital allocation, and this is particularly as businesses get to a different state of maturity, is just like the capital structure management of, you know, your debt, what that costs you, your buybacks when you're doing them, how you're communicating that to the market. I think that is something that the best management teams that I think often fly under the radar are making these types of moves quietly. Maybe the only people that are paying attention are the uber aggressive hedge fund analysts that will model the, you know, change in interest rate to 3 pennies of EPS. But those things compound over time, particularly when you see how often and how active they are with doing that, how they're thinking about structuring an M and A. So that's one thing that I think just flies under the radar. The other thing is, is understanding when to invest and how to invest. And the best management teams will take what is very strong cash flow and ultimately decide we have a major opportunity now to basically invest in something that's going to be very high ROI and, and being able to communicate that to a shareholder base. It's something interesting that Gavin Baker just brought up in a tweet. And the most interesting thing in the tweet was it was about SaaS companies and he ultimately thinks they should sacrifice margins. It is something that they should be willing to live with in order to invest behind this opportunity that's presenting itself with AI agents. And he doesn't think it would be a negative thing as long as it's communicated properly. And that was something that stood out as well. It's, it's marrying that capital allocation to the communication, to shareholders. But it is without a doubt probably the most important thing. Again, somewhat cliche, but the most important thing for a management team to do. And that is ultimately what can get you through tough periods by being active with raising capital when it's needed, stand out during periods of, you know, success for everyone, what are you doing, you know, on the margins? And, and it really piles up over time when you have the best capital allocators because those small changes each year can compound over time.
- [32:46]
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- [33:47]
Matt Zigler
This is one of my favorite parts about your show and your series because it's, it's these layerings and it and part of this next question because I want to talk about technology, because I feel like the entire technology, maybe not the entire technology sector, but we're seeing these companies who now have been around for 20 years more in some cases where just the environments have changed, but the management teams, the companies, the communication strategies, they've all like evolved aggressively. I'm not going to ask you to break down like what Oracle's doing with their capital allocation strategy on the spot, but I'm, I'm really interested. Like tech is this catchall phrase and I, I go to Warren Buffett saying I don't invest in tech in my brain and it's like, oh my God, it's changed so many times. Like where do you come down on tech right now? And just trying to understand these companies.
- [34:36]
Matt Russell
For me, tech remains incredibly difficult to invest in for long periods of time in the sense that what you often are looking at is a company with incredibly high growth rates, evaluation that reflects those incredibly high growth rates and a million changes happening around it. So tech. Like I always say, it's funny that so many of us reference chess as like the, you know, one of the best books the Art of Learning was, you know, from someone who was very successful in chess. But chess is this game that has very defined moves with a single opponent. The market, on the other hand, has completely undefined terms. A million opponents and variables that you can't even imagine that pop up out of nowhere. And tech is probably the most, you know, at the center of all those themes. So what's interesting to me is even after doing the show a million times, I feel like I still don't have a great grasp of I of differentiating durable tech growth versus one that's Less durable only when things, you know, kind of pull back to. I think there's, there's obvious things that stand out to me, I think the one thing that I've learned to look for is this sense of focus that is not just on the next three years, but what it could mean in five or 10 years. You know, how is what you're doing set up for a different stage? And I'm sure many hyper growth investors would say it doesn't make sense to actually think about that down the road. But to me it's like when you have all these different things going on and you're trying to, you know, lean into all those strategies, how does it all tie together, you know, in the future and what does that look like? When do you eventually pull back on investment, if ever? How do you adjust the revenue model in the future, you know, and what would that look like? How do you change your capital allocation framework, your labor framework, all of that different stuff. And for most companies, you don't know until there's a precedent in terms of how they're going to do it. But I think that's probably what stands out the most to me is if there's one thing I look for, it's that even if they're doing a million different things, how do they tie together, you know, in terms of a singular focus in strategy?
