(Ep.127) The Acquirers Podcast: Matt Cochrane – Moat Quality: Wide-Moat, Quality, Growth Investing

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In this episode of The Acquirers Podcast, Tobias chats with Matt Cochrane, Lead Advisor with 7Investing. During the interview Matt provided some great insights into:

  • Moat Attacks
  • Buy The Best Companies
  • A Never-Sell Strategy Will Get You Through Drawdowns
  • Average-Up Into Your Best Positions
  • Don’t Rebalance Because A Position Gets Too Big
  • Why Moats Still Matter
  • Great Businesses Always Appear To Be Overvalued
  • Visa & Mastercard Continue To Dominate The Payment Card Industry
  • Digital Wallets vs Credit Cards
  • Mark Zuckerberg Does Not Get Enough Credit As CEO
  • Great Moats Provide A Long Time Horizon
  • Some Of The Most Successful Business Pivots
  • You Have To Turn Over A Lot Of Rocks
  • The Early Investment In 3D Printing Disaster

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Full Transcript

Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Matt Cochrane. He’s the Lead Advisor with 7Investing. We’re going to talk about his wide moat quality, growth, investing style right after this.

The reason that I really wanted to talk to you is, I think that you explicitly straddle value and growth, and you think you think about them as two different groups, or maybe you don’t. I just wanted to get a feeling for how do you think about investing, what’s your approach to it?

Matthew: I would say, if you had to boil down my approach into two core principles at the end of the day, one, it’s long-term buy and hold investing. We can talk about like #neversell if you want because–

Tobias: I do [laughs]

Matthew: [laughs] I figured you would. But because I am mostly a believer in that, and then the second one is finding companies with economic moats like competitive advantages, that a company has against competitors in its field or industry.

Tobias: Yeah, let’s talk about the moats first. You’re not necessarily dividing the world into value and growth. Your approach is moats and then everything else.

Matthew: Yeah, I think that’s correct. Ideally, you can find both value and growth when you make an entry into an investment. That seems it’s hard to do right now. I don’t know if you have tips for me, but I think it’s harder now than it has been in the past for me anyway. But ideally, you find both in the same investment. But I think– Oh, sorry.

Tobias: No, no, no. It’s all right. I was just going to say, at this point in the market cycle, is that what you mean? Because it just seems like that we’ve run up a lot. There’s not as much around as there was, say, March 2020.

Matthew: Sure. Well, yeah. Exactly. March 2020 for sure. But even five years ago, I just feel right now the market, companies in the market are valuing those companies like they’re great. There’s not so great companies, and maybe that’s where you find your traditional value investments. But they’re not companies usually that I’m necessarily too interested in either.

Tobias: Let’s talk a little bit about moats. What’s your definition of a moat and can you give me some examples of that?

Why Moats Still Matter

Matthew: Yeah, absolutely. I would say a moat is just a competitive advantage a company has and you can break that down into– If you’re familiar with Pat Dorsey, he breaks down economic moats into network effects or high switching costs, patents, intellectual property. You could go on and on breaking them down into different categories. But just take Mastercard and Visa, for example. So, they have great network effects. I think a great mental model to do is like Warren Buffett once said, I might be butchering this quote. So, don’t grill me too hard for this quote. But he says something to the effect like, “If you gave me a billion dollars, I couldn’t make a competitor to Coca Cola, because it’s brand and distribution is just too great, and I couldn’t be successful.” So, I think a great mental model is like, “If somebody gave me a billion dollars, could I make a credit card network that rivals Visa and Mastercard?” a $10 billion or whatever that money is. I can’t imagine someone giving me enough money to really make that work.

Their advantages that they already have the relationships with the banks, consumer recognition, security, all these things just make them– Their moats are just, in my mind, incredible, incredible.

You can go to Facebook. With its network effects, it already has that user base that’s just very incredible. The more users that make content, the more people that want to come on and etc., etc.. That’s a very powerful network effect to attack. It doesn’t mean you can’t make a rival social media company. I think there’s plenty of viable models out there. From TikTok to Snapchat to Twitter, those are viable models. But like to usurp Facebook from their throne like as the king of social media companies would be extremely difficult.

Then, you talk about like Salesforce with high switching costs. Once a company’s data, and once all their information, and all their people and sales teams are trained on that platform, it’s an incredibly expensive process to switch to a different platform. So, a platform like Salesforce has very high switching costs.

Visa & Mastercard Continue To Dominate The Payment Card Industry

Tobias: Do you think that there have been some– I don’t know if it’s a more recent phenomenon, because Buffett does talk about this too, that the history of business is the history of moats being crossed given enough time. It’s not necessarily the case that all of them will be and it seems that there are many like Mastercard and Visa that seem pretty robust, but equally there are competitors out there for them that are making some incursions. How robust do you think they are now as opposed to where they were, say, 10 years ago?

