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- [00:00]
Eddy Palmian
Hello everyone and welcome to Investing by the Books, a podcast by Red Eye. I'm your host Eddy Palmian and with me here in the studio is my friend and colleague Niklas Sevos. How are you today?
- [00:10]
Niklas Sevos
I'm great. It's been a few busy weeks with the Q3 reports coming out and a lot of reading these last weeks, but we're getting out of this busy period and approaching Christmas, so I'm fine.
- [00:21]
Eddy Palmian
In today's episode of Investing by the Books, we have the great pleasure of speaking to Adam Cecil. Adam began his career as a newspaper reporter before taking his research skills to Wall street in 1995. He started at Sanford C. Bernstein and later became a mutual fund manager for Davis Selected Advisors in year 2000. Three years later, Adam launched his own firm, Gravity Capital Management, where he has achieved market beating returns. In 2022 he published his first book, where the Money Value Investing in the Digital Age, which is the book we will talk about here today. And what is it about?
- [00:56]
Niklas Sevos
Niklas so I mean Adam makes the case that there's been an evolution in value investing from relying on asset values and metrics such as price to book and price to earnings to studying the long term earnings power of businesses. And so Adam's approach is really to apply value investing to investing in technology companies. And as we will discuss further with Adam, the this includes a different approach in how to evaluate the moat of a business and also how to make sensible adjustments to the financials in order to understand the true earnings power of the business. And with his approach, Adam makes the case that traditional GAAP financials are not giving investors the right figures.
- [01:37]
Eddy Palmian
And how does the book relate to our equality rating?
- [01:39]
Niklas Sevos
At Red Eye we have this framework, business people and Financials. And Adam has his framework Business, Business, Management and price. And I believe this is quite similar to our Red Eye rating, but we have a quite broad list of checklist questions while Adam has a more condensed framework and includes the questions he believes are most relevant to evaluate the strength of the business and financials.
- [02:05]
Eddy Palmian
Where the Money Is was published by Avid Reader Press in May 2022 and it has received praise from legends like Bill Ackman saying that it's one of the best books I have read on investing in years. We are excited to have the author on the show today. Here comes our conversation with Adam Cecil. Hello Adam and welcome to Investing by
- [02:28]
Adam Cecil
the Books podcast Eddie, thanks for having me.
- [02:32]
Eddy Palmian
And where are you located today?
- [02:34]
Adam Cecil
New York City as usual in my office in Chelsea.
- [02:37]
Eddy Palmian
Manhattan looks nice. And to begin, what was the Spark that got you started with investing?
- [02:45]
Adam Cecil
Well, it's a bit of an interesting story. As I told you offline, I started as a journalist, so I'm familiar with what you guys do. And I enjoyed being a journalist in my 20s. But when I was turning 30, 25 or so years ago, I was getting frustrated with journalism. The pay was terrible, the hours were terrible, and the people were very grumpy. So I enjoyed journalism. I enjoyed righting wrongs and function, you know, helping a democracy function. But we were getting ready to have a family and I wanted to earn more money and I wanted more stable hours. So I had a friend who went onto Wall street from college when I went on to journalism, and he said, look, you know, being an investor is very much like being a journalist, especially me. I was an investigative reporter. You know, you have to read financial documents, you have to interview people, and it's really the synthesis of the document research and the human research that makes things work. So I decided to try Wall street and I learned that my friend was really right that, you know, investing is a combination of document based research with human research. And the parallels with journalism are really quite startling.
- [04:05]
Niklas Sevos
And as a background, you have written this great book on value investing. And I mean, there are many books on value investing. So why did you decide to write another book on the subject?
- [04:18]
Adam Cecil
Well, Nicholas, because I wouldn't write anything that I didn't think was exceedingly fresh and needed. You know, I agree there's been a lot written about value investing, and so why would I add another book if it didn't have an unusual or different perspective? But it came out of my own experience in the last, say in the mid decade of the 2000 and tens, where my traditional value investing methods, which I'd learned my first job after journalism on Wall street was at Sanford Bernstein, which was sort of the, the apex of value investing. And I'd learned all these tried and true value investing techniques, you know, that had been pioneered by Ben Graham and then passed down to Warren Buffett and were flourishing in firms like Sanford Bernstein. And then, you know, around middle of the teens, these methods stopped working. And I really had to ask myself, you know, why aren't low price to book ratios working? Why aren't low PE ratios working? And what I found was that this technological revolution that we see around us as consumers had really filtered in very quickly and dramatically into the stock market. And all these great tech companies were very valuable, but didn't look valuable when you use traditional value metrics. So I had to recast what I understood as a value investor, both theoretically about value investing, but also practically the tools that I use to analyze companies. I had to recalibrate all my instruments. And, you know, then Covid hit and I had a literary agent because I wrote for Barons and Fortune. And she said, well, you should write a book about it. And at first I said, no, I don't want to write a book. And then Covid hit and I had a lot of time on my hands. So it was my Covid project. So it's. It's my attempt to help other value investors think through the digital age.
- [06:22]
Eddy Palmian
And in the book, you write that you are inspired by Peter lynch and that investing is too important to be left out to the experts. So I'm curious to hear, who did you write the book for besides, like, value investing in general?