- [37:00]
Matt Zigler
I love that you said thinking about it in sort of five year and out chunks because I think that's one of the only things that I can do when I'm trying to understand growth rates on these technology companies. It's like, do I see a world in five years? I'm going to think five years in the past and now I'm gonna think five years forward. And do I see like what parts of this feel like? Yeah, that'll probably still be involved in everybody's life in some way. Or oh wait, this might be a fad tied to this other shorter term indicator. Okay, Inside of that extra, extra Kai Wu emphasis on this because Kai makes me, he doesn't make me feel dumb in a mean way. He makes me feel like yes, it's the intangibles, it's the software, it's all these parts that I do not understand how to really forecast. I know that they're important and I have some ways to think about them. But I'm just curious with you, like how do you think about all those intangibles and how they fit into this?
- [37:57]
Matt Russell
I think it ties into that self reinforcing sales dynamic where with Something again like Amazon, you have prime that sits in the center of all this. But they continue to load things into prime, like prime as a streaming service. You know, the delivery is one thing. All of the goods that they have now having the grocery, just different ways that you can use a Prime card and you're getting rewards.
- [38:30]
It's loading all of that stuff in which I think it can feel very basic in nature and not obviously tie together, but those are to me like certain intangible things that factor into it. And there's the intangibles which don't show up in accounting very cleanly. And then there's other things. But that I think is a very, very serious thing to think about with the self reinforcing sales model and then also the ability to evolve and adapt like that factors in as well. And those will never get picked up with accounting. That's where trying to understand a company's DNA, the cultural nuances to the company really play a role. And the economic scenarios change drastically with that. And you have to adapt your accounting or economic forecasting based on some of those things which are going to be difficult to otherwise. You know, a machine can't really factor that in because it's not going to show up in the numbers nearly as much.
- [39:35]
Matt Zigler
There's part of that I feel like is the management team communication of it too. Like there's a smell test of are you describing something about these intangibles or software or whatever else that feels like BS or does it feel like you're like, no, no, no, this really is a way.
- [39:52]
And the extreme example would be like the wework stuff and the counterexample would be like, no, you just, you don't understand Amazon Web Services yet. Like we're going to break this out.
- [40:01]
Matt Russell
Yes, yeah. And that, and that even, you know, there's so many aspects to that. Your point on how something is described to the market versus how users would actually describe it I think is always important. And you know, it used to be channel checks, now there's a ton of expert network calls. You can go into stores, you can use products and you can get a feel for it. I still think that's an important part of research. And then something like Amazon Web Services, which you know, I would almost. It's a totally different bucket. But that to me, you know, if there was this idea of okay, they're investing in all this infrastructure, it's for themselves, but now that they can roll it out to a wider customer base. Well, for me, I'm like I now have multiple examples of Amazon doing that because they did it with web services where it was like tool for their internal usage. Now we could sell it because we have excess capacity. We build a transportation network for our packages because UPS and FedEx can't deal with the holiday season. Well, now we have all this excess capacity, we're certainly going to offer it to others and now compete with UPS and FedEx and now most recently in adtech, you know, building the pipes for buying on Amazon.com and Amazon Prime Streaming. They now are making a very aggressive push to pick up additional customers in the ad tech ecosystem. So they. The first one, you know, with aws, it was understandable to me to not really have an appreciation for it. But once you start to notice, okay, they've done this before, there's a pattern to it, it's in their DNA, they can likely do it again like that. That is something that can emerge as well. And I think there's many examples of this. We just did something on Robinhood recently and someone was asking, you know me about the prediction markets and Robinhood and will they start doing it in house? They were using Kalshi, 55% of Kalshi volumes were coming from Robinhood, which was quite interesting. And the question was, well, will they ever just do it all in house? And there is a precedent for them taking something that they previously outsourced with trade clearance and then switching in 2015, I think to bring clearing in house. They also tried to take and get their own bank charter in 2018 that failed. So they continue to use JP Morgan for banking services. So it's like using historical precedent too can inform you on some of those things over time. For many tech companies, you don't have a lot of precedent for those specific businesses and those management teams. But once you do, I think that can inform, you know, your investing decisions on the back of that for sure.
- [42:50]
Matt Zigler
It's interesting because that's like there is a network effect of those things going on too that I think great investors have a sense of noticing. And whether that's Amazon figuring out books and music and physical non perishable items in warehouses first to then apply to these other areas. It's like this becomes part of the.