Matthew: With Mastercard and Visa specifically? That’s a great question. Actually, I guess one of my special areas of interest is FinTech in financial services. I would say there are definitely examples you can provide where– with Square, I think is a fantastic example. Because they have a seller side ecosystem and a cash app consumer side. What they’re doing more and more, especially with this acquisition of Afterpay is they’re creating an overlap between the two, which is just a closed loop, where they don’t have to use Mastercards or Visas rails, like when a Cash App user spends money on a Square seller like you can all stay within that Square ecosystem.

Now, that being said with that example, Square was still a tremendous catalyst for Mastercard or Visa, because now, you go back 10 years and you’re at a farmers’ market or a local seller, they couldn’t accept credit cards easily. You needed a landline, you needed expensive hardware, and you had to go through this whole rigmarole to accept the credit card. If you’re a small merchant, you had a ton of cash only businesses out there. Square, they just created this dongle that you plug into your smartphone, and all of a sudden, you can take credit cards within minutes, onboard within minutes, you go to Best Buy. You can buy it online. You plug it into your iPhone and you’re set up within minutes. Even with the encroachment of Square, which I think is one of the better examples of how a company is chipping away at their user base, it was still overall a tremendous catalyst for Mastercard and Visa.

The more payments go digital, the more payments go online, the more Mastercard and Visa are going to be used even if you can find small examples within those subsets where they’re not used. So, I think you still look at the global use rate of cash of cheques of this old money. The more that goes digital, the more it’s going to be a catalyst for Mastercard and Visa.

Tobias: That’s something like PayPal that I think has– Since it’s spun out, seems to become a more vigorous competitor to Visa and Mastercard. But it’s also looking at other things like Afterpay or there’s examples of like layaway spending where anytime you go to a website, don’t pay $120, pay four easy payments of $30. I noticed the last time, this is only in the last month or so that, I saw when I went onto a site PayPal said, “Would you like to pay for this with four easy payments?” which kind of surprised took them so long to get there, but they’re here now that seems like a pretty stiff competition to Afterpay, and there’s other sites like that.

Digital Wallets vs Credit Cards

Matthew: Yeah, I think PayPal is a tremendous company. This is a company I’ve been invested in almost since its eBay spinout. In those very early days, they were almost coming to a showdown with Visa and Mastercard. They decided pretty early on after spinning out from eBay that they were just going to partner with everybody. Visa’s old CEO, Charlie Scharf, there’s a comment from him in his old conference, analyst call from five years ago or so where he’s basically saying like, “We’re going to go to war with PayPal if they don’t change.” It looked like it was coming to the showdown.

PayPal, a lot of people I think– well, not a lot of people, but there’s some people in PayPal at the time that thought PayPal blinked. This was this great showdown, PayPal was supposed to be the great disrupter of Mastercard and Visa, and that they backed down from that, and I think they sold out of it. PayPal for a year after that, the stock price didn’t really move, even though they were showing pretty good results.

But I would say PayPal is more built on top of Mastercard and Visa pay rails. You go to your digital wallet, and yes, you can have money stored in your wallet. I think for most people though, that’s still a smaller amount. When you make a transaction using the balance in your account, that’s higher margins for PayPal. The more they can get people to have money in their account, the better for PayPal, absolutely. But most of it is still built on top of the Mastercard and Visa rails. So, even though, whether you’re paying for your designer shirt for $120 all at once, or you’re splitting into four payments over three months, or whatever the case is, you’re usually still paying that with a Mastercard or Visa debit card or credit card that’s attached to your PayPal wallet.

I still think these companies, it’s easier for FinTechs– If you’re a FinTech company, you want scale. The quickest way to go about that is to go on top of Mastercard and Visa rails. It’s a very, very hard, difficult road to reach scale without doing that. So, I think even– again, there are examples and PayPal has sellers too. So, there are examples of PayPal users, you have a cash balance in your account, and you can use that money to pay it out of PayPal merchant and all stays within that PayPal umbrella, those are very high margin transactions for PayPal. But by and large using your PayPal wallet, using your Cash App digital wallet, you’re still on top of those Mastercard and Visa rails.

Moat Attacks

Matthew: To go back to more moats generally, like the one thing I think you can look for is something called a moat attack. So, Toby, I interviewed you about a year ago, and it was one of my very first interviews, and I feel like I let you off the hook when we were talking about this, because we started talking about economic moats and identifying moats. I brought up moat attacks, but I used a specific example of Facebook, and Google+ attacking Facebook, and Facebook being able to withstand that “moat attack” is proof of their moat. Now, you took that opportunity to talk about Facebook specifically, but I wanted to have a more general conversation about moat attacks.

I would say, when you’re looking for economic moats to look for those types of moat attacks, and going back to Mastercard, Visa, there’s plenty of time for retailers. Large retailers have tried to band together and make their own payment network, because they don’t like paying these fees to Mastercard and visa, most of which actually go back to the banks. But still for a company like Walmart, those 2% to 3% transaction fees that they pay for every single credit card transaction, it adds up really quick. So, they would love to get that money back. So, these retailers have banded together before and it’s been extremely difficult to attack Mastercard’s or Visa’s stranglehold on that, and I think that’s proof of their moat.