- [06:35]
Adam Cecil
Well, I wrote it. I tried to thread the needle, Eddie, between amateurs and professionals. I really wrote it for both groups. You know, I mean, professionals like me who are steeped in value investing concepts. I think, you know, I've had a lot of good feedback from pros saying, gosh, you really helped me articulate what had been sort of in the back of my mind or in the front of my mind, but I couldn't really synthesize. So, so pros I wrote it for to who were struggling with the same things as I was. But also I wrote it for amateurs because amateurs need help with investing. And even if they're not familiar with value investing, you know, there's a. There's an interesting generational divide going on right now that I talk about in the book, where older investors, even if they're just amateurs, they understand, you know, the, the importance of compounding and buying and holding and letting the stock market build your wealth. If they've been in the market since the 80s, they've had stocks that have done very well, but those same stocks that have done well for them, like Exxon and Wells Fargo and so forth, are no longer doing well. So. So they understand the stock market, but they don't understand technology. Whereas younger people are the converse. They understand technology. You know, they have an edge over older people like me because they were born with Google and born with Apple, but they don't understand the stock market. In fact, they're quite suspicious of it because we've had, you know, several crashes here in their lifetime. If they're millennials, we had the dot com bust and then we had the great financial crisis and then we had the COVID crash. So they're quite scared of the market. So I was trying to familiarize them with the market because the market still is a great place to build wealth. I was trying to do that for young people and then for older people. I was trying to familiarize them with technology because there are many of them, including I, are intimidated by it.
- [08:37]
Niklas Sevos
And in the book, you write about this evolution from Benjamin Graham to Warren Buffett, and now you explain the differences to how to value companies in the digital age. So can you talk us through the evolution and mean, it's been quite a long evolution. I mean, Graham started in the 20s, 30s, so, yeah. Tell us about the beginnings and to now.
- [09:01]
Adam Cecil
Well, I'm glad you picked up on that, Nicholas, because I really love history and all history and financial history is quite interesting, and value investing history is especially interesting. You know, Ben Graham, as you said, started actually in the teens a little over 100 years ago as an analyst on Wall Street. And it was a crazy place back then. I mean, if you think it was, it's a speculative place now, as I write in the book, you know, one of his first jobs on Wall street was taking bets for who would win the 1916 presidential election. So you can't do that now on Wall street. That's illegal. But it was perfectly legal for a reputable firm like the one he was employed by to take bets on who would become president. So it was a real casino back then. And he didn't, he didn't have the luxury of being able to, you know, play the casino because he, his father had died and he was responsible for supporting his mother and his siblings. So he needed a method that could sort of reliably produce wealth. And so he came up with this, you know, method which we now call value investing, or at least the first iteration of value investing, whereby, you know, he, he only cared about hard, tangible assets on, in a company, which was understandable at the time because, because it was such a crazy place. You know, you, you really couldn't tell whether a management was reputable. You couldn't really tell whether what they were earning was, was what they were earning. You know, the auditing was very spotty, and the SEC had not been invented. He actually helped invent the SEC after the Great Depression. So he focused on things that you could measure, inventory and accounts receivable, factories, things that you could, you know, tangible assets that you could touch and feel. And he, his whole, his whole, you know, his whole method was sort of, you know, I want to buy a company that's selling for less than the liquidation value. You Know, if we took this company and we sold all its assets as auction and paid its liabilities, we would still have more left over than the stock price. So it was a very conservative, very asset based, tangible asset based approach which was appropriate for that era. He taught this system to many, many students at Columbia Business schools and professors, professor. And in 1951, you know, his best pupil ever showed up, and that was Warren Buffett. Buffett, too, had been seduced as a teenager by speculative sort of analysis. And when he discovered Ben Graham's system, you know, he had a sort of a religious conversion. Because here was a system that you could use to, to systematically beat the market and not. Not gamble and not sort of hope that things would go well, but a system that you could impose on the stock market to produce reliably good returns. So he started with that system, but as he progressed as an investor, what he saw was that America was an extremely different place. It was no longer a casino in terms of the stock market. The SEC was, you know, firmly established. Auditors were firmly established, and you could start to rely on the financial statements of companies. And moreover, after World War II, America had a huge boom of wealth and stability and the middle class started traveling. And so he started saying, well, wait a sec, this, this asset based, asset based method was a great place to start. But really, the franchises that can generate money for many, many years, profits are much more valuable than a liquidation company. You know, much more profitable than what came to be known as a cigar butt, where you pick up a cigar butt off the street and puff it for a couple puffs and throw it out. That was Ben Graham's type investing. He said, well, wait a sec. You know, Walt Disney has this great stream of profits that they get from their movies and their theme parks and their characters, but you can't find any of those assets on the balance sheet. You can't liquidate it, but it's very valuable, you know, American Express, you know, which was Travelers checks and credit cards. Here again, not a lot of assets, but a very valuable, trusted franchise that could earn a lot of money for many, many years. So this was what I call value investing 2.0. This was the evolution of Graham's value investing 1.0. And, you know, it's worked extremely well. And the problem that I ran across, you know, geez, seven or eight years ago was, you know, value 2.0 is not. Was. Was not working terribly well in a couple ways. First of all, the franchises that Buffett loved, many of them have sort of now had their best years behind them. You know, he loves banks for example. And banks I think are kind of dinosaurs in the digital age. And they make most of their money by taking advantage of people who don't, are too lazy or too ignorant to move their deposits to higher, higher interest bearing accounts. I just moved my bank from Chase bank, which is one of the great rent seekers in the world and I'm, you know, I just got my first month's interest payment for, for my cash balances and I was just elated. So he loved banks, he loved media companies. You know, obviously traditional media like ABC has just been decimated by the, by the digital age. And then in terms of specific technique, you know, many of these digital companies have looked expensive all the way up on a constant PE basis, on a current PE basis, I should say, which is how Buffett really likes to value companies. What are they earning now and what am I paying? Well, if you'd applied that metric to Amazon or Alphabet or Adobe or any of the dozens of digital companies that have gone up multiple, multiple times in the last 10 or 15 years, you would never have bought them. So we need to recalibrate our specific value metrics on how we analyze companies. And that's what I call value 3.0. So that's a very long answer, but as I said, I like history.