- [43:06]
Matt Russell
DNA to notice this stuff 100%. And what they were able to do with the transportation network, I still can't comprehend what they pulled off. And it had to do with a lot of things like earning the trust of investors to invest behind something like that. But those are insanely hard businesses to run. UPS and FedEx generate high single digit margins. They're not easy. It takes an incredibly long time to get the infrastructure build out. It's the traveling salesman problem of, you know, what's the fastest way? Except you have a bajillion packages all over the world and you're promising to get them there in less than 48 hours. So these types of things are insanely difficult problems. And I imagine, yes, part of the DNA, you know, came from just those early beginnings, but they haven't slowed down in terms of continuing to evolve on that.
- [44:00]
Matt Zigler
Yeah, there's something about when like the, the examples of, you're like, surely nobody would ever want to compete with these.
- [44:08]
Matt Russell
I would have bet against that 100 out of 100 times. So I, I was blatantly wrong. But I would can't say that I would go back and expect my, you know, to have learned a lesson from that.
- [44:20]
Matt Zigler
I, I still, I will forever remember one of the first like AWS outages where I was like, I think I understand how this works. And then there was an outage and I remember finding out all the things that went down, even though they weren't saying like, God damn you aws, you let us down. It was like AWS had an outage, so did all these companies. And suddenly we were like, holy crap, all of them are using this.
- [44:48]
Matt Russell
It may be like Cloudflare recently. I was like, there you go.
- [44:53]
Matt Zigler
Yeah, since that first time that I saw that happen, every time one of these outages happens, I'm like, who's complaining? And they're usually not throwing the vendor under the bus, but you're like, this is how interwoven it and we just don't see it, so we don't think about it.
- [45:06]
Matt Russell
Well, and yeah, it's a great point. And I think I haven't quite formed this theory, but I go back to Moody's during the financial crisis. Moody's into a lesser extent, S and P. If there was something that was going to kill ratings agencies, it was going to be them being blatantly wrong and causing this, you know, massive blow up in the financial system. They didn't cause it, but they were a key role in, in the blow up in the financial system. And guess what? Nothing happened to them. They're still ingrained in all the regulatory framework around mutual funds and, and you know, how banks, you know, consider what they can hold and what they can't hold and they've only emerged stronger from that. So it's almost like if you're that important to the system. And an event like that does not kill you. It's probably going to make you stronger. And those are always worth a look. Equifax with, you know, the big.
- [46:05]
Security issues. Like, there's plenty of examples.
- [46:08]
Matt Zigler
Yeah, yeah, Okay. I want to talk about some individual names just because I think they are. They're interesting in how inherently complicated they feel to me, in many cases. I want to start with Apollo because Apollo is one of those companies that we talk about. We just went through all these, the private credit shenanigans of the defaults and bankruptcies and the finger pointings at BDCs and things. But Apollo is like, you can't just say Apollo and mean one thing. That is like a thousand businesses in one. How do you even begin to tackle a business like an Apollo? I love this episode.
- [46:42]
Matt Russell
For the record, I find the right guest is the real answer because they can usually shape that. But what, what we ultimately try to do and what I try to do as a host is my goal is always to try to understand the thing that drives honestly, the stock the most. And there's usually a variable or a metric that is the number one thing. And for Apollo, I would say that's assets under management. You know, that. That is a fixed fee business. They're getting a percentage of those, you know, each year. That's reoccurring revenue that's going to be valued higher than whatever they generate on the profits. That just so happens to be, you know, something that's grown materially over the past 10 years since their IPO. And what went into that? How did that happen? What are the ways that they're going to continue to evolve that? So finding the right guest who can tell the story around that in terms of, you know, who the key players are, whether it's the management team or otherwise, what else was going on around the market, you know, getting into the insurance game or finding different pushes to grow this business, and what creative ways did they move the needle on that metric? And we could not even talk about the specific metric that much throughout the episode, but all of the stories tend to, you know, revolve around that thing. And I still think that's. That's probably true with most businesses. Maybe it's one or two metrics, but usually there's a single thing that's the most important thing that's going to drive it in the future. And figuring that out and then backing up and figuring out how to tell a story with a narrative arc is the next step.
