A (3:28)

How did those early years shape the firm's core philosophy?

C (3:33)

Well, there's two ways of answering that. I'll answer that from an investment philosophy perspective, then you can talk about how we run the company as well. But maybe we'll do that later. I'll save that. The investment philosophy was always very straightforward. You, in your introduction, you said, we buy good businesses for low prices. The problem with that thought is that good businesses generally don't sell for low prices. And so it's not an easy thing to achieve because we all evaluate what's a good business the same way. We look for companies that have good growth and high margins and dominant market shares and some kind of competitive moat that insulates them from competition and clean balance sheets and great management. That's what everybody would say is good. And if I had to find one of those at a low price, you'd be looking for a long, long, long, long time. The alternative, though, buying bad businesses seems kind of silly. So the reality is that there are good businesses that run into difficulties and people question whether they're good businesses when they experience some kind of a problem. So we developed a whole framework and philosophy and process around identifying companies that have great historical performance records. And then something happened that caused the the company to veer off that path, something bad happened or something that the market got fearful about happened, and the share price declined substantially compared to that long term historical trajectory. So identifying those kind of companies are pretty straightforward. You look for a long record and see somebody that's veered off the record where the price has fallen a lot. And it gives you a very rich universe of companies to look at and answer the question, is this really a good business? Are the problems that they're facing temporary? Is the management's plan to restore the earnings back to their historical norms a sound and sensible business plan? And so everything we've done in the last 30 years is basically try to identify those companies and answer the three questions and invest in the ones where we can say yes to those three.

A (6:13)

Has your definition of value investing evolved at all over the last 30 years?

C (6:18)

Not really. I mean, the basic concepts, it's just arithmetic. It's like. Does your idea of arithmetic evolve over time? No, but you can get a little more sophisticated at doing it and some of the things that you, you learn through experience. There's two key ideas that I would highlight that have changed over the course of our history as we've hopefully gotten better at doing this. One is that some businesses are really bad. And just because they're having a bad period that have made their share prices go down even more doesn't necessarily mean that you want to own them. I would have said 30 years ago I would buy anything if it was cheap. Today I would say I'm a little more selective about what I buy, but it still has to be cheap. The other idea is that there are times when the balance sheet of the company is in such difficult shape that the idea that they have enough time to fix things before the creditors come knocking is something that you can't ignore and, and you learn through experience the hard way, but you start to understand the patterns which the business may be good and it may be experiencing a temporary problem, but before they get a chance to fix it, the creditors foreclose on the assets and somebody else owns the company. And we've had plenty of examples where somebody else got to own the good business and we didn't. And that's something you have to be very careful about as an equity investor. So those are kind of the, I'm going to call them tweaks. I mean, they sound significant, but they're more tweaks to the basic concept.

A (8:35)

Caroline, do you have anything to add to that? Do you feel like the definition holds up today?

D (8:41)

Absolutely. So I mean, I kind of think value as that human psychological, emotional response to things not going well is really what creates the value opportunities in the first place. As long as we as humans haven't really evolved in our natural affinity for certainty for what looks good in the moment, it's hard to imagine the value opportunities not being there going forward, despite the more sophisticated tools that we have today to figure out what may be going wrong. On the other hand, even though the philosophy and the process do not change, what constitutes the value opportunities we think are constantly are always different. Because for lack of a better word, most businesses get into trouble at some point in time either because of self inflicted execution mistakes or because the external environments are changing and put new pressure on the business. So kind of where what we see as value opportunities, the industries, the businesses we're invested in are always evolving, but the underlying philosophy and the process I think have stayed constant over time.

A (10:06)

I think that philosophy, it doesn't just define our investment approach, but it also helped build the culture that we see in our firm, Rich touched on it for a minute, and we're going to circle back to that to stay with you. Caroline, when you first joined Pazina, which 2004, is that right? Yes. What do you think struck you the most about the firm's culture at that time?

D (10:32)

Yeah, I mean, I would even start with maybe before I joined the firm. So when I interviewed for the analyst role here at Pazina, I came in on a Friday to see Pizza Friday, back when we had pizza on Fridays, and also to sit on a research review. And what really struck me was you had multiple people in the room and really how rigorous and open and free flowing the discussion was. Whether you're relatively new to the team or you're Rich or John Goetz, who have been leading the team for a long time. People were just enmeshed in the discovery process of how this business works and what we have to resolve to be a long term investor in the company. So I kind of said to myself, wow, you have a great group of people who are highly intelligent and on top of it, they seem to be having a lot of fun doing what they do. So sign me up for that. And then it goes beyond just the investment process. After I joined, I think we were maybe 20, 25 people at the time, as a firm.