- [15:51]
Niklas Sevos
And I mean to summarize that a bit is that, I mean the fundamental analysis, the business analysis isn't changed. It's the metrics that you use to value the companies and maybe how to think about the businesses as well in different ways. But, but it's, I mean, I feel myself that the techniques that both Graham and Buffett used are still relevant. So if we go in a bit more into the digital world, just explain a bit more around why we need this new framework, these new metrics and maybe go in a bit into the metrics that are actually relevant in digital businesses.
- [16:32]
Adam Cecil
Well, I think it's actually quite simple Nicholas, in the sense that, I think I say in the book that Amazon's average current price to earnings multiple since its history as a public company has been 100 and or 200 times, let's say, I think it's 200 times. You know, so it's been 10 times more expensive than the average stock in the S P500. So looked at from a strictly value based perspective, you never would have bought Amazon. And yet it's gone up, you know, what, you know, 15,000 times or something like that. Alphabet, you know, the parent of Google is, is Similar. So, so, you know, as I say in the book, you know, either these stocks are just horribly expensive and are, you know, are gonna flame out like the, like, you know, like the dot com bust, which seems unlikely given their market dominance, or we're looking at things, you know, the metrics we're using are outdated and need to be updated. So I think it's the second explanation. And you know, central to my value 3.0 sort of framework is this concept of earnings power, Nicholas, where, you know, the financial statements say that Amazon is earning X and Alphabet is earning Y. But if you start working through the numbers, it's clear that they're, you know, that their economic earnings, that their earnings power, their ability to generate earnings is much higher than the reported financial earnings. And there are a number of reasons for that. You know, two main reasons. The first main reason is they themselves are reinvesting so much in their business. You know, JP Morgan just does the bare minimum of marketing investment, the bare minimum of research investment, because they're a mature business so they can bring all their cash down to the bottom line. They're in harvest mode. They're like, you know, they're like an apple orchard in the autumn, but Google and Amazon are like apple orchards in the spring, so it doesn't make sense to harvest their earnings. So they're, they're reinvesting earnings that otherwise would be coming into profits, but it's not appropriate for them to do so. And related to that, the second reason that their earnings, reported earnings are less than their actual earnings power is GAAP accounting is outdated. The accounting, the way we score for profit and loss, which for people outside the industry, they think, oh, profit is profit and loss is loss. No, that's not true. How you measure it matters a lot. And the measurement system, which is called GAAP, Generally Accepted Accounting Principles, was created in the 1930s. And you know, obviously we're not in a, an economy that looks like the 1930s. You know, General Motors and US Steel was created for industrial companies. So it, it favors in many ways industrial companies and it doesn't fully contemplate the rise of these digital companies. So it penalizes their profit and loss statement in ways that we can adjust so that when we adjust Alphabet and Google or I'm sorry, and Amazon and all these other companies run down the list. Adobe and Workday and all these companies, they look much more reasonably priced than they, than they would seem to from a traditional value perspective.
- [20:16]
Eddy Palmian
So if you could make one change of the GAAP accounting rules, what would that be.
- [20:23]
Adam Cecil
Well, if you'll allow me, I'll make two changes, okay? Because I don't want to pick between one or the other. But, you know, and they're related. You know, basically when you build a factory, you get in general 20 to 25 years to depreciate that factory. So, so if you spend $100 million to depreciate that factory or to build a factory every year, you recognize as an expense 4 or 5 million dollars. Whereas if you as a tech company spend $100 million in research and development every year, you have to recognize $100 million of expense in research and development. So as I say in the book, two companies, let's say they both have $100 million in revenue, one bill is a hundred million dollar factory. They have 95 million dollars in profit, right? Because they've only had to expense 5 million of that hundred million dollars of factory expense. Whereas the tech company has had to expense $100 million of research expense. So they show no profit. So same revenues, same capital expenditures, but one shows $95 million of profit and one shows zero. It's quite extreme. So I would, you know, in this day and age, there's no question that research and development has a longer life than one year. But the accounting rules say no, no, any research and development expenditure has to be expensed. The vast majority, there are certain small exceptions, but not 97% of all R and D expenditures are expensed in that year. And I would change that, number one. And related to that, selling expenses for a company are also expensed for one year. But if a customer uses a product for many, many years, then my, my, my expenditure to market and attract that customer actually has a life, you know, a lifetime value of longer than one year. Its value is multiple years. So, you know, as I say in the book, many, many tech companies use this, you know, lifetime value to customer acquisition cost metric. So, you know, I spend $200 on a customer acquisition cost and I get, you know, $1,000 of revenue from him, then you know, that's a sort of a return on capital calculation that's appropriate. But here again, the financial statements do not allow you to do that. So the tech companies themselves are making these adjustments to conform to economic reality. And I think that, you know, you know, gap should, should get updated in those ways because it is economic reality.
- [23:26]
Eddy Palmian
And here in Sweden and most companies in Europe use IFRS accounting instead. What is your view on that and how that differs?
- [23:35]
Adam Cecil
You know, I'm not terribly familiar with ifrs. I I, I only own a couple of European companies, although I did recently do start doing research on a what looks like a very fine Swedish company called Evolution, which I'm sure, sure you're more familiar with than I am. But you know, my, my impression is that ifrs and Gap are pretty close on this, on this measure, that they, they both penalize, you know, marketing and R and D expenses and favor industrial company expenses.
- [24:09]
Eddy Palmian
And in your identity as an investor, it's very clear that you are in the, in the value camp. And in the book you say that you, as a value investor, you disdain so called growth investors and that you are even more disgusted by momentum investors. So I'm curious to hear, why do you not want to consider these approaches as part of your investment strategy?
