Sean O'Malley (3:33)

That's such a good question. At this point, we spent something like 40 hours a week breaking down a different company over 50 times. So there's really been this incredible opportunity to build up my intuition and experience as an investor. And along the way I feel like I've gone maybe from one extreme to another. For years I spent most of my time just reading books and shareholder letters and maybe listening to podcasts like this one. And I had this very passive role as an investor. But at some point without any actual practical experience, the marginal returns on that information just diminished. I mean, I was probably spending 95% of my time learning, only 5% of my time actually getting my hands dirty digging into specific companies. And over the last year that dynamic has just completely shifted for me and I think it's been a game changer. I'm reading a lot less because I'm spending so much time trying to apply the lessons I've learned from years of reading and investing generally. So I don't know if that counts as something to kind of change your mind on. And I'm not saying anything against the value of reading as you know, but really what I mean is that if you are like me, you could probably spend years learning about investing without ever really gaining the confidence to act on it. And maybe the comparison I would make is staying in academia forever and never actually working in a job outside of it. And I just had this imposter syndrome And I never felt qualified to make big bets on individual stocks. It felt too risky to me and it just felt like I wasn't equipped to do it. And so I would read about the art of stock picking and then after all that, I would just go buy an etf. And through hosting the Intrinsic Value podcast, though, I really was pushed out of my comfort zone. If you are going to be researching companies the way we do and try to find ones that you like, I mean, how could anybody take you seriously if you're not investing in them meaningfully yourself? And that was honestly the push I needed. Investing in individual stocks with significant parts of your net worth can be scary. But as I've gotten more practice myself, even with just a paper portfolio at times, rather than simply reading about the investing legends who run these concentrated portfolios, I've increasingly felt comfortable doing that myself. And I've had a great colleague in Daniel helping push me to do that. So I guess you could say I've changed my mind a bit on just how risky individual stock investing can be if it's approached carefully and intelligently. And the other thing I'd say that I've had a real epiphany on is around this idea of finding hundred baggers. And I know we both loved Chris Mayer's book on the topic. Whether I'm actually looking only for companies that can 100x, I don't know. But I've come to appreciate that investing is a pursuit where hard work is required, but there's not a linear payoff to it. And so Manish Pabrai talks about how in Buffett's career, they're really just five of these investments that explain the bulk of his returns. And when you look at it through that lens, you don't even have to make one great investment decision a year. I mean, for Buffett, he was making one great decision a decade. And so there's this kind of cliche about swinging only on fat pitches. And even just a year or two ago, I was, despite having read Buffett and Graham, still tempted to make these relatively short term trades where you're swinging at a lot of pitches. And I think, oh, XYZ is happening to drive oil prices up. And so therefore I should be betting on oil to go in some way. I've just given up on that completely. Because the thing is, even if you make a bet that goes up 20%, the question is then what? You have to keep doing that across your entire portfolio consistently for years. And that's just a very high frequency of bets to be right on with a lot of work going into each one. And it's just, like I said, it's just swinging at a ton of pitches. But if you can find one exceptional business, they can really do that for you. You buy it at a reasonable price. They're compounding their intrinsic value at 20% a year by reinvesting into their own business. That is going to be infinitely less work and also less room for error as you're focusing all your attention on making one hugely correct decision once a year or maybe once a decade, as opposed to trying to make a dozen good bets a quarter, which is so much harder to do. And those kinds of great businesses can keep compounding at rates that blow the market away every year for many, many years. We've learned that lesson with the Mag 7 for really the last decade plus it feels like with a lot of these big tech companies. So you still have to work hard to find those special opportunities and understand them. But you're working a lot smarter than harder, in my opinion. And I'd rather try to be right once and find a company that can keep making great decisions on my behalf for the next decade than try to get really a great idea every few weeks. And I know that's ironic because we do on our show at a different company weekly, but we're really doing that through the perspective of trying to find companies that we'd want to own for a minimum of five years. So we're not looking at all these ideas, thinking, oh, let's trade this ahead of the earnings report. It's really totally antithetical to our approach. And even if you seldom swing, I just think you've got to be constantly looking for those opportunities because you don't want that once in a decade investment to just pass you by.

Clay Fink (8:40)

Yeah, I definitely came to many of the same conclusions you did in outlining that, especially just focusing on great companies that have the potential to be much bigger five, ten plus years down the line and giving yourself the opportunity to really benefit from these asymmetric payoffs that you really can't foresee 10 years ahead of time. But you know that the opportunity is there, especially with the optionality that many companies can bring you. Your point on not chasing say these quick 10 to 20% gains. It reminds me the other night I was at a basketball game with some friends and of course when you go to some of these games or you go to college football or whatnot, sports betting always seems to be one of the topics around younger people these days. I think and my buddy showed me that one of Nebraska's best shooters there was opportunity to place a bet of you could bet essentially if he was going to make a three pointer that game. And we played one of the top teams in the country a couple weeks ago and he had seven threes. And I'm like this is an absolute no brainer, but is it worth me to set up the app, deposit the money, incur whatever fees are happening there? And I've just gotten to the point where even if you have something that might look absolutely obvious, there's such an opportunity cost just on our time and our attention that I've come to appreciate over the years. Turning to the point on hunderbaggers, I think you know, many people can be drawn to like finding the formula for the next massive winner. But to play a bit of devil's advocate, I think it can also be harmful to some extent, you know, trying to pick the next hundred bagger because I think some people can be attracted to ideas that are either riskier in the obvious sense or maybe just have unknown risks being just like tiny companies, really small going into a new industry like space exploration for example. And I think the reality of a hundred baggers is that they can be just so incredibly rare, especially with how big many companies IPO today. So I saw just the other day I was looking back at Alphabet. Back in 2004 the search market was in its infancy and most would assume that if anyone bought Google at the IPO they'd be sitting on what, 300x500x, maybe even more. But it actually wasn't until just recently that Google, one of the biggest companies in the world, crossed the hundred bagger status. So the split adjusted IPO price was around $2.50 and as of the time of recording we're at 290. So this is a $3.5 trillion company and for all intents and purposes, practically none of the shareholders in Alphabet today are sitting on a hundred bagger. So part of this idea of getting a hundred bagger is also being fortunate to find a company just in its infancy when nobody really knew about it. So I think the big takeaway for me is that from the book is just understanding this process of finding companies that are compounding their intrinsic value and coming to understand companies long term potential. When we look at the intrinsic value portfolio and how it's performed this year, what are some of the things that stand out to you?

Sean O'Malley (11:49)