- [48:32]
Matt Zigler
All right. Another business that I find it feels like they should be simpler than they are. And I'm amazed by this is Home Depot and particularly I think because there's Home Depot in the phase of the building out and setting up all the stores, then there's Home Depot in the phase of the financial crisis crisis and what they do after the housing crash. What are some thoughts or takeaways from what should be a boring all we did was kill like a bunch of mom and pop hardware storage story, but it's not that at all.
- [49:06]
Matt Russell
Yeah, well, I loved that episode because it really explained to me why I enjoy the pain of going into a Home Depot asking for help for a certain tool and being shamed for asking. Absolutely shamed. Emasculated to the uncle.
- [49:24]
Matt Zigler
I'm so happy it's not just me.
- [49:27]
Matt Russell
It is like that is their job is to make me feel like a total dummy. And I for some reason choose to still go there rather than Lowe's because I feel like I'm getting the right answer. But what it all pins back to is they shifted their focus to the right customer base, which is the professional. And the professional is a better customer than you and I. They just are going to bring in more business. They're going to have bigger ticket items that they're buying. They're going to buy on a more frequent basis. They're usually picking up at the same time in the morning, very early or you know, on a per need basis so you can build a much better business around them. And I thought it was really interesting to kind of understand like that shift in nature towards focusing on the professional and then getting smart just around like the operational execution and again the financial hygiene of like you don't need a million of these stores everywhere, you know, within 10 miles of X percent of the population is often the right strategy. Keeping it bare bones, you know, just like a Costco warehouse. You don't need to fancy it up, keep it clean. But those two things stood out to me is like understanding who the right customer is and how to go after them can happen even for really, really big and successful businesses. You can make those pivots. And it's like if I were to draw like what's the pattern with AI? Well, it's like the enterprise sale for AI into enterprise businesses trying to get a ton of licenses, you know, negotiate these bigger deals, which it's amazing what they're doing with consumers, but that will be very sticky and if they can get ingrained with them, that can actually make it more likely that they're going to be around in the future if it is a winner take all model market because, you know, companies will get ingrained with their system. So it's like, it's just kind of interesting to, to think about those parallels.
- [51:28]
Matt Zigler
You've inspired this thesis that I'm still developing in my brain. So like, all good, half developed, half baked thesis. I'm going to throw this on the table right now. Yeah, well, so I think like the AI problem is how does AI figure out how to become Home Depot and not Radio Shack? Because, like the nerd shaming felt different than the contractor shaming. And there's a really fine balancing act between understanding who those clients are and then the right way to shame them and know they'll keep coming back and you'll have that dominant position. And I think AI is in a really tricky spot right now of where there's a lot of Radio Shack style shaming. We haven't upgraded to, to a Home Depot contractor level shaming. And I think that's a status game they have to figure out.
- [52:09]
Matt Russell
Yeah, it's, it's one of those early industries where all of the conversations tend to be these really high levels, really deep thinking. And I find that I went through this period of time where I just found people that, you know, had use cases that were on a similar point on the ladder to me. And it was like, wait a second, I don't need to be involved in these incredibly technical, complex discussions which I can read here and, you know, here and there, but if I want to actually learn more about AI, why not just find other people that are using it in, in creative ways and create groups with them? And, and that, that's kind of a tangent. I, I still like your theory, but.
- [52:48]
Matt Zigler
Yes, no, but a related tangent because that was my experience too. I was like, until we started using it on the podcast and the YouTube channel. So we started using it in other areas. Then it was my functional use case with people who are working on the same types of problems, which felt a lot like, you know, building a stereo or something in 1994 and going to Radio Shack to get some weird connection you hadn't heard about or fancier speaker cables and things. And you're like, oh, this is where I can talk to the nerd and he's going to be nice to me versus this is where, like, what do you mean? You don't know if it's a quarter inch or an 8th inch jack or whatever?
- [53:22]
Matt Russell
Well, I can't tell you the answer if you don't know you're just gonna.