C (11:47)

Sounds right.

D (11:50)

Most of the days, the majority of the firm, maybe even up to 20 people, will be having lunch together around one giant table in the only conference room that we had. At the time. It sounded like a small thing, but really you got to know people much better in those random, silly lunch discussions. So for me, it's really kind of how we value each other and our clients as partners, not just employees or clients. And really that rigor of the investment process, the camaraderie that you feel across the firm, and the genuine care that we have for each other and for clients, those are the things that really, really impressed me. And. And those are the things that I think everybody values about our culture.

A (12:44)

And you feel like those principles have kind of remained.

D (12:48)

Oh, absolutely, absolutely. I think that's what underpins the success that we've been fortunate enough to enjoy as a team. And that's something that's really important to our long term success.

C (13:03)

Well, Lisa, you've been here for 27 years.

A (13:06)

You should answer that question.

C (13:08)

You should answer that question.

D (13:10)

Yeah.

A (13:11)

When I think about what's changed and what's remained the same, I think what's changed, obviously, is we've grown. There's a lot more of us now there are more people, we have more clients, we thankfully manage more assets, and we're a global firm, which is exciting. It's, you know, just in terms of diversity of experience and perspective. But what has remained the same in my perspective is the culture of teamwork, what I call collaborative problem solving. I think it remains the same. I always say to people that we are a company where the best idea wins, and it doesn't matter whose idea it was, if it's the best one, we're going to go with it. One of the things that I am fortunate to be able to do is to hire and train new people a lot. I've hired a lot of people over the years and helped to train them. And what's important to me is to try to maintain that culture. It's a culture of striving for excellence. It's a culture of encouraging intellectual curiosity and really just recognizing that every team member is important. And those are the things that I think I saw from the beginning, from Rich and the other founders that I've tried to maintain over the years.

C (14:32)

You know, we've. We actually tried with the. Prior to the leadership transition, to write down what we thought our values were.

D (14:42)

Right.

C (14:43)

And it was a very interesting exercise to go through because you're sort of saying, I have some wisdom after 25 years of doing it and I want to pass it along. But in the end, if you have good people, you fix almost everything. So the whole key should be how do you make sure that you keep good people, you attract and you keep them.

D (15:06)

Yeah.

C (15:07)

And I think there's really only one way, which is that you care what they say. I mean, if you hire people and then ignore them, it's hard to build a good culture. And I think you sort of both hinted at this, but I always like to describe it in our research review meetings. If you didn't, like, have. If you couldn't see who was saying everything, you wouldn't know who was in charge and who was. I'm not going to say in charge. Who had a title and who didn't have a title. In fact, I didn't want anybody to have titles for a long, long time. It didn't work out that way because people somehow need titles, but the titles don't reflect the contribution. What reflects the contribution is what they thought about and what they've done. And if you actually honor people by respecting what they do and incorporating it into the decisions you make, you're going to keep more people than you lose doing that.

D (16:16)

Yeah. You know, when I. When Rich and I sat down and we talk about the transition of leadership, the role I'm going to take on, you know, of course, you ask for wisdoms, for lessons learned, and Rich is always like, well, it's simple. You have great people and there's no problem. But to your point, I think attracting and retaining the best people is what makes us a great organization and what helps us deliver the results that we aim for our clients at the end of the day.

A (16:50)

Well, it's obvious that that's important. It's one of the three tenets of our mission statement.

D (16:54)

Yes, absolutely.

A (16:56)

So I will say to kind of turn back toward the investment side. The consistency of values has been really tested because we've gone through some really tough market cycles, even, you know, over these past 30 years. And this is really a question for both of you. I'll let you decide who wants to answer. Who wants to answer first? How do you think that the tough times, the tech bubble, the GFC global financial crisis, the. The COVID era, how did that test your philosophy?