Well just quickly on your point on Alphabet because I think that was so interesting on Compounders. Daniel and I had the opportunity to invest in OpenAI in a private fundraising round. And I remember we were so excited about it. My wife thought we were crazy. She was like, how could you even be thinking, of course we have to participate in this. And I just remember talking to Daniel thinking, okay, it's already valued at like $500 billion. And you know, I mean, the revenue is growing, but it's absolutely unprofitable, just burning cash. And it was that same kind of lens of with Alphabet. If you're thinking, okay, you would think that this sounds like something that would be a hundred bagger, but the amount of growth, I mean, it would have to be bigger than the entire global economy, I think for OpenAI and ChatGPT at that valuation to be anywhere close to a hundred backer. With the point being, even really, really great companies that seem like the next Google or literally with Google, even if, unless you're very, very early to the process, and even with OpenAI, I think we're arguably too late to it, getting that real 100 bagger is difficult. But yet to your question on the intrinsic value portfolio, that sort of long term mindset I think has been really liberating for us because we can sit here and say, well, we're not trying to get into OpenAI just to do well in the next 12 months. Honestly, I'm thinking on a 30, 40, 50 year time horizon, I'm thinking for the rest of my life, what are going to be the investments I can make today that I'll look back in hindsight as really being the best decisions I made and being the biggest wealth creators, as you know, I mean, so many on Wall street don't enjoy that privilege. I mean, they're judged by these quarterly results and there's constant pressure to deliver. Even if they know it would be better to actually focus on companies that are positioned to win long term. But just the nature of their work and expectations from investors pushes them to think on a much shorter time horizon. And so people are always surprised when they see that so much of our portfolio is in cash. And actually there's a really simple answer to that. On January 1, 2025, we started at 100% cash. And it's taken us a good bit of time to allocate that over the last year. And if anything, in our view, allocating 70% of your portfolio in less than a year feels pretty ambitious to us. And in terms of how the portfolio has done, given that we've had this massive cash balance that has been A handicap, especially with the market continuing to hit new highs. But we're very satisfied with how it's done. At the time of recording, our entire portfolio, including cash, is up over 10% year to date. And again, I'll just emphasize for good chunks of the year, we had 90, 80%, 60% cash and so on. And even now we're down to one third cash. So for the total portfolio to do a double digit return, it's performed pretty well. And like I said, to drive that 10% total return, the bets that we have made have actually done much, much better than 10%, obviously. And so Reddit, for example, at one point was a triple for us. Uber has been up over 50% from when we first bought it. I think Nubank is up over 40%. And then Ulta, which is actually one of the first companies I ever covered on my podcast and also pitched on, we study billionaires, has also done pretty well, up 40% or so. Alphabet's up about 60% since we first bought it. And you know, that's not because we're geniuses. We've certainly had laggards along the way and some stocks that haven't moved a ton or declined modestly. But we've been fortunate that we haven't made any catastrophic decisions that have just totally derailed the portfolio significantly. And in theory, if we had allocated all of our cash from day one on those same bets, we'd have done fabulously well. But again, that's just not realistic. We genuinely have to work through the process of finding ideas, doing the necessary work, and then building conviction in them. And people can see that play out in real time on the show, and then at the same time passing on other ideas. And we tend to pass on many more than we choose. And our approach, as much as possible, has just to try and be very disciplined and patient, which isn't always easy. But we don't feel like just because we have cash on hand that we need to invest all of it as soon as possible. And in fact, that cash has actually come in really handy for us to be opportunistic. When the market sold off over these tariff fears in April, we use that as a chance just to have some common sense and say, yeah, we have an opportunity to build positions in some of our favorite companies that really are not going to be affected by tariffs at all. I mean, what do tariffs have to do with Adobe, Airbnb, Reddit, Alphabet and Uber? I mean, you could find some sort of effect, but wiping out 20% of the market cap of the business seems sort of absurd intuitively. And so the reality though is that even the best companies in the world still hit 52 week lows. By definition, that's just a statistical inevitability. So having some cash on hand gives us the chance to capitalize on really what are these inevitable opportunities that happen even with the best companies. And you might think that Alphabet is this mega cap stock that's bound by the efficient markets hypothesis and therefore rarely ever presents opportunities and is never mispriced because there's so many eyeballs in it. But in this past year alone, the stock has fluctuated from $146 per share at the low to as much as $290 per share. I mean, that's a double. And nothing about that sounds like an efficient market to me. It's something that Joel Greenblatt talks about a lot. And the point is, sometimes folks think they have to go into these super obscure areas of markets to find attractive opportunities. And yet perhaps the most well known company in the world clearly looked undervalued. And that's not just the benefit of hindsight either. Saying that, and Daniel and I wrote about that in our newsletter for months that we thought Alphabet was undervalued before that rally took off. And you can say, I think something similar with meta back in 2022, which I know was talked about on this show a few different times. Daniel and I weren't doing our podcast then, but it's just really incredible to think that the company behind Facebook, WhatsApp and Instagram, which are three of the most widely used apps in the world, could be an almost seven bagger in just three years from its low in 2022. And that's just absolutely astounding to me. And again, it's proof not only in the value of patience and waiting for those market distortions, but you also just don't have to look past large caps to find good investments sometimes. Many of these large tech companies are arguably some of the best businesses to ever exists in the history of capitalism. And Daniel and I have come to appreciate that when we get chances to buy them on sale, that's a pretty simple bet to make. That tends to work out well.

Clay Fink (18:26)

Yeah, you definitely make such a good point that the most well known and closely followed businesses have the potential to just be fantastic opportunities. And partly inspired by you and many members of our mastermind community, I've actually just been surprised to see how well one is able to do by investing in these types of businesses that are you know, relatively easy to understand and practically everybody already knows. And like you, I've been making some recent investments that were inspired by products that I personally use and I'm a happy customer of. And one of the other topics that's been top of mind lately is just how you know the Magnificent Seven is obviously making the headlines year after year, but I think big tech in general has just been really interesting businesses for me to study and better understand. I guess starting with the Mag 7. You know, Google's rise in share price this year. I'm just kicking myself for not having bought it when the market was so concerned about the fears related to ChatGPT. You know, it's just one of those cases where I see the biases playing out for me in real time, just letting the share price sort of alter my view of the company. And we'll be chatting about Adobe in more depth here today, which I'm very excited to get into. But you and Daniel were wise enough to add Alphabet to your portfolios in size, which I of course applaud you for. And it's not just the Magnificent Seven that interests me, as I mentioned, but also the big tech layer below that. If we think about just a market cap general range, we can say 50 billion to 300 billion. These are obviously very big tech companies, but they're also very well known and have very similar characteristics to the Alphabets, the metas of the world. So a few names in your intrinsic value portfolio that are tech companies include Uber, Nubank and Reddit, but there are others that we can name that have been covered on the show but aren't in the portfolio for various reasons. That includes Robinhood, Spotify and Shopify. And Adobe would also be in that camp. But the narrative around AI has beaten this stock down in recent months. So rather than putting your attention on the Magnificent Seven, you've put a good amount of attention on this second layer of tech companies. So talk to us about some of the things you find interesting about this segment of the market.

Sean O'Malley (20:46)