Tobias: Yeah, I like that approach. I think that’s a clever way of doing it. But Facebook, in particular, Facebook is interesting, because they have had that Instagram– I don’t know if Instagram was an obvious competitor to them at that time. But Zuckerberg clearly identified it as such and bought them so early on what seemed like an extraordinarily high price at the time, but now, just a complete bargain. So, I think that more than Facebook’s moat in that instance, I might be more inclined to bet on Zuckerberg. How do you feel about that tension between the management and the economic characteristics of the business? Which is more important to you?

Mark Zuckerberg Does Not Get Enough Credit As CEO

Matthew: Well, that’s a good question. To try to tackle it more on a case-by-case basis, maybe, I would say, again, ideally, Toby, in an ideal world, you find both. Let’s look at Zuckerberg. It’s almost funny to me that the FTC now is attacking this as– using that acquisition and the WhatsApp acquisition as any trust for the basis of their antitrust cases, because for most of the time, since, I made those acquisitions, the common criticism was, I can’t believe Facebook paid this much money.

Instagram wasn’t making any money when they bought it for a billion dollars. WhatsApp, it still hasn’t made even in all this time, I don’t think it’s recouped about a $20 billion acquisition price. Zuckerberg, I think has shown phenomenal vision. I don’t think he gets enough credit as a CEO because what started as a stupid website for rating the attractiveness of girls and then from there, from a Harvard– It was just meant for Harvard students, he’s shown incredible vision to navigate Facebook from that to the empire it is now. I think he’s very underrated as a CEO.

Tobias: Yeah, it’s an interesting point. It’s that pivot from– Yeah, Facebook, it’s amazing. That was like a basically a Hot or Not for Harvard or whatever it was, and then became The Facebook for Harvard. I think about examples of companies that have successfully pivoted. There aren’t very many, but one that really springs to mind is Microsoft, which I think has pivoted several times now and very, very successfully and under different CEOs too. Is there something in the water at Microsoft? Is it genetic?

Some Of The Most Successful Business Pivots

Matthew: I would love somebody to study the history of this but I think– are you familiar with Clayton Christensen and his work on–?

Tobias: The innovator’s dilemma?

Matthew: Correct. I think that’s now like more standard business procedure and I think more companies understand that now. I think before he wrote that, that would be a very underrated understanding or business strategy, I guess, that there are pivots necessary, and some of those pivots will immediately be a ding to profits. It’ll take a chunk out of profits, it won’t be profitable at first. You can go back to like– Before that, you have Intel. Moving from memory chips to processing chips, I think it was in the 70s or 80s when they did that. It was hard for them to do it. The leaders of Intel at the time, it was a really hard move, because you’re leaving this profitable business that led you to be a great company to that time. But it was a move that had to be made because memory chips were just being commoditized. They knew if they did this, it would immediately hurt profits. But coming out of that, they could be the leader in that. What a run they had by doing that.

Microsoft, Satya Nadella again, you want to talk about leadership. Microsoft had great economics as a business, but without Nadella’s leadership, would they be in the position they are today? It helps that they had such a great profitable business because it bought them time. It brought them time to make these changes in to do all that, and it gave them resources to do it all, like with their pivot to the cloud under Nadella. But you really want both. You really want leadership and you want a great business model behind it to support it. It’s not always possible, but if it’s there, you want both.

Tobias: I’m glad that you raised Intel because I think that Intel who had a successful pivot there right now, there’s some suggestion that they may not be able to do that. What’s your take on Intel? Have you looked at it?

Matthew: I am not the expert to ask on that. If you just asked for my really high view, 10,000-foot view, I think they’re in a tough position. I think it helps them that the US wants to have a robust semiconductor chip business at home, domesticated. So, I think that helps them tremendously. That being said, if you just looked at the companies, Taiwan Semi versus Intel, Taiwan Semi, they’re just lightyears ahead of Intel. Intel is losing a lot of their core business to AMD, too. So, there’s a lot of problems I think with Intel. Now, can they turn it around? I think they have time and I think, like I said, it helps them that the US government– It’s definitely in the US interest to have a strong chip business based at home within the borders of our country. So, I think that will help Intel make that turnaround, but it’ll be interesting to watch.

Tobias: Yeah, some interesting game theory in that one.

Matthew: Yeah.

Tobias: What’s your background? How did you come to be interested in investing?

Matthew: I actually got involved pretty late in life. I grew up in a great home. Two loving parents, very blue collar, but money was not really an issue. It was just money was needed to be paid for the bills, and we didn’t have enough money to invest because that was something that rich people did. I went to the Navy and I think even coming out of the Navy– I was in the Navy for six years. I think even coming out of it, I don’t know if I could have written a check when I came out of the Navy. Financially, I was totally clueless. Totally clueless. I got married and I married very well above my paygrade. So, I did very well there. One of the reasons was, she’s a great saver and she knew we couldn’t just spend on whatever we wanted, and go in debt, and all these things. She got me involved in or interested in Dave Ramsey, who was great– for beginners, for people who are clueless like me, he was great just to understand basic budgeting. I’m talking about very basic money skills that you need to get through life that I didn’t have.