- [24:28]
Adam Cecil
Well, precisely because for the same reason that Ben Graham turned his back on all the speculative methods 100 years ago. Because there's no discipline, there's no system, there's, there's no, there's no framework. You know, it's, it's just kind of luck. You know, you just sort of, you know, with growth or momentum investing, you're just saying, you know, this is a good company. You know, I don't care how much I'm paying for it. You know, I get, that's growth investing. This is such a good company, I don't care how much I'm paying for it. Well, that's sort of commonsensically absurd, right? I mean, it's like saying, you know, take me to a, the, the most beautiful apartment in, in Stockholm and, and then tell me how much you're selling it to me for. And you say 5 billion euros. And I said, great, sold. Like, I don't, I don't check like what the market is and what the second biggest apartment, best apartment is selling for. And it's, it's crazy not to pay attention to price. And then momentum investing is even worse because I would say, yeah, I'm going to buy that 5 billion dollar, 5 billion euro penthouse because I think that in a month I can sell it for 6 billion euros. It's the greater fool theory. So neither of those approaches have worked historically and it's no big surprise why they haven't because there's no rigor, there's no system, there's no discipline. So value investing needs to be updated. But as Nicholas was saying, the core of it is intact.
- [26:13]
Niklas Sevos
And you call your framework bmp, which stands for Business management and price, where you define certain checks to use for each section. So maybe we can start with the business section. How do you evaluate the quality of a technology business?
- [26:30]
Adam Cecil
Well, yeah, you're right, Nicholas. I lay out in the book, you know, that basically all that matters, you know, from a big picture perspective, is the quality of the business that you're considering, the quality of the management team that's running it, and then the price the market's asking you to pay. Right.
- [26:50]
Niklas Sevos
So,
- [26:52]
Adam Cecil
you know, in the way you evaluate the quality of a business, whether it's tech or otherwise, is, you know, does it have a competitive advantage? Does it have something special that keeps competition away? Because, you know, capitalism is, is, is so toxic to profits. You know, most people who don't understand capitalism think, oh, everybody makes a lot of money and it's actually not true. You know, capitalism, you know, if you and, and, and, and Eddie and, and I were competing against one another, we would basically be trying to beat each other's brains out to take market share and win the customer and so forth. And if none of us, if neither none of us had a competitive advantage, we would just compete each other away and we would lower prices and, and we would innovate for the customer. And the big winner would be the consumer. Which is why capitalism in general, for all its many faults, works because we compete very hard to serve the consumer. But none of us, you know, we, we bet all of us we make just enough money to stay alive, but we don't prosper. So if you have an edge, then you really prosper. Then you can earn excess profits for many, many years if you have an edge. So Google, with 95% share of search, has an edge and they are making excess profits because everyone comes to them for search. And the way to evaluate whether a company has an edge is actually quite simple, which is to say, have other people tried to come at Google, for example, and have they succeeded or have they failed? So usually, you know, a company gets a hot product and then companies say, oh, that's a good product and they're making a lot of money. I'm going to attack them. And prices come down and profits come down and here again the consumer wins. So, you know, selfie sticks, you know, they were hot and the company that made selfie sticks had a good couple of years. Then everyone imitated selfie sticks. And check out GoPro, the stock price of GoPro over the last five or 10 years. It does not look good, but Alphabet stock price has done great even with this 2022 correction, because it's very hard to replicate an excellent search engine and it's very Hard to take people away from, from habituated behavior. Once you have a search engine and you're used to it and it works. So obviously Microsoft tried with Bing, they spent I think 10 or 15 billion dollars to beat Google and they have a single digit market share. Amazon tried to do search and they hired the guy who wrote the book on search for, for yet from Yahoo. And two years afterwards he quit to join Google. So you know, Bezos says, you know, treat Google like a mountain. You can climb it but you can't move it. So and if Bezos said that, I mean he's invented two industries, right? He invented E commerce and he invented cloud computing. If he says that, then you know, it's probably a, got a pretty, pretty big advantage. So these are the businesses you want to look for. Businesses where big, well established, intelligent competitors have tried to take their market and failed.
- [30:37]
Niklas Sevos
That got me thinking about this term. If you can't beat them, join them.
- [30:42]
Adam Cecil
That's right. It's a variant on that exact phrase actually. Yep.
- [30:50]
Eddy Palmian
And in the book you mentioned several competitive advantages or moats and we can't go into all of them, but we of course recommend everyone to buy the book to read all of it. But one thing that I thought was interesting is that you consider brands among the most vulnerable. Moats and network effects in many ways as the most powerful. And we talked to Mark Mahaney, the Internet analyst and author behind Nothing But Net, and we discussed his book in episode 29 and some of our listeners might remember that we talked there about his thoughts about network effects, that they might be a bit overrated and that it's easier than expected to actually out compete digital businesses in that sense. What are your view?
- [31:34]
Adam Cecil
I don't know. I mean, I can't think of any examples where network effects have been easily competed away, can you?
- [31:41]
Eddy Palmian
I think the example he had was like Facebook is strong, but it's been quite easy for others to actually start up.