We haven't entirely avoided the Mag 7, right? We do have Alphabet's one of our largest positions, but we're also very disciplined about just try not to invest in things that we can't wrap our minds around. And Tesla as a member of the Mag 7 is sort of an easy one to avoid for us. You've got trillion dollar pay packages for CEO, humanoid robots and then the promise of self driving vehicles, while changes of tax credits and tariffs and competition in China are wreaking havoc on the underlying business so that's a company we've just never even bothered to cover just because it's a stock that doesn't seem to be driven by fundamentals and there's just too much going on to understand. And I think in a similar but maybe different way, we never bothered with Nvidia either. And you can say we missed out hugely. But I think that's okay. We'd rather earn satisfactory returns on companies that we understand and can buy with a margin of safety than roll the dice on a business that we don't understand that seemingly has huge potential and everybody else is yoloing into. And yes, I would probably reckon very, very few people actually understand semiconductors, which is the business area that Nvidia is in. These are maybe the most complex pieces of technology humanity has ever created. And so fundamentally, Nvidia is competing in incredibly advanced tech hardware, meaning the metric that matters most is performance, especially at the high end. And performance then is really all they're graded on. And that's a tough way to do business. And clearly Nvidia has done very well. But to me, without a degree in engineering and computer science, I'm just not sure how I could ever feel comfortable understanding the durability of their advantages. You know, are they going to continue to dominate the market for the next year or the next decade? I'm in no position to be able to tell. And the counter response to that we usually get is to say something along the lines of, well, you're not an expert on everything Alphabet does, so how can you invest there instead? And to me the difference isn't being more of a consumer focused business rather than B2B. And as a consumer, I can understand exactly why people use YouTube and Google search or why Apple's product ecosystem is so unbelievably sticky without me needing to actually know how to build an iPhone. But when you're truly at the forefront of technology in the way that maybe Tesla and Nvidia are, you're competing only on performance and you just don't have the same advantages like brand awareness and network effects that can help ease some of that competitive pressure. And so I don't have an opinion on Nvidia either way, but that was sort of the thought process for why we've avoided it. And even as the stock has done incredibly well and fortunately, I just think there are so many different ways to make money in investing. You don't have to play games you're not good at. And so to the crux of your question, what we really love about a handful of these kind of second tier tech businesses is that they're really consumer companies as much as they are tech companies. And I think that probably sounds a bit wonky to people, but famously, Buffett came to see Apple as something more like a consumer goods business as opposed to truly being a tech company, since he famously avoids tech. And I would think somewhat similarly here. With Reddit, for example, you've got a platform that has served as the front page of the Internet for over 20 years, but really it's an advertising business. They have millions of people who log into the app every day or access it through Google after searching for some type of question. And then from Reddit's perspective, their business is about monetizing those eyeballs as effectively as possible and keeping them engaged on the app for as long as as possible. But let's not pretend they're doing rocket science either. They're not inventing new types of battery chemistry. It's an ad business capitalizing on its massive network effect. I think you can say something similar for Uber. Far from being a tech company, whatever that even means, they are tethered to the real world. Every time you book a ride or food delivery through Uber, a real person in the real world has to get into a vehicle and deliver you or your food from one place to another. So really, to me, it's a logistics business with membership, subscriptions, network effects and advertising layered over it that make it much more attractive than a traditional logistics company that just does interstate trucking or shipping or something like that. And on that point, they realized that if they can just get users to use both the Uber ride sharing app and the Uber Eats app at least once a month, that will increasingly turn into a habit. And as a result, users of both apps tend to spend three times more than users of just one app. And that's why they launched Uber one, which is this subscription that offers free delivery on eats and discounts on rides. And they're trying to encourage people to use both apps and to use them more frequently. And the data around that has been very promising from an investor standpoint. But to me, again, that's just good business decision making logic. It's not rocket science and humanoid robots. They leverage technology to scale and diversify their business in ways not possible before the Internet and mobile phones. But Uber is not a tech hardware company in the sense that they're constantly trying to make physical science or computing breakthrough. Not at all. And that's why companies like Nvidia or TSMC do give me pause. Because they're at the cutting edge of technology, which is great when you're in the lead, but it leaves no other margin of safety, such that as soon as someone else does make a breakthrough, you can be displaced more quickly. And semiconductors, after all, were literally the example that Clayton Christensen uses in his book the Innovator's Dilemma, as the industry that faces the most change and changes the fastest, where therefore any existing competitive advantages are the most fickle and can erode away the most quickly. And so you contrast that with a business like Amazon, where it just feels like for, I don't know, the last decade, maybe 15 years, Americans can't live without it. And just personally speaking, I have only gotten more and more reliant on their ecosystem over time. And you can probably say the same for Apple. And look at Robinhood. As Robinhood has rolled out more and more value adds for its gold members. Again, I've only gotten more entrenched in their consumer ecosystem. And it does help that they're a digital first business without physical storefronts weighing them down. But again, it's more about the fact that they have the best consumer interface and design, the most generous benefits, kind of scaled economy shared. And combining all that together creates this incredibly sticky consumer ecosystem that makes me much more reliant on the business over time. And so we didn't actually end up investing in Robinhood despite kind of hyping it up there. But what we're really trying to do is use our consumer insights to frame our investment decisions. And that does not mean you invest in every company that you use as consumer. But it's a great starting point. I've used both Spotify and Reddit for probably 12 years now, and I use them both more now than ever. And the question is, why is that? Well, that's the type of question I'd want to answer. And as we have looked into that on our show with many of these second layer tech companies with consumer ecosystems, we've really come to appreciate just how powerful their business models are. Even with Adobe, you might say that, hey, that's not a consumer facing business, but we've had insights into that company in the same way as we've had with Spotify and Reddit, because we are a podcasting company and we actually use Adobe for nearly everything we do on the backend. Which means that if I saw us as customers moving to competitors, then that would be a signal for me to consider as an investor. And again, that's using your consumer mindset to kind of frame how you think about things as an investor, and I think you can get advantageous early indicators by doing that. And so I really do believe it can be that simple in that by evaluating businesses that you're organically a consumer of, you put yourself in the best position to make investment decisions where you're not speculating on industry trends or going off of what others are saying, but actually just following your own intuition about the direction the business is heading in and how its value add is changing for better or worse. And that more authentic approach, at least for Daniel and I, we found, works a lot better. Let's take a quick break and hear from today's sponsors.

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Sean O'Malley (32:06)

All right, back to the show.

Clay Fink (32:08)

Yeah, I definitely appreciate the consumer aspect of these being very much branded companies that consumers are familiar with. And I think there's also just something to be said with technology businesses being capital light. Once these platforms and ecosystems are built, the incremental returns on invested capital can just be insanely high as they continue to spread a lot of these fixed costs out over more and more customers each year. And the margins on these businesses can just be ridiculous. So I actually invested in one of Robinhood's peer companies, if we can call it that, is Interactive Brokers, and just recently covered it on the show. Their gross margins are 82%. Their operating margins are 75%. We'll be talking about Adobe. Their gross margins are 89%. It's just like these types of margin levels are just out of this world and impossible for companies in previous generations. And when you combine high switching costs that are in place and the data, the value of the data they hold, it's just hard to not get attracted to some of these names. And in many cases there's a feedback loop that becomes increasingly difficult to disrupt these companies. So if we look at a company like YouTube, for example, which is owned by Alphabet, every view, every like, every comment they receive feeds their algorithms and it helps them make their platform even better. And as those recommendations to viewers improve, users spend more time on the platform, it attracts more creators, more advertisers, generating more revenue and more data for YouTube to further refine their algorithm. So I also can't help but notice that there are a few retail names in the portfolio, which I must say is a bit of a bold move given how brutal capitalism can treat the retail sector. So three retail names in the portfolio include Nike, Lululemon and Ulta Beauty. The running joke when we were over in Montana a couple months ago was that if you really wanted to get Sean going, just bring up Lululemon. And you weren't shy to mention to me when I got to the airport that I was wearing a Viori sweatpants, which is one of their top competitors. And the discussion around retail reminds me at one of the Berkshire meetings, Buffett mentioned that in the investment business you don't have to do exceptional things to get exceptional results. He said, whether you jump over a seven foot bar or a one foot bar, the ribbon they pin on you is the same regardless. So in the case of something like TSMC or Nvidia, they're jumping over seven foot bars every single year trying to develop the next new technology. So he's really getting at this idea of not overcomplicating the game of investing, which is why he did so well with bets like Coca Cola and Apple that were relatively easy for him to understand. So carrying this over to the discussion on retail and to just play a little bit of devil's advocate here in my mind, why spend time investing in businesses like Lulu and Nike that faced a never ending list of competition when you can instead invest in say something like Visa, which faces little to no competition?

Sean O'Malley (35:11)