From there, I got interested in investing, and I started, but I had no clue what I was doing. Just the things I would do, it sounds so stupid in retrospect. Like paying very high commission costs for very low amount trades. Somebody would say, you should buy this company, so, I would buy it. Then, a month later, if it didn’t do anything, I would sell it because oh, it didn’t work. No concept for time horizons or any understanding at all stocks.

My wife left the workforce for a few years to care for the kids, so we really didn’t have enough money to invest. We bought a house, and it was just several years later, before I returned to investing, but my wife was going back to the workforce, you’re going to have more money, and I knew I should do something with that money. Somewhere in my head said we’re going to have extra income coming in, we need to do something smart with this. We’re living off of salary, so, we should do something smart with her salary. I was up very late one night, I saw one of those clickbaity ads, that 3D printing was going to be the next industrial revolution, something like that.

Tobias: Was that a Motley Fool one?

Matthew: Well, let’s just– [chuckles]

Tobias: If you don’t want to say, it, don’t want to say it.

The Early Investment In 3D Printing Disaster

Matthew: Yeah, it was just a clickbaity ad that I saw. I clicked on it, and 3D printing was a spectacular disaster. Spectacular disaster for me. But because it was such a disaster, it forced me to learn what did I get wrong here? It was one of the best mistakes I ever made in all truth. It was a great mistake for me to make, because I realized–

Tobias: What did you get wrong?

Matthew: I got it wrong that– it was a complete bubble. If you looked at the peak of 3D investing, I bought literally maybe a month before that. You couldn’t have timed it worse if you tried. It was just a complete bubble. There was no valuation, it was just all a story. I ordered a book online, because I was so sold into this. It was just talking about like, “When you move in the future, you’re not going to move your furniture across the country. You’re just going to scan it and when you get to your new house, you’re going to 3D print it.” I was like-

Tobias: It sounds frightening.

Matthew: [laughs] -“How could this not work? It’s going to be amazing.” So, that’s what I was thinking about 3D printing. There was no basis, the economics of that, I don’t know. I did not take the time to carefully think that through, obviously. But getting all that wrong, really forced me to evaluate, “Okay, what am I doing? I know, I need to do something smart with my money. This isn’t it.” It forced me to learn and I did learn. As I started learning, I just loved it. I loved it. I geeked out on it. I fell in love with investing, and I just learned more and more, and I just dived into it. But that was my introduction to– My first real introduction was 3D printing.

Tobias: When was that bubble? When did that pop?

Matthew: About 2014.

Tobias: Is that the curve of– I can’t think what– the curve of adoption of technology goes through that initial peak that vary.

Matthew: Yes, yes, yes, yes. The S curve or the hype cycle. The hype cycle–

Tobias: Yeah, [crosstalk] hype cycle. Thank you. Yeah. So, has 3D printing gone through the trough of despair or whatever that bottom part is called? Ws it worth a look?

Matthew: There’s scars that sometimes don’t allow you to go back to look at something. There’s scars there. There’s real scars there. I’m sure there’s industrial uses for-

Tobias: That’s funny, isn’t it?

Matthew: -3D printing. But yeah, that’s not something I will be looking at any time soon.

Tobias: What did you read then that got you on the right track? Who’s your influence in that way?

Matthew: I would say, there’s two really initial great influences. One was Peter Lynch. His investment books- and again, going back to when I knew nothing about investing, I literally I think I walked into Barnes & Noble, and I went to the investing section, and I picked up the Peter Lynch book. Totally lucky, but Peter Lynch’s two books on investing like, One Up on Wall Street and Beating the Street, just completely influential books and my basis for investing. Then two, the Motley Fool. I learned a ton from those services. Almost more so from their discussion boards, to be honest with you, Toby. Not so much anymore, but there’s still a few robust discussion boards. But a few years ago, they had some discussion boards that were hopping.

I think, maybe FinTwit sucked the air out of those discussion board rooms. But there were some great, great investors on those discussion boards that really helped walk me through some things. When I would have stupid questions, I remember asking someone on a board like, “Okay, well, how do you figure out free cash flow?” Literally, he had to go and he did out of his own free time, but explained to me like, “I go to this company’s– 10Q and you do this, and this is the line item.” He had to walk me through it. He kind of just be like, “Oh, operating cash flow minus capex.” I have no idea what that meant. He had to walk me through it step by step, and people like that were extremely helpful whenever I had a really stupid question.

Buy The Best Companies

Tobias: You used that as your basis but then how do you evolve? How do you start valuing companies or thinking about how you make money out of the stock market?

Matthew: I would say it started off with a really simple thought. At one point, I just had an epiphany. I had this hodgepodge of a portfolio and everything was a very different thesis. it was just a little bit of everything turnaround stories mixed in with, and there’s nothing wrong with that. But I didn’t have an overall philosophy. I was maybe trying–

Tobias: Trying to find them.