C (17:26)

Maybe I'll take the tech. The tech bubble, because that was the most traumatic, at least as a startup. Because if you. You realize that we started investing other people's money on January 1st of 1996, and in 1998 is really when the Internet stocks went crazy. And these at the time were companies that barely had any revenues. They had ideas, and they were driving the markets. And of course, we didn't invest in any of them. And from 1998 through the first quarter of 2000, we underperformed the market every single quarter. And it had added up because we were earning zero, basically for two and a half years, and the market was accelerating at 30% a year, something like that. And so by the time we got into the first quarter of 2000, we were 60 percentage points behind the S&P 500. And at that point, you just assume it's over. We're a young firm. We went back into the red after we had this fairytale beginning. We broke even by the end of the first year, and then all of a sudden we had more expenses than revenues because we were losing clients in a world where people were going somewhere else and we didn't waver. We went and tried to explain why it was that we were doing what we were doing. And the fact that you could buy a whole portfolio of companies that sold for like, five times what their earnings averaged over a full economic cycle, you'd say, well, these are kind of unprecedented opportunities. And so we're Just going to keep doing what we're doing and we're going to explain very carefully why we're doing that. And it didn't, you know, it didn't work for a long time. So fortunately we persevered and it turned around almost instantly. I mean, from the Between February 28th of 2000, when we were all ready to jump out the window, to March 10th of 2000, like 10 days, the market turned around. By the end of December of 2000, we were ahead of the S&P 500 from our inception. And so many of our peers did not do that. They either gave up because they couldn't take it and they said this is just not working and we're closing, or they, as I would call it, cheated and put some tech, even if it wasn't the hot ones like Cisco, was the hottest, the first company ever to reach a half a trillion dollars into their portfolio. So that when it turned and they were supposed to be value investors, they lagged behind us and we got to have five straight years of top decile performance and it's what made the firm.

D (20:52)

Yeah, I'll take the GFC and the subsequent periods. The GFC did play out a little differently for us. We certainly had our mistakes and we broke one of the key tenets of our investment philosophy, which is downside support. So we had permanent capital impairment in a number of the financial holdings that we had. And by the way, I was the Fannie Freddie analyst at the time, so I paid for full responsibilities for that. Now, critically, when you look back, what's the benefit of hindsight? I think one of the things that we realized was yes, we were right about what the ultimate losses were in the mortgage portfolio. However, we didn't appreciate the vulnerability of the business model to changes in market confidence because that precipitated the nationalization and a lot of the permanent impairment in some of the financials. Now, look, we've always been very conscious of leverage in a business because it robs you of the ability to, to have your claim to that net income over the long run. But financials come with a lot of leverage to start with. So we ascribed a lot of that to just the natural operating leverage embedded in the business. And I think in hindsight, my lesson, and I think the lesson for us as a team is sometimes operating leverage turns into financial leverage very quickly and you have to be super, super sharp, laser focused on really appreciating where the vulnerability is and fully sketch out low probability but potentially catastrophic downside scenarios and that informs your Willingness to invest and the sizing of the positions. Right.

C (22:56)

And I think just to interrupt for a second, when you add culture to this, I mean, a lot of firms would have fired the Fannie and Freddie analyst and, and she's now running the company. And you know, after Caroline's first year with the firm, I told her in a review, oh, you're going to be the next chief investment officer of this firm. And so while she says it's her fault, the reality was that we made the decisions as a team. We don't get rid of the person that we want to blame because the team made a decision and we made it with good intention, but we made mistakes. And so part of what makes a culture is having the backs of your teammates in the adverse situations.

D (23:51)

Yeah, I mean, coming back to, for me, the biggest learning coming out of that period is really what good leadership looks like, what's required on an investment team, what that leadership looks like, because it's very easy to be supportive when things are going well. And really what people do when things are not going well is what speaks to the quality of the leadership and the quality of the culture of a place. And I remember all the conversations, all the sort of post mortem we did. Rich, to your point earlier, every firm makes investment team, takes their own lessons from things and would have been easy for us to say, well, don't ever get involved with financials in reaction to it. When in the value space that we were looking at, the financials were the ones that people have given up any hope on, have ascribed zero sustainability future to the business model. And we went back, examined everything that we went through in assessing how did they make money? Why should they make money in the future? What are the things that broke that could be changed? Our view is we should have exposure in that part of the market because they are where the devalue opportunity sits. But we could do the sizing of the exposure. We could think about the construction of that exposure a little bit differently. I think the lessons from that period has served us well since then. During the European sovereign crisis, for example, we went through the same trauma in that sector, but we did not have the type of permanent impairment that we had during the gfc. Covid is a very different story. And I think all the lessons from really appreciating the quality of the operating model and how that operating leverage could translate into financial leverage really meant we went into the cycle, we went into that downturn with a very high quality portfolio where we didn't have permanent impairment in These businesses. And if anything, the team was very energized about the extreme valuation that we saw. Frankly, that was a very exciting time for the team. It's unprecedented because you have to tune your mind to how can a business operate and survive when your revenue disappeared overnight and you kind of don't know when it's going to come back. Now you do go through. Well, what they do is it really needed for the society to function. So even if it's locked down for a month, it will come back. And does the company have the operating flexibility and the financial flexibility to get through that difficult time? Everything that happens kind of makes you. What doesn't kill you makes you stronger. And I think we've put some of those lessons to good use, and the experience the team has developed through these different cycles has really been invaluable.