Gosh, I've gotten teased so much about Lululemon and it's not just because the investment has been struggling but but I do tend to be very passionate about the brand. I have some close friends actually who just to give me a hard time, they go out of their way to wear Vuori or Nike or Aloe whenever they're around me. And definitely not anything from Lululemon. But I just think their clothes are incredibly high quality. And even though competition has arisen, I don't think their brand power has completely fallen off a cliff. At least not in the way you'd expect from looking at the stock chart, which has just been really ugly the last year. As far as premium retail goes, this is a brand that has industry leading rates of customer loyalty, meaning customers keep coming back to buy more over time while relying much less on discounting than other brands do to drive those sales. And so finding good sales at Lulu is mostly pretty rare. And that's on purpose for protecting the brand. They sell everything first party, so they have complete control over pricing. And while it would be tempting to boost earnings in the short term by offering discounts during periods where maybe some of their styles are falling flat with consumers, I'm actually glad that they don't do that. And to me, it's not a question of whether a brand like Lulu can regain their trendiness, but really can they avoid the temptation to destroy the brand while trying to do so with, like I said, maybe excessive discounting. And so, yeah, you and Daniel have not been shy to remind me about just how brutal capitalism is. And if I do prove to be wrong about Lulu, it would really be an illustration of how using consumer insights can let you down. It's not a bulletproof strategy. But intuitively though, when I'm still wearing the brand daily, most of my friends are, most people at the gym are most people at the sea, you know, a ton of people. The airport are wearing out. And then from just kind of an income statement level for the entire company, sales aren't even actually declining. And then yet the Stock is down 50% in a year to a PE below 12, despite very strong growth prospects internationally, especially in China. Then you have this aggressive share buyback program. I look at all of that together and get this kind of mosaic where I start to feel pretty good about the risk return profile being at least skewed in our favor. And that doesn't mean that every investment you make will be guaranteed to work out. It's really just trying to make investments with favorable odds. And to me, it's a question of trying to consistently stack those odds in your favor across a lifetime as much as possible. So it's just funny to me because at this valuation, Lulu actually looks like a one foot hurdle. And now maybe that will age very poorly. And you're right that competition in retail is incredibly tough. But I would say Lululemon has been an industry leader for 15 years now and Nike is going on what, four decades of dominance. And so there's been plenty of competitors along the way. But just like with Coca Cola, the power of a strong brand can go a long, long way in any consumer facing business, whether that be with beverages, sneakers, or yoga pants. And so I caveat that with saying there are definitely some industries that are uninvestable. I've never really heard of an airline, for example, that was a durable compounder or a commodity miner, with the exception of maybe a few really rare cases. And so while I would say that retail can be trickier at the median level, as a lot of brands can surge into popularity for a few years, you know, become publicly traded and then fall off the map. Kind of like what happened to Allbirds, if anyone remembers that brand. But again, that doesn't mean that there are no quality compounders in retail. And in hindsight, just looking at Allbirds, I think it'd be easy to say that the brand was a fad. But I also never would have invested in a retail brand that had such a short track record of consumer loyalty. That's really how I think about. And what I'm trying to say is that, yes, on average, most retail brands are terrible businesses, but the best of the best can endure for decades, as with many other compounders in different industries. And so the bet I'm hoping to express is that Lulu is more durable than the market is giving it credit for. And I've been willing to make that bet because the current valuation is so favorable, based on the recent financials, it looks attractive, but we're watching it closely. We're not married to the idea. And if sales are suddenly weaker than expected, especially internationally, while the company leans more to discounting or continues to flop with new releases, I'd be the first to say we should reconsider it. It could easily be a value trap. And if it does prove to be a value trap, where the business looks cheap only because the trailing results look good while their future results actually fall off, then that would be a great learning opportunity for me. And also the reason you maintain a certain amount of diversity in a portfolio is for that reason, right? I tell Anyone to bet 100%, 50%, or even 20% of their portfolio on a company like Lulu, or really any other retail brand for that matter. But for us, 5% of our portfolio felt reasonable because we know that we do have these more typical quality compounders like Alphabet and Adobe and Airbnb, Uber, Berkshire and Universal Music Group, that we do feel very confident in their ability to chug along and kind of anchor our portfolio. So the question then is still, why even bet on Lulu at all? And I don't think I have a great answer. But the simple answer is that from the prices we entered at, we think the returns over the next five years can be as attractive as any of those other businesses. That maybe seem like surer bets, but Daniel and I like to remind people that, again, investing is this iterative process. You have to try different things and give yourself room to have big successes and hopefully make limited mistakes, because otherwise you'll never actually progress and you'll just be destined for mediocre returns where you're really just owning an index and owning what's popular. And that's not what we want to do. And so we're experimenting really as we go. And to your point, on Visa, unfortunately, the market also knows that it faces few competitors and it's typically priced to reflect that. Right? It was so at the time we looked at it, and it has been priced very richly since. But at the right price, we would love to own it. And for better or worse, you do need companies to face some genuine uncertainty for these really attractive opportunities to arise. And to me, it is easy to understand why consumers love Lulu and why it's been such a durable brand. And it's even easier to understand why Nike has done great historically. So many of us grew up idolizing Michael Jordan, and now the brand is synonymous with so many great stars, and that's been part of their strategy. And I would say, yes, Nike has squandered some of those brand advantages in the past years, maybe to an impressive extent, honestly. But the benefit of being such a wide movie business is that you also have a lot of room for error before competition can permanently take market share. And that's why we're actually willing to pay a higher PE for Nike, because we believe the business has arguably the strongest brand in all of retail, really, outside of luxury, and that gives them a ton of leeway to turn things around. They're not guaranteed to do so. And maybe it's not a business you want to own for a decade or 20 years, and maybe the same with Lulu, but I can very much see why both could do very well over the next five years based on just how bad expectations currently are. Despite the strengths of the underlying brands.

Clay Fink (42:35)

I honestly was a bit surprised to see Nike enter the portfolio. Not that it's a terrible brand or anything. I myself own Nike clothes, but more so because of just the lack of returns both for the stock and the business over the past decade. So when I look at the share price and earnings per share, those are flat over the past 10 years. And in my eyes, just to overly simplify things, it almost looks like a turnaround situation to me, which is probably why the investment opportunity exists, because I just don't even want to try and crack that code. But the earnings are also pretty volatile. We saw an earnings drop off in the past year or two, which would really make it difficult for me to judge where earnings are going to be, say five years into the future. And I would probably opt to just buy more of the dominant tech companies we already talked about that. Just have the odds really stacked in your favor instead of betting on a turnaround situation. So please talk a little bit about Nike.

Sean O'Malley (43:32)

Daniel and I aren't in the game of trying to predict specifically where earnings will be. And we take more of the reverse DCF model where we like to see what kind of growth rates are implied by the current market pricing. And so when we think about Nike, I mean Nike is in my opinion, not going anywhere. And if we can get it at a multi year low as opposed to buying it at a 10 year peak, then that is part of what makes the investment more attractive to us. Where we feel the odds are more so in our favor that if anybody has the brand credibility and power and resources to even just have a modestly successful turnaround that would spark a much bigger rally in the stock, it would be Nike. And so I would say more than anything, what we love is strong and enduring brands. And oftentimes the best brands are these kind of second tier tech companies or top tier tech companies that we talked about earlier that feel almost like a central part of our lives and are integrated deeply into our mobile phones. But the best brands are also not always these tech companies. And so I was very skeptical of Nike at first too. And I think the reason we both are is actually because of where we live and our age. Nike has lost a lot of relevance in the us it's just not as cool as it was when we were both growing up, I think. But Daniel has, has really helped me to understand and appreciate that Nike is a global brand and in Europe it's still very trendy. So there is something to be said for that kind of global diversification to their business, speaking to how strong the brand is still. And the other thing is, I would generally agree that we should be skeptical about turnarounds because in fact most turnarounds are just bad businesses selling an optimistic narrative about the future. But again, if there was any company that had the brand credibility and the status to deliver a turnaround, I do tend to think it's Nike. And when I think about using my own consumer insights to inform my thinking. Personally, I don't wear Nike much anymore, but I also probably would wear it again, I could easily see that with the right marketing, Nike could be cool with our demographic. And so what I'm trying to say is I don't think the damage to the brand is permanent. It's more like they're in limbo right now. You're almost betting for better or worse that things can't get any worse for them. And so that does not mean that they will succeed. But with some of the the management team that made the company returning to run things while they double down on third party distribution at places like Foot Locker and Dick's, I see one of the strongest brands in the world actually returning to their playbook for success historically. And so even with the mixed results over the last decade, they still managed to generate what's a really incredible 25% return on invested capital on average, over the last five years. And that does illustrate to me that they have competitive advantages. And anytime you can continue to generate excess returns on capital more than twice that of the market average, then, yeah, that's a sign of an excellent business, an excellent brand. And what got them in trouble, for context, was that their CEO at the time, a couple years ago, just got way too ambitious in the kind of pandemic era and thought they could sell first party through their own stores. And they started moving out of these other retailers that we now know are really essential to the business. And it was maybe one of the worst business mistakes I've ever seen made, honestly. And now they're in the process of trying to fix it. And when you're a company of Nike size and with the brand power it has, I think it is easier to make up for lost ground after mistakes. Those mistakes can be less damning. And just to give kind of a tangible illustration, with 46 billion in revenue in this past year, Nike could spend only 1% of its total sales to do $500 million in R& D, to develop the highest quality sneakers and sporting gear in the world. Whereas smaller competitors might have to spend 10% of their revenues on R and D or more just to match what Nike's able to spend. And the point there is, at their scale, they can be structurally more profitable than most of their competition. And they can ramp up research and development or spending on brand partnerships as needed to rejuvenate the brand at a scale that really nobody else can match. And so that's what I mean when I say I wouldn't bet on any turnaround. But when you take qualitatively what we know about Nike's branding and the financial advantages they have, plus them returning to this playbook of success that's worked for them in the past, then reinstating Their previously great CEO, Elliot Hill, after he retired. I see a lot of reasons to be optimistic that the market is too pessimistic on Nike. And it felt like the risk and rewards have just really been in our favor with the stock down over 50% since 2020. And we think the market is clinging a little too much to the mistakes of the past that Nike has made without fully appreciating Nike's ability to recover from them. And with all of that said, though, Nike is only a 2% holding in our portfolio, and we actually normally aim for positions of 5% size, so it's not our highest conviction bet by any means, just to be fully transparent, because as you've said, retail is this structurally very difficult business, and they are going through this sensitive period in the turnaround, and so depending on how that continues to unfold will change how we continue to size the position.