Matthew: Yeah. I think that’s a good way to put it. I was really searching. Then, I really think it was something just clicked in me one day, and I was like just buy the best companies. If you just buy the best companies, you’ll be okay. I used to go to stock price charts, and just be like, look, pick any stock chart in the universe of any great company, Coca Cola. I’m talking about 50-year stock price charts. Johnson & Johnson, IBM, any great company that has been a phenomenal investment over a really long time. There are plenty of periods but if you isolate like, “Look, if you bought this stock right here, for six years, it didn’t break that price.” That’s a frustrating six years. Yeah, if you held on, you would have done phenomenally well.

I think just doing that and understanding, okay, if you buy great companies, over the long term, you’re going to be okay. Now, from that very simple thought, the next question is what’s the great company, right? It was that first thought that was, buy great companies and hold on for a really long time, and you’re going to be okay. And from there, everything else just filtered through.

Tobias: So, that leads us to the never sell discussion. Let’s discuss that a little bit. What’s your interpretation of that and how do you think about it?

Matthew: I think people when they criticize it, mostly get it wrong. So, first start, I would say it’s mostly aspirational, not prescriptive. There’s nuance here, it can be prescriptive too. I would first start to say though, when I buy a company, there’s no exit plan. Yes, of course, there’s things I’m going to look for, I’m going to keep tabs on it, and if it starts to really fail– we’ll get into this, but there is a time to sell companies. However, going into an investment, one of the things I really look for when I establish a position is, do I think I can hold on to this company for a really, really long time? If that’s the case, okay.

Now, again, going back to just looking at really long-term stock price charts and isolating these periods of time where a company maybe got a little ahead of itself in valuation, maybe had some short-term problems like you could talk about Chipotle. When they had, it’s like food poisoning issues. I don’t have a position in Chipotle. But if you looked at that, you could say, I don’t think this is going to kill the company. They’re changing their procedures or they’re changing their policies, and it’s definitely a short-term hit. But like David Gardner, one of the co-founders of Motley Fool says like, “Are these storm clouds you can see through?” Are these storm clouds like you can see like the sun like– Yeah, it’s dark, where, I live in South Florida and there can be a thunderstorm coming in, but if I look on the horizon, do I see a patch of sunlight there, and a lot of times, the answer to that is yes. Okay, these are problems this company’s having.

Now, sometimes, you don’t know. We talked about Intel a little bit. Are these storm clouds you can see through or are these permanent dark clouds that Intel’s never going to regain its greatness? I don’t know enough about the company to know the difference. However, if you know enough and you think they are temporary, this is probably a great time to get into Intel. Or, if you know enough and know it’s not temporary, then it might be a horrible time to get into Intel. But being able to discern the difference between long-term fundamental problems with your thesis or short-term problems that a company can get through can make a real difference.

A Never-Sell Strategy Will Get You Through Drawdowns

Matthew: I think that philosophy, never sell, it can get you through those times. Especially, 7Investing, we’re really for individual retail investors. We want to be champions for them. That’s something as an individual investor, you don’t have to answer to other people. You’re not managing other people’s money. You don’t have to answer if you have a bad quarter, or two bad quarters, or you don’t have to answer to that. You’re just answerable to yourself. You’re accountable to yourself. If you don’t have anyone to answer to and you really know like, “Okay, I understand what’s going on. I understand why the stock price is down.

I get why the market is dinging this company right now but these are short-term problems that it’s going to work through.” That philosophy, that underpinning of never sell of long-term buy and hold investing can get you through those kinds of problems. You’re an individual investor. You can add at these dips. You don’t have to establish a position once and for all. You can never add to that. Most people in their working careers are adding to their portfolios regularly, and if you can do that, then these are great opportunities to add a company and to add to a position. So, I think never sell gets you through a lot of those short-term problems that every single great company has ever had.

Tobias: And that’s why you refer to those particular periods, that’s the prescription in the sense that don’t be scared out of the position, because there’s some short-term issue or the stock’s down. In that instance, just follow the rule that you never sell, and then, when you’re a little bit cooler or something like that, consider the exact nature of the problem that you’re confronting and whether this is a permanent issue you should therefore, sell out of all temporary and keep holding.

Matthew: 100%. You can’t be scared or drawdowns. They’re going to happen. think every great Investor ever has had those periods. If every good company has that, every investor has them. It’s gut wrenching. It’s gut wrenching when your portfolio falls or when a company in your portfolio falls. I remember having some real values of doubt like, “What am I doing?” Especially, early on. Especially, and I think for newer investors, that’s the biggest danger because my portfolio now, I’ve been very blessed, I’ve done very well over the last few years. It’s been a great market.

I can’t imagine drawdown that takes me under the amount of money I put into it. But when you’re a new investor, and you go below that level, it’s gut wrenching. You will have those periods like, “What am I doing? I should just index or I shouldn’t invest at all because the market is rigged.” You’re going to go through those periods. I think everybody does. I think everybody does. Not everybody gets in at a great time. So, I would say you have to understand, though, that is the cost of playing this game, and you’re going to have those drawdowns and it’s never fun. It’s always painful. But if you’re invested in the right companies, you’re going to get through it.