A (26:59)

Do you feel like the research process or the investment process has changed as a result?

D (27:05)

I mean, again, the core of what we do has not changed, because here is the inefficiency we're trying to take advantage of in the marketplace, but the tools you use and really the efficiency of kind of what you do probably has evolved over time because our ability to gather information very quickly today is leaps and bounds better than what it was 20 years ago. And if anything, AI supercharges that a little bit. But understanding what the controversy is and what the market collectively believes is really the easy part. The difficult part is that human judgment around how does this business even exist in the first place and what's the real value add and what can happen five years down the road that is really not that different today versus five years, 20 years ago? I don't know, Rich, if you felt

C (28:04)

differently, I think it's the same. Different issues to look at, but same concept. These businesses have the staying power to navigate through what we're going through today. Technological change. But it's not like this is the first time we've gone through technological change. We've been doing it for my entire career.

A (28:27)

I want to turn, because we have you two here sitting together today. I want to turn a little bit to talk just briefly, about the leadership transition. I know we've talked a lot in the past, even on the podcast about succession, but, Caroline, what advice did Rich give you that guided your leadership most? I know you touched on it a little bit earlier.

D (28:49)

It's as simple as that. Have the best people and everything just falls into place. I mean, really, to Richard's point, when we sat down to write down the leadership principles of the Firm. It really comes from place of this is a people business. Culture is the most people, which is what the culture is for is the most important part. But when people talk about culture, it always feels a little amorphous. So it's really putting down the things that we felt.

C (29:25)

I heard a great speaker on culture who said it doesn't matter what you write in your mission statements or your or your firm values. If you are at a neighbor's barbecue and they ask you what's it like to work for Pesina, what they say in the first sentence is your culture.

A (29:48)

That sounds about right. I think that's probably about right. I want to pose a couple of questions and again, these are for either or both of you about the state of value investing today. We what do you think are the biggest misconceptions about value investing that are persisting?

D (30:06)

Yeah, sure.

C (30:08)

I mean, I think the biggest, the single biggest misconception is that value investing is distressed investing, that you're buying companies that are financially insecure. And it's just not really accurate. Because if you were going to be. If you were going to be a distressed investor, you would not invest in the equities, you would invest in the debt because you would control the destiny of the company. So it's just not the same thing. And you have to distinguish between stress and distress. Stress means there's something going wrong in the company that they have to deal with. And that's what we like to deal with. Distress means it's now out of your control. I think that's a common misconception. And I think the other common misconception is you can only buy bad businesses. Most people would say, well, it's true. Just look at the companies that are in your portfolio. That's prima facie evidence that you buy bad businesses. But the reality is these businesses have really great histories and in our judgment, really great futures. And the present is having difficulties.

D (31:25)

Yeah, I mean, I'll just add on to that. A lot of people think if you're a value investor, you're not thinking about risk or you're just a risk junkie, for lack of a better word. Kind of goes back to that distress investing point. But the reality is, I think about risk as most people would define risk as what can go wrong going forward. Am I worried about what can go wrong? Am I misunderstanding that? And for us, our view is, so why not get involved after what can go wrong has already gone wrong and is reflected in the present and most likely in the present valuation price of the company. So rather than sitting there thinking about what risk is, I kind of view it as we're actually getting involved after the risk is already evident to everyone and therefore more likely to be in the valuation. So you're getting paid to take on that risk versus when everything is going well. You're actually not getting paid to take on the risk of things moving in the other direction, but psychological, it's more comfortable for people to be in the place where everything is going well. And. And it's just an extrapolation or kind of ongoing momentum of what's good.

C (32:44)

I also think people think of value investing in very simplistic quantitative terms. Oh, you're just buying low price to earnings or low price to book. And any idiot can do that. Which is true, any idiot can do that. But the reality is, and we use this as our slogan on our website, that value is, is not a factor. It's a philosophy. And it is, it's the way you think about investing. And it doesn't always show up in the factors.