Clay Fink (48:55)

Yeah, the new CEO, Elliot Hill, seems to be a good fit to help steer the ship. And as you alluded to, turnarounds can be tricky to gain a lot of conviction on, especially if you're betting on the execution of a different strategy or an adjustment in their strategy. I do like that you kept the position relatively small, though. When you look at the portfolio today, which companies look most attractive to you?

Sean O'Malley (49:19)

Is it a cop out to say almost all of them? I mean, naturally we like all of them, and any that we don't like would be out of the portfolio or trimmed. And so, I mean, it's probably easier to say which ones were least excited about currently. And we just talked about Nike a bit, and given the run that Ulta has taken since I first pitched it to Stig and Toby and a Mastermind episode earlier this year, we think that company is getting pretty close to being fully priced, and we've taken some gains there. And Reddit is actually the only other position we've trimmed, but only because at its peak, I mean, it was just almost impossible for us to justify the valuation. And so you've got to be mindful of not trimming the flowers to water the weeds, as they say. But at some point, you also have to have a sanity check on how much you're willing to let an investment run before you lock in some of your profits. And so for us, with Reddit, the implied growth at $250 a share after we first entered in the mid-80s and thought it was expensive at that price, just felt unbelievably unrealistic, to put it charitably. So we trimmed it back to our initial position size of about 2% after it had risen to more than 5% of our portfolio. And if we do get some more attractive prices again, I'm sure we'll add to the position. I think Daniel would probably say the most undervalued pick in our portfolio is PayPal, and I don't necessarily disagree, but Daniel's the payment expert of the two of us. And we're also very bullish on Uber even after the stock has jumped this year, because we still think that the market has some lingering concerns about the effects of autonomous vehicles on the terminal value of that business. While we actually differ in our view and see maybe an opportunity for them there with you have the core business continuing to compound dramatically at the same time, while also a chance to improve the business as they integrate autonomous vehicles more onto the platform. And I don't want to talk about Uber too much because I know the last time I was on we went into them in pretty in detail.

Clay Fink (51:15)

Well, for Reddit, I do appreciate that you guys did trim it after it rose significantly, because as you mentioned, even a company like Alphabet swings by a total of 100% from bottom to top. So I mean there are opportunities to move around in the position but also kind of keep that core holding as the business continues to compound. And I'll be sure to get that previous episode linked in the show notes. We covered Uber and Reddit in greater detail and of course you and Daniel have recorded an episode on each of them as well. And I of course on the show like to pick out stocks that are a bit different than some of the others that you've touched on, either in the portfolio or on the watch list. And I would put Nike in that camp given the developments in recent years. And on the opposite end of this valuation spectrum, you also recently covered Ferrari.

Sean O'Malley (52:04)

This is a company that Guy Spier loves and so sometimes you have to clone the greats a little bit. And it's not in our portfolio at the time of recording, but we've gotten really close to adding it in. So what an incredible business and brand it is. They are the epitome of pricing power, honestly. Right. You could probably go across a lot of college dorm rooms in this country and there are a lot of 18 year olds with Ferrari posters on the wall. And that is, that's brand power. And I was pretty shocked to learn about just how much of a compounder they've actually been. And with the shares down a pretty decent bit this year, it certainly looks more appealing than it originally did when we first looked at it, but Daniel and I are, I don't know how it sounds, but we are fairly conservative investors and so we actually would need probably a larger margin of safety before we pull the trig. And what we love is that they have this cult like following of ultra high net worth customers who take immense pride in being a part of the brand. And that is a formula for excellent returns. Shares have compounded at something like 24% a year since 2016, and that's not necessarily unsustainable either because earnings per share have grown at a similar rate while you've also had operating profit margins inflect from 20% of revenues to 30% at the time of recording. And so I think it's just pretty fair to say that Ferrari remains at the top of our watch list. Actually, Daniel and I have an exercise where we go through and right. Basically every company we've ever covered is on our watch list and we go through and rank. Okay, what are the top five on our watch list that we're most interested in? And yeah, for a few weeks now, Ferrari has been consistently in that number one or two position where we're getting pretty close to thinking we'd like to invest in it.

Clay Fink (53:45)

I love that whenever you and Daniel get the same consumer familiarity with Ferrari as you have with Lulu and Uber, please do invite me over sometime. I'd love to take one for a spin. So let's talk Adobe. I'm really excited to get into this one. This is a stock I've admired from the sidelines for years. It's one of those companies that's just been what many would call expensive. The PE has been so high, yet it's continued to outperform the market for many years. Then comes along chatgpt to spoil the party for shareholders, a stock that, you know, historically it's been a pe of around 50 and has seen the multiple decline over the past 18 months. Essentially today PE multiples around 20. And turning to the points earlier about the attractiveness of tech companies, Adobe requires little in the way of maintenance. Capex and the business has historically generated just more and more cash every single year. In the trailing 12 months, the business's shares outstanding have also declined by 5%. And as you know, TIP has used Adobe's products for years. We edit our audio for the podcast on a tool called Audition, which I use every single week. And I believe that you guys are reviewing the video for your show on Frame IO and I was like, oh well, maybe this is a competitor of Adobe. And of course I look it up and Adobe owns it. So they bought this company in 2021 for $1.2 billion. So talk to us about what makes Adobe one of the most interesting picks in the market today.

Sean O'Malley (55:24)

All it takes to see what makes us so bullish is just a little charting. And I would encourage anyone to look up the growth in Adobe's earnings per share over, let's say, the last five years or so, and the contraction in their valuation ratio over that same time. And so if you look back to December 2019, Adobe has compounded its earnings per share at 18% a year, while the PE ratio on its shares have fallen by 14% a year. I mean, think about that difference. It's just astounding. And I actually cannot think maybe of a better definition of a stock not tracking its fundamentals. And as we know from basically really every study on the stock market long term, what matters is growth and earnings per share, and eventually stocks will follow that. And so of course the market knows that too. And what's happening is they're afraid that earnings per share in the future will dramatically decline because of generative AI and these competitors for Adobe at the lower end of graphic design with brands like Canva. And so the thing is, this is maybe a cop out, maybe it's a straw man argument, but there's a bear case for every stock in the world. And if you can't think of what could go wrong, then I think you don't know the investment well enough. And I kind of say that tongue in cheekly because I do think Adobe has made mistakes. They seeded the lower end of the creative design market for casual creators to Canva. And then AI is progressing so rapidly, it is entirely credible to worry about the company's earnings power. And for that reason, I would never argue that it should be trading at 50 times earnings like it was. But does that then mean, with this track record of just continuous compounding that they've had, that this stock should be all the way down to a PE of 20, which is, for context, about a 1/3 discount to the S&P 500's P E ratio more broadly? And so, despite all the narratives and pessimism floating around the stock for years now, the business has kept pushing along unbothered. Net income and revenues are up by a total of nearly 50% since 2021, and both are still growing at double digit percentages year over year. And you also have a company that has the majority of its revenues coming from corporate customers, who in many cases have been using Products like Photoshop and Acrobat in a commercial capacity for decades now. So it's about as ingrained into their workflows as possible. 95% of Adobe's revenues come from occurring subscriptions, and I couldn't even imagine higher quality earnings than that, honestly. It literally does not get better than that. And so to me, what I see is a company that has been arbitrarily labeled an AI loser potentially. And for as wildly optimistic as the market has gotten about AI, and everybody loves to debate whether we're in a bubble, I would say it's equally pessimistic about anything that doesn't seem to obviously be an AI winner. And that's where the nuance really comes into play. And for starters, Adobe does have its own AI model called Firefly integrated into its ecosystem, which is unlike any other AI model, actually trained entirely on data that they've certified to be legally licensed. And that's a huge deal. Adobe's customers are these major marketing agencies for brands like Coca Cola and Hollywood movie studios. And so those kind of customers cannot be using generative AI for movies or commercial production because it just opens them up to these major copyright violations that can be very, very costly to settle in court. So that's how we start to think, wow. Not only is there no evidence of mass defections from Adobe yet, the numbers still look great. They're actually creating an AI integration that appears to be hands down, the most commercially viable. Which is not to say it's the best, but sometimes the most practical technology is what ends up winning. And so I think the center of the misunderstanding is that while generative AI has made it easier for anyone to play around with image creation and editing or even to make these, you know, short movies, that does not mean that the high end clients, these really creative professionals that Adobe has, are going to switch away from Adobe. Right. It's really easy to see these viral videos on Twitter of like, oh my gosh, Adobe's dead, it's so over. But Pixar is not going to be using chat GPT. I can tell you that with a lot of confidence. And so you can simultaneously have this proliferation and content creation driven by competitors without Adobe's core business being disrupted. And to me, that explains why the business has continued to deliver stellar results quarter after quarter, even as the stock keeps selling off because of these narratives that continue to swirl around it. And fundamentally, there's really nothing that you can look to in the numbers that would explain or justify the stock selling off by more than a Third over the last year. And that's really just one of those reminders of being mindful of the purchase price that you enter a stock at. Because anytime you're entering a company at 50 times earnings, you take on this risk that even if the underlying keeps doing well, the market narrative can change dramatically against it. And so when we were talking about Ferrari earlier, you could probably say, well, why not just if you like the business so much, why not just own it? And it's because, well, at the current PE ratio, there's just not enough flexibility, it's too fragile. The company could keep doing well, but if the market narrative turns on us, we could be really punished by it. And with Adobe now, we're at the other extreme where it'd be almost hard to imagine the stock getting any cheaper unless the business just completely falls apart. And so Daniel and I just keep buying more as the stock falls. And in the meantime, we've just been watching the earnings continue to compound and share buybacks continue to reduce the share count and that increases our ownership of the business. And so in fact, I would say we aren't even really bothered about the stock being down. Eventually we want it to recover. But you know, what it really does is it gives management a chance to get more bang for their buck with these share repurchases. And so with the same amount of spending, if shares are lower price, then you can retire more shares, which again is great for us as long term shareholders. And so our views on companies are always subject to change as the realities of the competitive dynamics evolve here. And that is why we post weekly updates on our holdings in our Intrinsic Value newsletter. And that's the best place to keep up with how our thinking on these companies progresses. And our opinion could change. But Adobe has really looked attractive to us for a while now, and it only seems to be getting cheaper. Let's take a quick break and hear from today's sponsors.