Great Businesses Always Appear To Be Overvalued

Tobias: Given that your approach is aspirationally never sell, ideally, never sell, to what extent does a valuation come into your purchase of a stock? Do you think that this is an unusually good time, or this is a good time to enter, or this is a bad time to enter for those reasons that if it does get very expensive that–? When you talked earlier about there might be a six-year period where Procter & Gamble or something doesn’t go anywhere. My interpretation of that would be that probably it got a little bit ahead of itself six years before, and it just takes some time to work off that overvaluation.

This happened regularly with companies that were very good through to the 2000s. It was a tech bubble, but it was a little bit broader than that. There were a lot of great companies that got very just– Microsoft being one, just got too expensive. Then there was a period of a decade or more 10 years to 15 years where they didn’t go anywhere. Even though, the underlying businesses were still quite strong and quite young growing very helpfully, that was probably as a result of them just being too expensive. I think you can avoid some of those problems by incorporating valuation into your approach.

Matthew: Valuation matters. I will not be the one here to say valuation does not matter. There was [unintelligible [00:36:54]. If you’re familiar with his blog, he did a great look at some of the NIFTY 50 stocks from the 70s. These were very loosely I think you could say maybe the FAANG of their day. These were the stocks that were supposed to do great, and great companies, and just invest in the NIFTY 50 stocks, and you’re going to be okay. One of the companies he highlighted from that time was McDonald’s. I forget the years. I’m being very loose here.

But basically, in the late 60s or early 70s, you could have pitched McDonald’s and said, “They’re going to grow internationally. They can expand to breakfast. There’s still room to grow in this country, and they can grow their sales by this amount over the next few years. This is a great company to still get into.” Up until that time, McDonald’s had done nothing but growth. You would have been right about all those things. Over the next decade, McDonald’s expanded internationally, opened up for breakfast, kept growing within the country, grew same store sales, all these things. In fact, within like a– I forget the period. But it was a nine-year horizon, they 6xed their revenue. They grew phenomenally, and yet during that time, its stock price was down because the stocks just got too ahead of themselves.

One, you have to incorporate some valuation into this. There’s some great companies out there that you look at the valuation and you’re like, “This can’t be the right time to buy this company. It’s just not.” I’m trying to think of a really good example right now, but there will be great companies that maybe– It’s not always like this. You can definitely pick some SaaS names right now, but I think you can also pick some of the more mature dividend aristocrat names too, that pay a dividend and they’re selling for almost 30x multiple and they’re growing very slowly. Great companies, but is it the right time to buy those companies? Probably not.

I wish there was a magic number. I think we all wish there’s a magic number. Don’t buy any stock with a PE over 25 or there’s a magic number like that. There’s not. I think you really have to take it on a case-by-case basis, you have to look at the markets there and you have to look at their growth rates, you have to look at their competition, their moats. Is their moat growing, is their moat shrinking? You have to look at all those things. I wish there was a magic number. So, if there is, help me out here, Toby.

Tobias: I’ll always hoping you were going to tell me.

Average-Up Into Your Best Positions

Matthew: But I think you have to take it on a case-by-case basis. Now, that being said, one thing I do, especially, when it comes out– I might be getting a little ahead of ourselves. But when I build positions in my portfolio, I do it slowly. What works for me is, there’s been times, if I think a company has a great economic moat, and I’m not talking about wildly overvalued. But if I think this is not where I want this stock. Just hypothetical, let’s say, I could justify a stock trading at 30 times PE, but it’s in the high 30s or at 40 PE. Is that I my ideal valuation for that stock? No. I work it out in my head, and I look at the IRR, I could get on that position in the next few years, and I don’t know if it works. But I’ll take a small position.

If I think the moat is great, and I think it’s a great company, if I think it has the right leadership, if it checks all my boxes besides valuation, I usually do not let that stop me from establishing a position. It’s a small position. When I take these small positions, we just talked about never sell long-term buy and holding, when I take that first initial position, I don’t believe in that. I can cut these kinds of companies quick, especially, when I’m still learning about that company.

I’ll throw out a company, Palantir. I think it has very interesting management. It’s expanding into commercial applications with data analysis, and it’s using a really neat mix of human intelligence, and AI, and machine learning to do this data analysis. I think when a company or a government agency is using Palantir, I don’t think they’re leaving the Palantir platform. That’s what I say is my thesis. Its valuation, I cannot make sense of right now. So, I bought this company late last year, a very small position. Within months, it more than tripled. I didn’t know really what to do with that, because I thought in five years at its high valuation that I thought I bought it at, I thought in five years best-case scenario, it could triple. So, it tripled in a couple months. I held it. I held it and it’s come down from that. It’s still very expensively valued. But I want to keep tabs on it, and I want to learn more about it, and I think it could really surprise to the upside.