- [53:26]
Matt Zigler
Oh God, yeah. Love that. All right. Ge. GE is also a notoriously only because I feel like I started learning about businesses and GE was still cool, great and the epitome and you read the Jack Welch stuff and whatever else and then they become the punching bag for so long and you did a really great breakdown of GE and trying to just parse them through the entire cycle. Takeaways from ge, how do you think about them?
- [53:55]
Matt Russell
It's made me probably overly terrified of any businesses that are growing with credit, you know, really fueling them. And you're seeing this more in certain parts of the E commerce market internationally obviously with Buy now, pay later names where you just become so sensitive to cycles. And I'm sure that I'm oversimplifying it, but that, that was one takeaway. But I think the more interesting thing is, you know, just in some of the themes we were talking about before, what a great management team can do. So Larry Culp stepping in after. There were, you know, several failures, you know, to, to succeed Jack Welch and basically taking this conglomerate that was dated, that didn't really intertwine the right way, being a smart capital allocator in the sense that not only deciding what assets to say sell off to save the company, shoring up cash, stilling the cost discipline, understanding the market was going to value this business more in the parts rather than the sum of the parts. So separating these different businesses with healthcare, with the power business, with aviation, now standalone entities, and the success that those companies have had since then is remarkable because they're bigger than the, you know, original conglomerate. GE was at its peak. If you were to take them and combine them, which I think is quite notable. But seeing how he was able to do that at the same time as adding this cost discipline and then turning around the revenue model, at least for aviation and for power into being these reoccurring again services driven razor blade, razor. Razor blade models and being really thoughtful about the discipline around new contracts. You know, how they're going to take the growth that's coming towards them and pursue it. And it's just very interesting to me because right now you have this GE power business which was the absolute thorn for GE from 16 through 20. I mean, Larry Culp's predecessor was basically booted out of the company because they couldn't know, plug the hole that, that the power business was causing. And now this business looks to be one of the bottlenecks for AI buildout, you know, in terms of power and gas Turbines and how quickly they can build them. And they're being very thoughtful about not going after this irresponsibly. And there's so much to learn from the case study of what he's done. Then you combine that with the case study of the original GE and you basically have a full graduate level business program, you know, all in one through, through this company's history.
- [56:39]
Matt Zigler
Yeah, you, because you literally have, you know, good to great to God awful to good enough to maybe great and back again. All right, I'm going abstract next because this is one of those ones where I almost. You almost don't even want to try. But you tried SpaceX. You almost don't even want to try because it's so big and abstract and far away. And I mean, Star Trek is literally like what we're talking here. How do you even. The audacity, sir, of going after SpaceX.
- [57:13]
Matt Russell
That was fascinating to me and I would put it simply, Elon, I was not familiar with your game because what they built there is a real business. And doing everything that they did with, you know, the launches and getting a rocket to be able to come back and land beyond belief. And that is what all of the focus should be on. But understanding how expensive it was to do that, how risky it was that you were going to have issues from time to time and that was going to be extremely costly and figuring out a way to build a cash cow that could support at least some of the capital requirements that you're going to have. And rolling out starlink was fascinating to me because I didn't appreciate, you know, what that business represented within SpaceX and then understanding that they are now the capacity to get into space. So if you want to put something up there, you need SpaceX capacity. There's going to be more that comes online in the future. But at this point they are like the.
- [58:25]
Apple, you know, app store layer to space. And for all these companies that want to go out there, SpaceX has a lot of leverage in their ability to take economics or some type of share, especially because they're sending their own stuff up there. So it's this really interesting.
- [58:45]
Paradigm shift where they are this controlling layer that is not technology driven. It's not like, oh, you need this to be compatible with Microsoft Windows or Apple iOS or, you know, the web and the mobile. Like all of these shifts. Now we have one in space. That's, that's fascinating to me and I just did not appreciate how the business itself was actually running in a thoughtful way. It wasn't just this idea of something that could eventually go to Mars there, there's a real business inside of it already. Whether that supports the valuation, who am I to say? But it made me really appreciate what's going on much, much more.