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Clay Fink (64:58)

I mean it is such a interesting pick in today's market more broadly. One of the just interesting things for us as investors is just how fast things are changing. I mean I think Back to when ChatGPT was first launched. They reached 100 million users in two months. I mean it is amazing. And of course it's hard to see them directly seeding share from Adobe because Adobe is plugging these models into their offerings already. You know with how quickly these Technologies can emerge. You know, you can better appreciate a company like Ferrari in the portfolio because you know, chat GPT isn't going to be whipping up, you know, luxury sports cars anytime soon I don't think. You know, I can definitely resonate with AI fears and poor sentiment punishing a stock downward and you know, it's just so difficult to forecast the long term impact and it's bringing about I think a lot of opportunities and leading to more people really considering how is this going to impact their companies And I think even the companies themselves don't necessarily know for sure. And this is also why I appreciate your guys focus on valuation because if a sentiment changes on a stock or even just growth just marginally slows, that could change the sentiment significantly and you can see the multiple go from 35 to 20 rather quickly even if the business is continuing to strengthen as Adobe is. Though with regards to Adobe, I'd like to talk more about the switching costs. So you know, you and I are using these tools here at TIP and like for audition for example, we're paying something like 280 bucks per user. So it doesn't seem too out of reach that you know, a competitor can come in offer a very similar offering for our fairly basic needs for what we're doing. I hadn't actually done this before, but I looked at some of the other audio editing tools that are available and I'm just shocked by how bad some of them are when reviewing some of these websites and offerings which helps explain you know, Adobe's brand power and the premium price that they're able to capture. And one of the statistics that stood out to me in doing some more research on Adobe was it's estimated that over 70% of their customers are professionals, meaning that they're working for a company like, you know, you mentioned these larger businesses like the say the Coca Cola as the Disney's of the world and over 90% of their revenue comes from these professionals. So you know, it can be understanding that they would seed share to Canva, say on the lower end, but it sees the enterprise customers that are really moving the needle for them. And oftentimes these professionals based on my understanding, rely on a suite of products. So it isn't as simple as a competitor spinning up a tool and starting to steal share rather quickly. So perhaps it could harm Adobe around the margins. Some of these new companies that are entering and these new technologies that are popping up, but it sounds like their core enterprise customer base is pretty deeply entrenched, at least in the near Term.

Sean O'Malley (68:06)

So the example I like to use when thinking about switching costs is Microsoft Excel. And so you've got generations of workers on Wall street who were trained exclusively on Excel for spreadsheets and for new competition to enter. You're immediately going up against a massive amount of inertia. And I say that as somebody who used to work at S and P Global before I came to tip, and I can promise you there is an unbelievable amount of time and attention that goes into training their staff on the intricacies on specifically how to use, let's say, Excel in this example. And so if you have some new technology emerge, and let's just call it the chatgpt of spreadsheets, how quickly would these firms risk the efficiency and the quality of their internal operations by just immediately and kind of whimsically switching to some hot newcomer instead of sticking with what they actually know works? You could probably see the same for us with Adobe Audition as a company, right? We know that it works. And so something would have to be either dramatically, dramatically better or, or dramatically, dramatically cheaper for us to even take on the risk that this might disrupt our basically workflows, which would be a much bigger opportunity cost than the price of $280 for addition, as you say. And so this is not to say that no disruption can ever happen because, oh, that historically it does. But the point I'm making is that Microsoft, like Nike and Adobe and many of the other companies we've talked about today, is in a position to integrate tech breakthroughs into their existing products where customers already are, and they have some time to do so before especially these corporate users who do have higher switching costs, change their workflows. And so we were already seeing this with Alphabet and ChatGPT. Yes, ChatGPT caught them off guard. And ChatGPT took most of the market share and LLM usage, which I should say is a bit different from regular search. But now Gemini is the only competitor that's legitimately taking market share back from ChatGPT. And that's because Google has been able to embed the best of ChatGPT into these AI overviews directly in search or into actually AI mode in search as well. And so the problem is when incumbents ignore breakthroughs for too long. But what we like about Alphabet is that they're not doing this at all. And if anything, they are leveraging all of their different apps and consumer touch points to make folks even more dependent on their ecosystem. And so I see it similarly with that Microsoft example, even if a new spreadsheet app came out that was twice as good as Microsoft. I really think that Wall street and really every corporation in the world would probably prefer to stick with Microsoft, which they've trusted for decades, and just simply wait for the next Excel update to contain something similar. And I think it's kind of like how for years people talk about how Androids are more cutting edge and have, you know, objectively better features than Apple. And yet, at least in the US most people don't care. They just wait for Apple to eventually create their own version of these new features because that's so much simpler than switching. People actually in many cases don't care as much about the cutting edge as I think technologists like to think they do. They just want something that works and that's simple and that's easy. And as a consumer of Apple, yeah, I'm happy with their phones. I don't, you know, I don't care if there's some feature that Android has or they don't. If my phone and iPad and watch and headphones are all seamlessly synced together, that's pretty valuable. And so in Daniel and I's view, I think you could say really the same for Adobe and the corporate customers who use the whole suite of Adobe products that are linked together. And obviously the numbers financially have attested to the stickiness and quality of their products.

Clay Fink (71:52)

I've really come to appreciate that the switching costs for these enterprise customers can just be so high. So any new offering that does enter the market does have to be significantly better for these customers to even consider the idea of switching, especially something that's so deeply entrenched in their workflows and whatnot. Just the headache of moving over, especially with a firm that has thousands of employees, is quite interesting. And in preparing for this chat, I've also just thought about, okay, if all these tools are making these creatives much more efficient, does that mean there's going to be less users of their products? So, say a small marketing agency goes from 10 creative designers to five. How's that going to impact Adobe? And yeah, it's just something to really think about. How do you think about just the bear case or what would lead you to changing your mind on Adobe? What are some of the things you would need to see to trim or sell this position?