- [31:49]
Adam Cecil
I would, you know, I, I would say Facebook definitely has, is a vulnerable business. But that's one, you know, that's one network effect business that hasn't worked. But I can count many, many more that have worked. And you know, Facebook has its own problems. I mean, first of all, you know, I never owned Facebook, I never liked Facebook. You know, he was quite cynical, Mark Zuckerberg and how he built the company. You know, he like Google is demonstrably the best search engine. Amazon is demonstrably the best E commerce site in terms of price selection, convenience. I don't think anyone would Say that Facebook is demonstrably the best social media site. Like, no one says, oh, Facebook is so awesome. Let me go to Facebook. You know, like, I like going to Amazon because they, they cater to my needs. Facebook is sort of, you know, mediocre. And so you think, see, he had the ability to make it a fantastic site, but what he did instead was he milked the business for profits. He was much more in harvest mode, much more quickly than any of the other companies. His margins were in the 40 to 50% range when Google's margins were half that. So what happens? So, you know, WhatsApp comes along and he says, oh, that's a threat. So he buys them, you know, and then Instagram comes along, he's ooh, they're doing a better job than we are. So he buys them, you know, both of which are illegal under American law. You know, I can't believe that the, the American authorities haven't yet made a case against Facebook because he says in emails, Zuckerberg, it's better to buy than to compete. And you can't do that, it's illegal. But he did that very cynically. So he, instead of trying to make his site the best, he, he milked the profits and then he bought the potential competitors. And now the jig is up because TikTok is now eroding his franchise and he can't buy them for various reasons which are all well known to us. And so what's he do? He changes the company's name and spends $10 billion on the metaverse a year. It's, you know, it's what we call in the United States a Hail Mary. You know, it's the, it's the year, it's the European equivalent of, you know, it's, it's 95th minute in stoppage time and the goalie is up in the, in the penalty box trying to head the ball in for a last minute goal. I mean, I mean, it's desperate. It's absolutely desperate. And you know, you could kind of see it coming from his behavior. So I don't think Facebook's failure is a, is an indictment of network effects. I think it's an indictment of his specific way he's run the company.
- [34:46]
Eddy Palmian
It will be interesting to see how it plays out. But a follow up on that is regarding brands. Why, why do you think they are not such a strong motor?
- [34:56]
Adam Cecil
Well, I think it's just obvious, Eddie. I, you know, I mean, the number of brands that have died, I mean, we could, you know, you could count in Sweden. Right. You could just start railing off the number of brands in Sweden that were great when you were young or your parents were great, and now they're terrible. Certainly in the States we have brands, they're very fickle and they depend on entirely on consumer taste. You know, Google does not depend on consumer taste. Google depends on fast, reliable, accurate value added search, you know, and it's free. So there's a value proposition there, a brand. There's no value proposition with a brand necessarily, with a pure brand like a consumer brand. In fact, it's the opposite. They're trying to trick you. They're trying to trick you that a Hermes scarf is worth $20,000, you know, and it costs, you know, I don't know, a thousand dollars to produce. Coke is trying to trick us that their sugar water is better than anybody else's sugar water. They're trying to trick us with the magic of marketing. Now look, you know, fair play, I mean, it's, you know, that's how you run a business. But, but in terms of a competitive advantage or a moat around a business, it's very vulnerable because it's all about who can trick you better. But now, you know, in terms of brands like of the top 10 most best brands in, in the world, most of them are tech companies. But none of them rely on tricks. Like no one, like no one like Google isn't seducing you. Like, you know, buy our search engine. It's 10 times more expensive than the next guy's search engine. But it's really awesome. It'll make you look good. No one says that, you know, Amazon, I think, is the world's most popular brand. Amazon is not sexy. You know, there's no, there's no sex appeal, there's no magic. It's just that they deliver a lot of goods to you cheaply and fast. So there's substance to that brand. There's substance. It's in, in many ways it's not a brand, it's just a, it's a, they're, they're doing something for you. And, and so people love you because they're doing something for you. Even Apple, I think, you know, the iPhone is demonstrably a superior phone. So these tech brands are much more durable, in my opinion, because they're based on functionality, whereas Coca Cola and Hermes and so forth, they're just air.
- [37:42]
Niklas Sevos
And I mean, if we go back a bit to your comment about Mark Zuckerberg, we have talked to a lot of guests who have said that. I mean, they're looking for management to our owner operators that really have skin in the game. And I mean, if you look at Zuckerberg's record, he founded one of the most valuable businesses on earth. And I mean, he did a few really good acquisitions, especially Instagram. So that takes me to the question, what do you look for in terms of management?
- [38:15]
Adam Cecil
You know, look, I mean, Zuckerberg is a very good technologist and a much smarter person than I am. So I don't mean to demean him anyway, but you know, we get to pick, you know, the very best managers. And you know, what bothered me about Zuckerberg and you know, what I look for in general about managers is, you know, how they reinvest their profits. So he did not reinvest his profits. So, you know, there's an old expression, I think it comes from an English poem, jam today or jam tomorrow. So do you want to eat your sweets now or do you want to eat them later? And he was a jam today guy. So you know, he was, he had profit margins of almost 50% in his heyday. And so I look for companies that say, I don't want 50% profit margins now because I need to build my competitive advantage. I'm not going to buy my competition, I'm going to out compete my competition by giving the customer something that they love. So I, if I were Mark Zuckerberg ten years ago, I would be reinvesting in Facebook to make it look like Instagram, essentially, right? To make it look and feel much more attractive and interactive and user friendly. That's what I would have preferred. And he would have produced less profit because he would have been spending. But then he wouldn't be in the pickle he is now. So I look for managers that are jam tomorrow. Managers like Bezos who, you know, who spent, spent, spent, spent, spent. And now who can compete against that logistics network that he's built? You know, he's now taking market share from UPS and FedEx and the postal service. Like that's pretty impressive. So I look for managers who understand return on capital, but who are also willing to take less now and more in the future. Long term, greedy, get rich slowly. That's the kind of person I look for.
- [40:36]
Eddy Palmian
And in the book you argue that business quality always has been the most important component of long term stock performance, but that it's especially important today. So why is that?