- [59:25]
Matt Zigler
Totally agree on that. And it's amazing to see the pairing of the story of Go to Mars with all these viable businesses stacked underneath. That was hard to appreciate until you actually hear somebody break down all those layers and being like, oh, no, no, this, like, if you want to put this there, this is just how you do this now. And it's not quite Amazon prime for satellites, but it's not that far off.
- [59:51]
Matt Russell
Yeah, yeah, it's very interesting to see how much of the capacity that they theoretically control. And you can't really launch that many, you know, rockets. It's not like there's only so many launch sites, seasons that are, you know, comfortable enough to launch in and, you know, weather conditions, all that. So it's very interesting to think about.
- [60:14]
Matt Zigler
So one of the things that's been, I mean, we talk about it way too much on this channel or just the right amount, if you ask certain people. Valuations, margins, the Cape ratio, blah, blah, blah, all this crap. The point being, do you think with these lessons, because these lessons are being learned by business managers everywhere, it doesn't mean they're, they're expertly, they're not executing at this, at the top level, at every single business across the board. But is there a case that business quality has just by and large actually improved in some, maybe not permanent way, but like a new sustainable plateau of quality?
- [60:52]
Matt Russell
I think.
- [60:55]
You have seen, like, the software is eating the world model of software businesses coming out with 90% gross margins.
- [61:06]
Matt Zigler
I haven't still gotten over Jimmy eating the world, let alone software eating the world.
- [61:10]
Matt Russell
So, yeah, great, great reference. Yep. Little brother, right? Lead singer's little brother, which Jimmy. That's right. So I think that that is kind of one example. And we're actually seeing a threat to software and those 90% gross margins with AI and what it can do and kind of creating this competition and whether they can stay in that space. That's the Gavin quote that I referenced earlier. So that's kind of an interesting thing. There's this other side of the equation where you have kind of the private equityization of the world around us, where everything has, you know, gone away from being mom and pop and now has turned into an institutionalized, professionalized business where the costs are very tightly managed. You know, the revenue is, is very thought out. In terms of the price that you're getting and how much you're paying and making it reoccurring. So I do think in general, it makes sense that, you know, over time, the business world is more competitive. It's run by more competitive operators, more thoughtful operators. So in general, the business quality would go up, But I think that.
- [62:24]
The. The counter to it would just be. There is always going to be competition, and competition is now easier in my mind, to create or get off the ground with all the tools that are available. So I think we've seen how many incumbents have fallen and yes, you have the Mag 7. Now, if I were, you know, if you were to ask me would I bet on those being the top, you know, seven companies in the world in 20 years, I would say no, you know, by a pretty wide margin. Just because there is always something evolving coming out new and attacking those. And many of those companies are loose with, you know, their costs and whatnot. And it's hard to evolve that quickly. So I think short answer is like the bell curve would suggest, yes, the quality of businesses has gotten better and better and more institutionalized. But I don't think it's this, you know, permanent period of time where as consumers, we are stuck, you know, with these businesses that are run, you know, at our detriment.
- [63:27]
Matt Zigler
People will always find a way to do something more daring and more stupid. And that cuts in both directions. Right.
- [63:32]
Matt Russell
We're risk takers, so that's.
- [63:35]
Matt Zigler
Yeah, somebody's got to stand on that roof and declare they're a golden God. You've said that the value of business breakdowns, and I think it's inside of that mag 7 in the next 20 years point you just made that the value in business breakdowns lies in pattern recognition, not stock picking. I think that's an insanely useful point for how you're thinking about this. Explain what you meant by that.