D (33:14)

Right.

A (33:15)

You both kind of touched on the idea that the companies that we invest in are temporarily experiencing some pain. How do you explain that to clients? How do you get them to have patience and know that, you know, it's a temporary and not a permanent impairment?

D (33:34)

Yeah, I mean, look, we're not perfect, so we know we don't get it

A (33:37)

right all the time.

D (33:39)

What you do is you go through, first of all, why does this business exist in the first place? What's the value add? Why do people show up to buy the service and products and then you walk through kind of what's causing the current pain and what you view as permanent versus temporary. I mean, you know, coming back to the current environment. And I think we see that in some of the valuation is, on one hand, the market is very excited about the potential of AI as a new technology, technological advancement, and that maybe it's bigger than anything that's come before. It probably is. And they're very. They're so excited, they're willing to pay ever higher evaluation for that. On the other hand, they're looking at really the vast majority of the businesses out there and say, well, we don't really know they have a future for some of them, they're really worried about how the business will adapt to the new technology. For us, you really only know how it can adapt because you understood what made it good in the first place and what's changing or potentially not changing about that competitive dynamic. But ultimately, you're not going to get it right 100% of the time and we fully accept 40% of what we invest in may not work out the way we expect.

C (35:04)

We tell our clients at the beginning

D (35:05)

before they hire us, we're going to have value traps. But what really allows us to be value investor is that asymmetry in risk or trade off that you're exposed to because of the low valuation that we're paying today, which is the only thing we know for certain. Right.

A (35:26)

Well, I think it's really remarkable to see how much has changed over these 30 years and yet how much really feels grounded in the same ideas and the same philosophy and the same process. But I want to close today by just looking ahead a little bit, thinking about maybe the next 30 years or 50 years or we won't be around. But for her, for the, for the business around as a person, I hope to not be working 50 years as a person. Caroline, what do you, what would you say excites you the most when you think about Bina's future?

D (36:05)

You know, it's coming back to value investing is just makes sense at the end of the day. Maybe parts of the world don't really agree at the moment, but we think it makes sense because it's grounded as a philosophy in that human psychology. We have great tools to do that. We have really interesting valuations that we're seeing in a wide range of businesses that we're excited about. So that's a little bit about the current moment as a starting point. But really this is something that we deeply believe in as what can deliver Alpha over the long run. And we think we can execute that in a really systematic and repeatable way. We want to do that for clients and we want to have the team, the great people that we have to execute that for the next 30, 50 years. There's nothing greater, more satisfying than knowing that you've really delivered value for your clients. At the end of the day, Rich,

A (37:11)

when you look back 30 years, three decades we've been doing this, now, what do you hope people say Pazina stands for?

C (37:21)

Well, I mean, I think there's part of that as a brand, right? Pasina stands for value. That's the way I would answer the question. And I think we've achieved that in this 30 year period. Whether they like value or not is a different story. But I don't think there's any doubt in anyone's mind that we did what we said we would do. And I hope in 30 years from now they will look back and say exactly the Same thing, right?

A (37:51)

Yeah. Yeah, that was really what I was going to ask you. Caroline, what do you think you want, you hope, 30 years from now?

D (37:57)

Yeah, I mean, same. Same as the machine we've always had. This is where the best value value investors are. This is a firm that. This is a partner that you can trust as a client, as an investor. This is a partner that you can trust as, as an employee and as part of the organization. So.

A (38:22)

Well, I think we should end it there. And as we celebrate the firm's first 30 years and look forward to what is ahead. Rich, Caroline, I just want to thank you for being here with me today, for sharing your wisdom and your insight. What I think really shines through about the firm is the consistency, the consistency of purpose, the belief that value and patience and humility and teamwork, they still matter.

D (38:53)

Lisa, we want to thank you for being here for 25 of those 30 years.

C (38:57)

27. 27.

D (39:00)

Sorry.

A (39:00)

Oh, it's fine. You were making me a little younger.

D (39:05)

Yeah.

A (39:06)

Well, congratulations. Congratulations to all of us. I suppose partners on 30 years, really strength, staying true to our philosophy and to everything that you set up Bridge. So in the end, we thank you for founding this firm and establishing the culture and the philosophy. I'm Lisa Roth, and this is Pizza Perspectives. Thanks for listening. And as always, if you'd like more information about Pazina Investment Management or value investing, subscribe to this podcast or visit our website@www.pazina.com. that's www.pzena.