- [40:47]
Adam Cecil
Well, you know, look, there are exceptions. There are people who make, you know, a mediocre business great, but they're very rare, you know, and you know Buffett is very articulate and has been very articulate for many, many years on this subject. So he'll say things like, you know, when a tough business meets a great manager, usually it's the tough business that wins because, you know, it's like poker, you know, like, yeah, there are great players who can make a bad hand win, but it's not easy and it usually doesn't happen. Whereas a good player can take, or even a mediocre player can take three or four aces and win. Right? I mean, you just have a good hand. So here again, Buffett's quote. You know, I want to buy a business that's so good that even an idiot can run it, because one day an idiot probably will run it, right? Like, you don't want to bet necessarily on management playing a tough hand. You want, you know, you want aces, you want aces. Now, if you have aces run by a good manager, then you're really cooking, you know, then you're really, really, really cooking. So that's why, you know, it's not business or management quality. We look for business and management. If we get, if we get the two, then we're really, really doing well.
- [42:12]
Eddy Palmian
But are there any companies or situations where you consider management more important?
- [42:19]
Adam Cecil
No.
- [42:21]
Niklas Sevos
Then, then we're going to talk about the, the price and to know if the price is right. As you mentioned in the beginning, some rely on, on multiples, and in Graham's day, it was like price to book and price to earnings. And now, I mean, the conventional wisdom is to do a dcf. So what analysis do you do to know if the price is right in your work?
- [42:47]
Adam Cecil
Well, I would disagree with you, Nicholas, respectfully, that the conventional wisdom is to do a dcf, at least in the
- [42:54]
Niklas Sevos
analyst community, not in the investing community in general. I agree.
- [42:59]
Adam Cecil
You know, I and others learn DCF when I never went to business school, but I went to, you know, when I, when I changed from journalism to finance, I, I took business courses and learned, you know, capital market, capital allocation, pricing model and discounted cash flow and so forth. And I started to try, when I started as a working analyst, to try to use discounted cash flow as a practical tool. And I, and almost all other working investors, including Buffett, never use DCF because conceptually it's a great tool. Like DCF just says, you know, the value of a business is just the, the, all the future cash flows of the business, all the profits discounted back at an appropriate rate to the present. So that, and that's true. Like, you know, If I give you a business that's earning a million dollars today, but will only last a year, that's less valuable than a business that earns $50,000 today, 20 times less, but will go for 75 years and will grow 10% a year. Like so conceptually, you know, those long term, long dated, slow and steady businesses are the most valuable. And that's, that's you, you definitely want that mindset of a discounted cash flow model, but practically the, the models are useless. Nicholas, I'm telling you from personal experience because, because first of all, you can't predict the cash flows. You know, you can't even predict next year's cash flows, let alone 10 years, 20 years. I mean, who knows, right? You can have a sense that Amazon has a long Runway of growth, but you know, the world is an unpredictable place and you know, things happen and people pivot and you know, if you did a discounted cash flow model on, on Amazon in 2007, where was your cloud computing unit in there? Like that just came out of nowhere, you know, so, and then the second thing is the discount rate is impossible to know. And as you know, if you've worked on these models, if you change the discount rate even a little bit, you'll get a very different answer. So I tried this for a year or two. I was like, conceptually a great idea, but practically useless because you can't predict the cash flows and, and if you change the discount rate even a little bit, your answer changes dramatically. So I still vote for current PE as a proxy for discounted cash flow. So, you know, and the way I think about it, for better or worse, is the better the business and the more certain the cash flows, the higher the multiple I can pay today. Because what is a multiple except an expression of the value of all those future cash flows in relation to the present? So a crappy business without much of a future should have a low multiple and a great business with a, with a, with a relatively certain future should have a high multiple. So I very much favor that method. And then the only tweak is, you know, this whole concept of earnings power that, you know, if you value Amazon on current earnings, it's, you know, I don't know what the current Multiple is probably 90 times, but for reasons we've touched on earlier, those earnings aren't the real earnings, I think.
- [46:41]
Niklas Sevos
I mean, we talked with Michael Moboson who is, I mean, one of the gurus in valuation, in my view, and he said that you have to earn the right to Use a multiple. And, and what he meant was that you have to, as you described more or less, you're thinking in DCF terms when you're using a multiple.
- [47:02]
Adam Cecil
Absolutely.
- [47:03]
Niklas Sevos
And if we go in a bit further to that, I mean, how much effort do you put into knowing if the price is right compared to understanding the business fundamentals and the management?
- [47:12]
Adam Cecil
Oh, a lot, Nicholas. That's a good question. And I put a lot into it. Mainly I think what's the earnings power of this business? You know, like the, the reported multiple is X, but the, the true multiple, so to speak, is why I put a lot into that by the time I've gotten to price. Because it's the last one after I've evaluated, you know, do they have a competitive advantage and is the management long term oriented and thinks like an owner and jam tomorrow? Then I think about the price. And if I can't get to in the book, as I say 20 times or under in terms of earnings power, then I pass, you know, because then it's the Stockholm condominium at 5 billion euros. Like great business, great management, but just too expensive. So I do spend quite a lot of time on price. It's the hardest variable and the one that in some ways I agonize over the most. Because, you know, after a while you can say this is a great business and after a while you say this is a great management, but is it a great price? I mean, that's tough. That's a tough question.
- [48:23]
Niklas Sevos
Yeah, and I think that, I mean, I think that's also just to summarize the discussion on the dcf. I think many, many investors using a DCF put a lot of time in that dcf. And to think about all this, I mean, the rows in the dcf, instead of really focusing on the business quality and the management quality.