Sean O'Malley (72:49)

We really take seriously the idea of using our insights as consumers to tip us off as investors. And I'm sorry if I sound like a broken record, but it's just so integral I to how we think about these kind of Questions. And so, just as an example, if the investors podcast were to substantially shift away from using Adobe's products like Lightroom and Illustrator and Photoshop and Audition and Frame IO and so on, then that would be an early indicator to me that many other companies are at least tempted to come to a similar decision. And actually, we have an opportunity to be sort of a canary in the coal mine. Because we're such a small company, we can make those changes sooner and more nimbly than these huge movie studios and marketing agencies of the world. So that gives us kind of an advantage in that sense. And it sounds a bit anecdotal, and of course, if there's industry data that's saying something similar, I would be concerned. But this is why, seriously, I check in with our behind the scenes team here to ask them whether they still use Adobe in the same way, whether they've explored new types of tools, and kind of similar questions to that. And every time I've asked our colleagues behind the scenes, at least so far, I've always been told that Adobe is invaluable. The team was trained on it in college and has used it for years. And the AI tools within it are getting better by the day. And there seems to be really no serious consideration of moving away from Adobe. If you know something internally that I don't, please let me know. But just as a business, we definitely have, I think, other things to worry about. Honestly, the convenience of the Adobe ecosystem is just unmatched. Every step in the creative creation process, distribution, marketing, and then performance analytics and tracking can all be done in Adobe's suite of tools. And then they can bundle those together and just make them more attractive to corporate customers with discounts. And so I'm sure there are plenty of startups that can do one narrow thing better than Adobe or a handful of things better. But can they replicate that entire ecosystem and do so at a better price that justifies the massive switching costs? I would say probably not. And for as much as we joke about big companies being tied down by bureaucracy, they really do want to minimize it. Having one package of subscriptions to Adobe for your whole marketing team is so much more simpler than paying for a dozen different tools. And I'm just imagining, you know, some middle level manager at an office going, okay, I have to keep track of all these different expenses, a dozen different subscriptions. I'm speaking with the sales team at Adobe already and we can just renew our existing contract. Like, why would I want to take on all that work? To basically rebuild the ecosystem that Adobe already has in place for us. And so sometimes that kind of common sense logic can be really helpful. And so beyond maybe the anecdote of simply watching what our company does, if the financials did suddenly start to deteriorate, whether that be declining revenues or contracting profit margins because they were forced to reduce prices to fend off competition, we would of course be watching all that. It would be very concerning, and we would probably have to reassess the position. But fortunately, so far, we've seen nothing like that. And so when you combine those kind of anecdotes, the kind of qualitative logic, and then you just look at the numbers and you see a very different picture than what the market is portraying, that's how we start to feel good about the bet that we're able to make.

Clay Fink (76:01)

Yeah, it's just so easy to be down on the company when the stock is down. But let's not forget that Adobe's been the standard in the creative space for 40 years now. And so many people have been trained on Adobe and just, you know, it's just integrated as a part of their daily life. It's pretty clear at this point that this company will not be taken down overnight. They're still growing top line around 10% over the past year. So so far, I mean, it doesn't seem clear that AI will be a big disruptor. If anything, it might be an accelerant to them continuing to grow their suite of products. But one of the things I just really appreciate about your show is that I think you just make the investing process much more approachable. I also appreciate that you outline your estimate of the intrinsic value and use that to help guide your decision on whether it's added to the portfolio or not. I'm always a bit skeptical of trying to estimate the intrinsic value because it's just so sensitive to just a few different inputs. And many of the best investments throughout history have historically been overvalued over much of it being publicly traded. So, you know, David Gardner talked about this on the show with me just a few weeks back. Even if you take a company like Amazon and you caught it on a drawdown and then you see the stock double or triple, a lot of people that are valuation focused will let go of such a stock when it appears expensive again. So it's just a tricky balance of understanding a company and where you sort of fit in, your style and process and how valuation fits into that and understanding the implications of selecting the approach that you do select. So in light of your Views on Adobe. What is your intrinsic value estimate of the company?

Sean O'Malley (77:49)

I would agree. I mean, it's funny to call it intrinsic value because it sounds so objective. And we know that investing is not a hard science. And so at the end of the day, there is a lot of subjectivity baked into any estimate of intrinsic value. And so different expectations, for example, for future rates of returns, just via the discount rate you were to use in, let's say, a dcf, those would generate different intrinsic values for different people. And it's kind of a funny concept to think of that a company's intrinsic value can actually, to an extent, vary based on the hurdle rate that you demand. And so obviously, we all want as high of a return as possible, but we know that for the same future business growth, the price we pay will determine whether we earn a 10%, 12% or 20% return. And again, everyone knows that. And so the two questions are whether your expectations for the future approximately come true and whether you can actually buy the stock at a desirable enough price to yield a satisfactory return for you personally. And that does matter, that personal aspect. Some people try to buy many stocks that may only slightly outperform the market for short periods of times, and if they can get a price that suggests a 10% expected return, they're happy with that. Others have much higher hurdle rates, with a trade off being that they probably have to sit on cash for much longer, and then it's not guaranteed that they will ever get the prices they desire on the stocks that they're watching. And that's probably much closer to the Warren Buffett approach to investing. And so Daniel and I think that a fair value for Adobe is north of $500 per share right now. And even with a 20% discount to that, which is our usual kind of margin of safety, we look at that's a $400 implied price per share, and the stock is still undervalued today by nearly another 20% to that margin of safety price target at $330 per share. So, yeah, we see the margin of safety as being substantial at this point for what has been one of the highest quality businesses to ever exist. And that we have a unique appreciation for working in the media industry. And so at current prices, we've been continuing to add to the position, and it's been a controversial name in our intrinsic value community. We've had a couple calls debating it, A couple members have invested in the company alongside us. And just strictly looking at the numbers and the implied growth rates, at current prices, it's really hard, I'm biased to not find this stock attractive, but it's also not the company we sleep easiest with. And we know that there's a wide range of potential future outcomes that could fluctuate against us. And so, you know, AI image and image generation are improving very, very quickly. And it's scary to feel like even I would argue that we're not. Feel like you're betting against that in some way in kind of the entropy that's unfolding in this industry. And while we think the fears around Adobe are overblown, again, it's something we're watching closely with Lululemon, Nike. You can't be an active investor and just totally sit on your hands. It's a great mental model of not reacting to everything, but at the same time, you have to be monitoring these risks. And so we're not blindly in love with any of these companies because they all face legitimate competitive challenges. It's just that we liked the risk return profiles at the prices we were able to get them at.

Clay Fink (81:09)

Yeah, and it's certainly good to see just Adobe, instead of just ignoring this potential disruption, they're trying to integrate it into their offerings. I mean, you know, first level thinking would suggest, oh, this AI tool can do a creative in like a split second at very minimal costs. And, you know, this output's just amazing. But, you know, if you're Pepsi or if you're Coca Cola and you're creating advertisement, TV advertising you're spending millions of dollars on, you need to make sure your creatives are as good as they can be. So these designers need some level of control. So they might get an output from AI, but they might want to make some tweaks to it and improve it even more. And it's just really difficult to justify how that element of control, I think, is really important. Just thinking about Adobe more broadly, the best returns are going to come from these more contrarian bets, where your views differ significantly from that of the market. So when you're buying a great business, when everybody hates it and you have all these factors or narratives working against them, it can really play to a value investor's favor. So you look back at just the examples throughout history that we've referenced several times, they can seem so obvious in hindsight. Of course, Meta's stock was going to rebound after its drop in 2022 when Zuckerberg went crazy about the Metaverse. Or, of course, ChatGPT wasn't going to overtake Alphabet's entire business model. But in real time, it's actually much more difficult to act on that information. So today Adobe stock is down over 50% from its all time high. The market's clearly telling us that it's not going to be a beneficiary to AI, and it requires the work that you've done to have that conviction to actually act on that opportunity. And if anyone wants to see the inputs Sean used for the intrinsic value calculation, I'll be sure to get that model linked in the show notes as well. And anyways, we were talking in New York just last month about your research process and it happens to be a question that you get quite often researching a company every week. You need some sort of process because there's just so much information to take in when looking at a company like Adobe or any company for that matter. So please talk more about your research process in covering stocks on the podcast. You're right.