Great companies have a way of doing that. We could talk about Amazon, and AWS, and then advertising, and now, logistics, just great companies find ways to continue to find ways to make money, and they surprise you. So, I’m holding Palantir. I think it’s expensive. I don’t know if I could justify to you its valuation, but it’s a small position. If it dips a lot or it goes back to my original stock price, or it starts to grow more, and I feel that’s not reflected in the stock price anymore, I might take another little bite of it. But I usually build positions at very little bites. And by doing that, I feel there’s obviously diversification of your portfolio, you have different asset classes, and different industries within your stocks, and things like that. But I think another way to diversify is over time.

Averaging up is a big part of that. I feel like a lot of investors don’t like averaging up. I think that’s a hurdle you just have to get over. I think some people get in their heads and like, “Why?” But I have a 10 bagger in Square. So, I don’t want to add to it here. I have a 10 bagger in this company. If I add to it, well, then it’s only a two bagger. I don’t want to do that. Who wants to do that? I want to say I have a 10 bagger. You have to get over that. If you have a great company that can continue to grow–

We could take Microsoft for instance. It’s a sizable position in my personal portfolio. It’s something I’ve added to almost every year for the last six years. I bet every year at least once a year, five year. Sometimes, more than once a year. It’s something I slowly add to. Hopefully, in those times, I’m finding good times where its evaluation is more reasonable than not because every stock zigzags up and down. Hopefully, I’m trying to do that. But by diversifying over time, I feel I’m just like– the same way people dollar cost average into an index, I believe in dollar cost averaging into a great company. So, I’m a big fan of adding to a position slowly, and over time, and I don’t mind taking a small bite, especially to get started if I feel like it’s overvalued.

You Have To Turn Over A Lot Of Rocks

Tobias: What’s your sourcing process like? How do you find the ideas that you ultimately want to own but certainly want to research more?

Matthew: That’s a really good question. I wish I had a really straightforward process for this. Sometimes, I just run screens at night on Ticker or YCharts. I remember once it was over my Thanksgiving break, there’s a thread on Twitter, and somebody asked like, “What are your best microcap stocks? What are your best microcap ideas right now?” It was from a big account, and so there was like a hundred responses. I started plugging them all in Morningstar on my phone. I think it was after Thanksgiving dinner… you’re following me just starting them in Morningstar. I think I went through… right away, you can tell. You look at stock, that’s not for me. It might be fine. It’s just not me. I got to… that’s really interesting… up not only buying it for my personal portfolio, but recommending it for 7Investing subscribers.

But… Twitter, I just feel like it’s a game where you have to look under a lot of rocks and I wish there’s a better way to do that. That’s one of the problems, hopefully, we’re solving for 7Investing members, is that we have a lot of people looking under rocks, and we can just present those ideas to them. But Toby, if there’s a position, I look at through 13Fs– Toby, I looked at your portfolio. What is Toby think is a really good value right now? Does that work for me? Does that work for a long-term buy and hold? I look through 13Fs, I look up on Twitter, I’ll look almost anywhere.

Don’t Rebalance Because A Position Gets Too Big

Tobias: What about diversifying the portfolio, and if something gets too big in a portfolio, do you cut it back or you say that’s just that’s the luck of the draw and let it ride?

Matthew: It’s a great problem to have, because it usually means a position has gone up a lot. Usually, I’m in a position where I add to my portfolio almost every month, because I’m working, and I just continue to add money to my portfolio. When a position starts to run away from me, I just stop adding to it. Most of the time that solves the problem. I just started adding to other positions, I don’t add to it. Like I said, I like to add to– I bought Microsoft several times over the last five or six years. I bought a company called Paycom, a lot less, because I got in it when it was $30, and now, it’s $400. So, I’ve never had to add to it. It just did it on its own. But it’s not too big of a position in my portfolio, because during that time– that might have been four or five years ago. During that time, I’ve just added to everything else. I don’t think I’ve ever added to Paycom again. But it’s at a nice size of my portfolio because it’s grown so much, but it’s not ridiculous either.

Usually for me, a lot of retail investors are still adding to their portfolios during their working career, I say just start adding other things. Let it grow. If you are not at that phase in your work life, where you’re withdrawing from a portfolio to live or something like that, then withdraw from that position. If you’re retired and you’re living off your portfolio, start withdrawing from that position. If you have the kid that’s going to college and that’s too big for you, then withdraw to that. Very rarely would I advise someone to rebalance just to because it’s too big in their portfolio. Winners keep winning and never sell are good things to keep in mind for that. A lot of times, if a company is up 50x– and not always, there’s a million exceptions to that. But a lot of times the company is doing something right, and it has an economic moat to get that far, then it’s going to keep winning and keep doing well.

Tobias: In 7Investing, when you have periods like now where the market seems expensive, there don’t seem to be a huge number of opportunities around. What do you do in those instances?