- [48:45]
Adam Cecil
Well, I think that's a very good insight because the allure of a DCF is it gives you a precise number. It gives you a number as if it's some sort of math problem. Like it's just multiplication. It's not. This is the real world. This is with, you know, all sorts of stuff going on in the real world. You know, look, let's go back to the father of value of investing himself, Ben Graham. I don't know if you remember, but in one of his books he said most stocks have a range of a hundred percent in terms of fair value. He said, I can't remember. I think he's talking about like an old supermarket chain here in the United States. A and P A and P has a value of 50 to $100. That's not a DCF. Like a DCF says it's worth 87.62. It's baloney. It's, you know, it's a false precision. And I say that, I talk about this in the book. You know, like, if you're an aerospace engineer. Yes. You want 87.26. You actually want it out to several more decimal places or else the airplane will fall out of the sky. Right. My son is a software engineer. You know, if one line of code is not right, the program doesn't work. Investing is not like that. Investing is judgment. Investing is, you know, directionally accurate. Buffett says.
- [50:15]
Niklas Sevos
You know, I think we, we, we should go into the, the current climate a bit. A bit? You, you released the book in May 2022, and, and financial markets were, of course, already in turmoil, and it seems now that investors focus much more on profits than growth. And it seems like investors again, believe that most investments technology companies make are for maintaining their positions and not for future growth. So, I mean, has anything changed in terms of how you view this? In light of what? Of that, of that many technology companies actually seem to have thrown away money in low payoff projects in, in recent years? No,
- [50:59]
Adam Cecil
no, Nicholas, not much has changed in my view. I mean, the market sentiment has certainly changed. You know, we've, you know, the zero interest rate policies are over. And long term, that's probably a very good thing to have some positive interest rates. Short term, it's very jarring. And look, I think we're in sort of a shakeout phase where, you know, we're separating the, the really sustainable tech companies from the, the pretend companies, you know, and so there was a lot of froth in the market, tech and otherwise, and now we're going through a sort of a, as I say, winnowing process where we're, we're figuring out who's really valuable and who's not. And, you know, I'm the first to admit that the vast majority of tech companies are like any other company. They're, they're, they're, you know, they're doomed to fail or doomed for mediocrity because they don't have a competitive advantage. So I'm not surprised to see companies like, you know, Carvana, Coinbase, even big companies like Netflix, not surprised to see them down 70, 80%. And I don't think that's an error. I think that those are correctly marked down by the market. But of course, when markets correct and markets get jarred as they were. You know, starting earlier this year, everything gets jarred. So, you know, Amazon's down 40%, Alphabet's down 40%. I'm pretty confident that those are just temporary markdowns on their northward journey to increased, you know, market value. But, but we'll see.
- [52:51]
Eddy Palmian
And if we go into a bit, your role as an investor. You are the founder of Gravity Capital Management, which manages money for high net worth individuals and investors institutions. So why did you decide to start your own business?
- [53:07]
Adam Cecil
Well, in a nutshell, Eddie, I, I don't like working for other people.
- [53:13]
Eddy Palmian
That was in 2003, right?
- [53:15]
Adam Cecil
Yeah, it was about, almost 20 years ago. Yeah, I just, you know, I, I'd worked for three very, very good shops on Wall Street. They taught me a lot. You know, I started at a deep value place, Sanford Bernstein. I went to the total other end of the spectrum with Ron Baron, who's much more of a growth investor. And then I went kind of into the middle with Davis, the, the Davis family. And I felt like I learned a lot, but you know, it had nothing to do with them. It's just, you know, I'm strong willed and opinionated if you can. Couldn't tell that by talking to me now for an hour. And I wanted to do my own thing.
- [53:56]
Eddy Palmian
So next year there will be a celebration for the 20 years of grand prize.
- [54:00]
Adam Cecil
Oh yes. It'll be a huge, huge party in the Empire State Building.
- [54:04]
Eddy Palmian
Nice. And besides the lessons that you have shared in the book and here, what do you know now that you wish you knew when you started 20 years ago?
- [54:14]
Adam Cecil
Oh gosh, I've made pretty much every mistake you can make as an investor, as a business person, you know, I've made so many mistakes. But it's one of the nice things about our business is it's such a good business. It tolerates mistakes. You know, it's not like the semiconductor business. If you, if you miss a cycle, you know, you're, you're really behind the eight ball. It's, it's much, it's much more forgiving business than, than a business like that, you know. You know, I, you know, all the cliches apply, you know, it's, you know, your journey and you learn as you go and I mean, but I've learned, I've learned so much and I look back 20 years ago and I'm, I'm, I'm in awe of how much I didn't know. But I was young and foolish, so sort of normal.
- [55:08]
Eddy Palmian
It seemed to have Turned out very well during turn.
- [55:12]
Adam Cecil
It turned out okay. But you know, good investors, you know, a good, you know, we've been talking about the sort of the intellectual side of good investing. But, but a good investor always has an even keel. And I really try to cultivate an even keel. So you try not to get too upset when things are going badly and you try not to get too excited when things are going well. And you know, you understand that mistakes, you're going to make mistakes and you know, you correct them and you know you can forgive yourself and the business forgives you your mistakes and you, you just sort of build in the fact that you're learning and making mistakes and you can constantly improve. It's a much better way to run an investment management shop than always being tense and tight. And you know, it's just, it's, you'll self destruct if you do it that way.
- [56:04]
Niklas Sevos
And what are the biggest challenges you face as a money manager today?
- [56:10]
Adam Cecil
I mean, look, the stock market is hard to beat. I mean The S P500 is an excellent index and you know, American companies in general are the best in the world. So you're competing against the best market index in the world. So it's not a surprise that a lot of mutual funds, they pick lesser indices to, to compete against. They benchmark themselves against crappier indexes than the s and P500. You know, I was recently doing a project where I kind of learned how the S and P rebalances because not only do they, it's a great collection of companies, 500 of the best American businesses, but they're constantly high grading the index four times a year they kick out the bad companies and they add good companies. So it's like competing against a team that's constantly getting in better athletes. So that's a constant challenge. You know, I am, I'm up against a tough, tough opponent but that's what makes it, you know, stimulating and interesting.