Sean O'Malley (83:37)

I think it's probably Besides, how do you find companies to choose? How do you go about the research process is probably the most popular question we get. It was funny the first time I heard it, I was like, research process, I don't know, I just do a bunch of stuff and then I bring it all together. Of course there is a process there. And actually I had to take some time to, to really reflect and say, yeah, there are a number of different approaches that we take. And I'll just say, you know, one of the first things I always do is I'll go to the company's investor relations page and I'll download the last couple of years worth of 10Qs and 10K filings along with transcripts from earnings calls. And then what I like to do is I'll dump all of that into Notebook LM. That's a free ad for NotebookLM. It's an Alphabet product. So you can say I'm a little biased to promote them, but it's really incredible. And so normally with AI you have this issue of hallucination, but NotebookLM goes solely off the source material you provide. It was actually at a valuex event that a hedge fund friend pointed out to me and said, hey, you need to get on NotebookLM. And that was months ago and we've really embraced it ever since then. It's just incredibly effective for parsing through years of filings. And so I might ask it to summarize business segments, how risks have evolved over time at the company, how maybe executive comp is structured. There's so many questions you can ask and it's only getting better at parsing through all of these different filings. And actually just before we hopped on this podcast, I think I uploaded 50 different filings on Snapchat into NotebookLM, because that's a company we'll be covering soon on my podcast. And so the next thing I'll do is then I'll kind of look into what public research is available on the business and to help me get a high level understanding of how the puzzle pieces fit together. So I'll look at different podcasts, substacks, Twitter threads. I'm certainly not above doing any of that. And I'll even go to the Value Investors Club forum to see if there's anything that's been written up on the stock. Just as I'm trying to get maybe the lay of the land for what is going on with this business and kind of the current narrative around it. And then from there, like I said, I start to get a pretty good idea of what's been going on and what is currently happening. And then I'll listen to some of the more recent earnings calls through. I use an app called Quarter and I will look for interviews with the CEO on maybe on YouTube. And then all the while, I'll just be dumping every interesting insight and chart and data point into what becomes this massive Google Doc. I have of maybe 20 pages of just raw, unfiltered information. You know, I was like, oh, let me copy that from the 10K. Oh, let me write down that quote from CEO. Just anything you can imagine, any chart, anything, I throw it in there. And once I feel like I've scraped maybe the most important information from all of these different sources, I do what is then, in my opinion, the most important thing ultimately, and that is trying to connect the dots. And so I can't tell you how many times I've had dozens of pages of notes on a company. But I'm sitting there looking at it, going like, gosh, I don't really understand what's going on at all. My understanding is completely fuzzy and disorganized. And my threshold is usually whether I could explain the business model and investment thesis to a fifth grader. And if I can't, that's a sign that I need a more fundamental understanding. And usually just by reading a bunch and consuming a bunch of information, I can't quite get to that level of clarity. But the incredible thing is that oftentimes, even without ingesting any new information, I can get what feels like an order of magnitude more clarity about a company by simply trying to tie all the bullet points in my notes together. And it's something I've had a lot of practice doing as a podcast host now. And so I have this tendency as an investor to believe that there's always something missing. And I don't think that's a bad thing, but it can be paralyzing if I don't feel like if I have, you know, the complete picture. And so the thing is, though, it's not usually a lack of information that's hindering my confidence. It's usually a lack of critical thinking. And so by being forced to try and tie all my notes together into a cohesive story for our newsletter and podcast, everything just suddenly becomes much clearer to me. And so the act of trying to explain things in written form dramatically advances my understanding in a way that I just think is not otherwise possible. Or at least it's something of a cheat code. And for context, in high school, I come with this background of being something of a creative writer. I really believe in the poets and quants aspect to investing. It's just not all about numbers. And so just by spending a day writing, editing, and rewriting my thoughts until I've covered everything from the origins of the business and their competitors and the management team and anything else that's relevant, I eventually gain what is a whole new level of appreciation for all decisions that have been made along the way and really how they got to where they are. And so the thing is, thinking and writing in that way are hard. Not to give myself a pat on the back because we do it a lot, but, I mean, it's hard. Most people are not doing that. It really is, and that's why most people don't do it in investing. But I think it's one of the best advantages we could possibly have as individual investors, because we certainly don't have access to the most data and raw information. So we have to take what we can win at and focus on that. And so anybody can look at PE ratios and best based on the numbers, but how many can actually see how all the puzzle pieces fit together and think like an owner and then make a capital allocation decision independently about whether to invest or not? And I think those traits are things I'm very much continuing to practice and are also much rarer from what I've seen in the investment world. And so the writing process is really not only part of my job, but it's become essential to how I've, I think, have become skilled at relatively quickly appreciating the most important aspects of dozens of different businesses. And then all along the way, I'm using ChatGPT's advanced thinking models as something of a sparring partner. Because, you know, inevitably, as you're writing everything out and you're connecting the dots, these new questions will arise that you had never thought of before. And then, you know, I'll send them to ChatGPT and we'll go back and forth and get feedback from it. I think, oh, yeah, why didn't DoorDash just acquire Lyft to compete with Uber? Or maybe they will. And should I expect that to happen. And sometimes I'll have this convo with chatgpt where I'm going back and forth and I'm not relying on it to think for me, but I'm using it as a tool to progress my thinking even further. And after all of that back and forth and reading through sources and taking notes and trying to connect everything to this bigger picture that I'm starting to form, as if almost as if I was writing a book on the company is really kind of what it feels like. I eventually get to a place where, for starters, honestly, I just simply don't have time to go any deeper because we are doing episodes weekly. And because of that, I'll get maybe what I think is 80 to 90% of the key information from the first 40 hours of work. And then the returns beyond that, I found, especially when you're looking for quality compounders, it's different with special situations, but the returns start to diminish on any incremental work after that because it just becomes almost too easy to overthink things and you get bogged down by nuance. And so, Yeah, I mean, ChatGPT Notebook, lm listening to earnings calls, reading quarterly filings, all that stuff is great. But again, anyone can do that. And it's really about how you build your critical thinking muscle. In my opinion, practicing writing, even if it's just once a month in a substack that you know that nobody will read, and you have no illusions of ever building a following. I mean, that can still be one of the best ways to differentiate yourself and grow as an investor. Because I can promise you, most people on Wall street don't have the time or the flexibility or the interest in writing 10 to 20 pages on their investment thesis in a post that nobody's going to read. They're trying to do what their manager says to do, or they're trying to just do something that looks good by the numbers. And so the fun part about recording all your thoughts and writing out your investment thesis is not only that it pushes you to be a smarter investor and to think things through more meaningfully, but down the road you can go back and read all your old writing and see just how far you've come. And sometimes I go back and read some of the first newsletters we wrote just earlier this year and I cringe and I go, gosh, I've come a long way since then.

Clay Fink (91:37)

Excellent. Well, thanks so much for sharing the research process. It can certainly be quite intimidating, and with many great companies, it's all about really understanding the key fundamental two, three drivers that will take that business to earn more money five years into the future. And sometimes there's beauty and simplicity in not overthinking things. And I think having that sort of framework to go off of can help tremendously because there's just so much information to take in and it can just be so easy to miss something too and put it out in a public forum. You can get feedback from people that work in the industry, so that can be valuable as well. So I think we'll wrap up the discussion there. Thanks so much for joining me here today, Sean. It's always a pleasure having you on the show. For those in the audience who would like to plug into the great work that you and Daniel are doing, where should they head?

Sean O'Malley (92:28)

They can search for the Intrinsic Value Podcast and whatever podcast app you're using at this moment. Or if you want to find our newsletter, you can just simply sign up using the link in our show notes below for this episode and otherwise, a good default is to always just go to theinvestorspodcast.com and you'll find our podcasts and newsletter there as well.

Clay Fink (92:48)

Excellent. Well, thank you, Sean. Really appreciate it.

Sean O'Malley (92:51)

Yeah, thanks Clay.

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