- [63:59]
Matt Russell
Yeah, there's one thing that I've taken away from the show is that pattern recognition is very real and somebody it might have been. Bill Gurley said recently, like, you know, an amateur calls it their gut feeling, a professional investor just calls it pattern recognition, and that makes all the difference. But I think the more examples you see, you start to be able to connect dots for other companies that might be experiencing this. And for me, the biggest value has been, okay, I'm mostly looking at companies that have performed incredibly well over the past five or 10 years. And there's a reason why an investor wants to talk about that. They've Likely owned it. It's a success story. They can kind of cement it. I'm less interested in that. It might still have room to run, but I'm more interested in what are the lessons from that and how can I find other companies that are like that at an earlier stage. And that is something that more recently I've actually been able to do. And it's been very interesting to see how not only am I seeing the pattern, but it's a market and other investors are looking for those patterns as well. So even if you believe, oh, it's this fluffy concept of pattern recognition, what does that really mean? Well, the market is run by, you know, people who are looking for patterns and that's how it operates. So as, as they became more obvious, there's more appreciation that's reflected in the multiple. So these are things that really, you know, adjust the dynamics. So I think for all the talk about, oh, you know, are you giving me good ideas to invest in? You know, this thing has run so much. That is not the point. Like, yes, you can look at this as a, you know, buy or sell candidate, but you can also just take away, you know, what were the ingredients here? How can I take that as a download and then use that when I'm looking elsewhere? And that our last question is always know, intended to be, what are the lessons you can take away and apply elsewhere as an investor? And that's very much the point. It's like if, if investing is a pattern matching game, that there should be lessons here that you might be able to look for elsewhere.
- [66:06]
Matt Zigler
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- [66:42]
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- [66:51]
Matt Russell
And breathe.
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- [67:03]
Matt Zigler
1-800-Contacts.
- [67:06]
Not for Schadenfreud's sake, but also not, not for schadenfreude's sake.
- [67:12]
Big missteps, big mistakes. Any in particular? We were like, oof, that hurts.
- [67:20]
Matt Russell
There were a couple companies where we agreed to do breakdowns on them.
- [67:27]
More often with management teams that were not great ideas. Like, we, we don't want to be a propaganda machine. I understand, like, it's always going to be a positive commentary, but particularly when it's coming from a management team that just feels like unnecessarily positive and they're oftentimes going to have more restrictions.
- [67:48]
Matt Zigler
At least convince your friend to come tell me.
- [67:50]
Matt Russell
Like, exactly.
- [67:51]
Matt Zigler
Yeah, right.
- [67:51]
Matt Russell
Yes. Somebody who, you know, has a different bias. There's still going to be bias, but a different, you know, set of circumstances. So those, those would be the main things.
- [68:05]
And then, you know, there's some companies that I think are, are fascinating and I want to learn more about. And I dive in and I think to myself, I didn't. I kind of missed the point. You know, like, I should have asked about this. And so that's the other thing. So that's more of a personal misstep. But it's, it's who we talk about. We try to have, you know, certain guardrails about market cap size, different things like that in place to protect from, you know, pumping or, you know, illiquid securities that we're featuring. But for the most part, I, I feel very comfortable with what we've published.
- [68:42]
Matt Zigler
All right. Based on all you've learned, a single most important listener you'd want listeners to take away for breaking down a business, you got one for us, I think.
- [68:52]
Matt Russell
It'S, understand that most important metric or, or variable, like the single most important thing. Can you figure that out for this company? And particularly if you're looking at it as an investment, you know, for that stock, what is that thing? And then what drives that thing? And how do I get, you know, understand everything around it? Because there's going to be a ton of noise and there's going to be, you know, 75% of the information that you take in about the company will not be about that single thing. So the more you can focus on it, that is going to set you up well, and the sooner you can find it, the better. I think that's another kind of lesson is the sooner you can find the most important variable. That's a good signal just for you in terms of your awareness of the market and different businesses.
- [69:41]
Matt Zigler
Matt Russell, People want to learn more bug you on the Internet where you want to send them.
- [69:46]
Matt Russell
Twitter is probably the easiest spot and it's my last name first name. So at Russell Matt, Very creative. You can find me there and that'll link to anything interesting that I'm doing. Otherwise.
- [70:00]
Matt Zigler
All right, start on Twitter, don't call it X, bug them there. Find business breakdowns wherever you get your podcasts. This is Excess Returns, like subscribe all the things below and we are out.
- [70:11]
Matt Russell
Thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess returns network@excessreturnspod.com if you have any feedback or questions, you can contact us@xsreturnspodmail.com no information on this podcast.
- [70:31]
Sponsor/Ad Voice
Should be construed as investment advice. Securities discussed in the podcast may be.
- [70:36]
Matt Zigler
Holdings of the firms of the hosts or their clients.