- [57:17]
Niklas Sevos
And how has it been talking to your clients during this tough market climate we had?
- [57:23]
Adam Cecil
You know, it's been great Nicholas there, you know, you kind of get the clients you deserve. And so I'm always, I'm so long term oriented and you know, invest through a cycle and you know, good times and bad times. And so the fast money investors do not come to me. I get all the, the, the, the, the, the relaxed, you know, we're in it for the long term investment. So they've, I've actually been more, I haven't been all that upset about 20, 22, because, you know, I've lived through three or four market corrections now, and it's just sort of in the nature, you know, I don't have much patience for people who are upset about it. Like, oh, you mean the stock market should go up all the time every year? Like, are you crazy? Like this, things happen. Like, you just have to build this in. But I'm more upset about it than my clients, which is good.
- [58:18]
Eddy Palmian
And like Howard Marks, for example, you also seem to have this open mind and a curiosity to learn. I mean, you write in the book that you are not interested in technology per se, but you, you kind of have to, to be able to, to be a good investor. So. And as Howard Marks, you have both accepted learning from your children. So I'm curious what your son has taught you.
- [58:39]
Adam Cecil
Yes, yes. I think it's very important, you know, is either as an investor, as a human being, to be open to new ideas and, and learning and growing and evolving. And, you know, I mean, look, it's. Value investing must evolve or, you know, you know, its practitioners are going to go out of business. I mean, if you, if, you know, if you ignore the tech economy, you know, good luck as an investor, you know, you know, if you're going to keep investing in, you know, you know, companies that make, you know, rail cars and legacy banks, I mean, you're going to do okay, but you probably won't beat the market. You know, to my point about rebalancing, like, the S and P is not putting fewer tech companies in their mix, they're putting more. Because tech just like, think about it as an average citizen, tech is becoming a bigger, bigger part of our economy. And most of those businesses will just be like any other business. They'll be mediocre. But there will be some. And we've talked about a bunch of them today that will excel. And if you don't learn about those and how they work and how they make money, then you're doing yourself and your clients a disservice.
- [60:04]
Niklas Sevos
And as human beings, we share that. We have all these cognitive biases that are hard to tackle sometimes. And I wanted to ask you what, what cognitive biases has cost you the most as an investor?
- [60:23]
Adam Cecil
Probably the cognitive bias that, that I, that I sort of uncovered middle of last decade, which is that, you know, price is always the most important. That's probably been my biggest problem. You know, start with price and then look at the business. No, no, no, no. Look at the business and then look at the price. I always wanted cheap stuff first, now I look at the quality of the business. So now the cognitive bias that I'm having to have to struggle with is the quality of business always matters. And don't worry so much about the price. So it's trying to get that balance. Trying to get that balance, that's the toughest. It's probably the most important for me right now.
- [61:12]
Niklas Sevos
And was that a problem when you think back about, I mean, the booming market in 2020 and 2021, that, I mean, was it maybe did you focus too much on the business and management then? Or how did you escape that if you did?
- [61:29]
Adam Cecil
No, I don't think so. The businesses I bought, you know, they're all good, good. And I bought them all at good prices. I think I'm still above my cost basis on all my tech investments. So I didn't, I don't think I made any, you know, mistakes in terms, you know, I never bought Netflix, I never bought Facebook. You know, all my businesses are down, tech businesses, but they're down, you know, for, you know, I think, transient reasons. But here again, I could be wrong. Let's see,
- [62:04]
Eddy Palmian
will be interesting to follow. And we started this conversation with your background as a journalist and you have also written for both Barons and Fortune. And now you have also published your first book, where the Money Is that we have discussed here. Do you want to write another book?
- [62:20]
Adam Cecil
Yeah, I do, actually, Eddy. I enjoyed doing the first one. I'm not sure exactly what I'll write about, but right now I'm focused on just getting through the end of the year and maybe I'll think about it in 2023.
- [62:32]
Niklas Sevos
And is there any book that you wouldn't want to write but that you would like to read?
- [62:37]
Adam Cecil
Oh, that's a great question. The Secrets of the Universe Revealed. No, it's such a good question. No, because most books that I would like to read, I would probably like to write also.
- [63:01]
Eddy Palmian
Sounds promising. Looking forward to that. And Adam, Cecil, thank you so much for taking the time to come on Investing by the Books podcast to talk about you and your great book, where the Money Is. Do you have something more you want to add before we finish up here?
- [63:14]
Adam Cecil
No. Thank you for your good questions, Eddie and Nicholas. It was thought provoking for me. You know, if people want to reach out to me after they hear this podcast, the best way to do it is I'm in LinkedIn and I find that a very efficient way to interact with people and happy to answer questions as long as they're not, you know, too involved. Happy to answer questions and so forth on LinkedIn.
- [63:40]
Eddy Palmian
Perfect. Thank you so much Adam.
- [63:41]
Adam Cecil
Good to see you guys.
- [63:42]
Niklas Sevos
Thank you Adam.
- [63:44]
Eddy Palmian
Thank you for listening to Investing by the Books, a podcast by Red Eye. Follow us on Twitter bradaie and email us at IB PodcastedEye SC to improve. We'd love to hear your feedback, so please rate and review us. Notice that the content in this podcast is not and shall not be construed as investment advice. This information is meant to be informative and for general purposes only. For full disclaimer visit Redeye Se. I'm your host, Eddie Palmian, and until next time, I sincerely wish you the best of luck on your journey through life and investing.