Matthew: Well, there’s never been a time I have not felt good about adding to a company. There’s usually some company I follow. Now, we can talk– I know we have different views on valuation. But I think a fantastic conversation would be absolute valuation versus relative valuation. I add personally to my portfolio every month, and sometimes, I’m not thrilled about evaluation, but again, I feel when you add to great companies over time, one thing I like about this style of investing is that time I feel is on your side. So, when you buy a stock that’s overvalued a little bit, but it has an economic moat, and it’s done well, but maybe I feel the stock price is a little ahead of itself– In fact, most of the stock purchases I make in my portfolio, I feel like it’s never the valuation I want. You always want a better valuation. There’s never a time where you’re like, “Oh–

Tobias: [laughs]

Matthew: I’m just– [crosstalk]

Tobias: Got it.

Great Moats Provide A Long Time Horizon

Matthew: But timing, I feel it’s on your side for these companies. One of the things that I’ve tried– I would say I’ve tried value investing. The thing that always worries me is that it feels like most of the time, not all the time– Correct me if I’m wrong, but I feel like it’s a melting ice cube as Bill Brewster would say. It’s that melting ice cube and time is not on your side. You need that catalyst to get its valuation back to what you’re looking for, intrinsic value or whatever it is. You want it to close that margin of safety you have before the business deteriorates further. I’ve been caught personally in several what I would call value traps, where I just thought it was a great value, and it was just too cheap. The business isn’t great, it’s not doing well, that’s more than reflected in the stock price. But I never know like I always feel there’s that ticking clock, that the hourglass of sand is running out on time for that stock to regain its intrinsic value or back to the mean. So, I feel like when you buy a company with a great economic moat, time is on your side. They usually are overvalued, or look overvalued at least at first glance. So, that’s the other thing. I feel like with these types of companies, time is on your side.

I bought Amazon five years ago. At the time, Toby, I would have told you with a straight face. I think it’s overvalued here. It’s probably a little ahead of itself. But it’s been a phenomenal investment, and I feel a lot of times these great companies look expensive, and maybe they are in that moment based of trailing metrics. But I don’t think they’re expensive on longer-term time horizons. So, I personally have not felt like– I always recommend stocks I own. I would never recommend somebody else buy a stock that I don’t own. Usually, stock I recommended stock I’m adding to my personal portfolio that month, unless it’s like a really large position. I have not had to worry about that yet.

Now, we’re still less than two years old. The company, 7Investing, we’re still less than two years old. So, I don’t know what would happen if we went through a 2000-type bubble or something like that, where I thought things were really outrageous. But I don’t think we’re in a bubble anything approaching the 2000 tech bubble right now.

Tobias: How would you characterize what you do then? If it’s not value investing, what would you say? Where does 7Investing come from, the name?

Matthew: We offer seven recommendations each month. That’s where the number comes from. Now, a lot of those recommendations are re-recommendations. I don’t want to give out something we recommended, but there’s been several companies we recommended more than once, more than twice, and as we continue, that number will continue to grow. We have plenty of freedom to re-recommend companies over and over again, that we think are great investments. So, that’s where the name comes from, and what was the other part to that question?

Tobias: Well, how do you characterize–? Potentially, the 7Investing was related to the style of investment, but how would you describe your style of investing? How would you characterize it?

Matthew: I would say in a very generic way, quality investing. Again, it gets down to always how do you define quality and things like that? I think it might be different for different types of companies. But that’s how I define it to myself internally. Buy companies with wide economic moats. Mostly, if somebody looked at my portfolio, somebody looked at most of my recommendations, they would say growth investing but not always. So, you can take a company like Moody’s. I don’t think that’s a growth company necessarily. I just think it’s a great company that’s not going to be disrupted outside of regulatory actions that I do not see on the horizon right now, it’s too invaluable to the way the entire fixed income market works.

S&P Global is another one. Same market. I wouldn’t call those two companies growth companies. I mean they’re growing. Yes, but they could have years where they don’t grow, there’s a bit of lumpiness to their cycles, but their economic moats are so wide, I feel you could buy it, and hold it in over time, 5, 10 years, you’re going to have market-beating returns.

Tobias: Wide moat quality growth investing, you’re going to [unintelligible 00:56:18].

Matthew: Yeah, rolls off the tongue.

Tobias: [chuckles]

Matthew: [laughs] rolls off the tongue.

Tobias: Matt, we’re coming up on time. If folks want to get in contact with you or follow along with what you’re doing, what’s the best way to do that?

Matthew: One, thank you for the opportunity. But I’ll plug the website like 7investing.com. I offer monthly recommendations there with my other fellow lead advisors. And also, I’m probably too active on Twitter. I check it too much, and I’m @Matt_Cochrane7 on Twitter. If you DM me or just tag me, I will see it probably way too quickly.

Tobias: [laughs]

Matthew: Some of you will probably be like, “Oh, wow, I caught him while he’s on.” Yeah, you probably will. But those are the two best ways.

Tobias: Yeah, great Twitter account. I can attest to that.

Matthew: Thank you.

Tobias: Matt Cochrane, Lead Advisor from 7Investing, thank you for your time.

Matthew: Thanks, Toby.

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