In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Doug Ott discuss:
- Putting 100% Of Your Net Worth Into One Position
- The Three-Body Problem: Chaos Theory in Investing and the Economy
- The Case Against Investing in Metal-Based Industries
- How Forced Divestitures and FTC Actions Spark Investment Ideas
- The Never-Ending Fed Roadshow
- Why Arthur J. Gallagher & Co. (AJG) Is a Key Insurance Brokerage Pick
- Is Visa Really Abusing Its Market Power? FTC Takes a Closer Look
- Mettler-Toledo International Inc (MTD): A Case Study in Premium Pricing and Market Lock-In
- How Pool Corp (POOL) is Capitalizing on Relocation Trends
- Steer Clear of Oil, Gas, and Financials for the Long Haul
- St. Joe’s (JOE) Finally Coming of Age? Lessons from a 15-Year Journey
- FTC Overreach in High-End Fashion!
- How H & R Block Inc (HRB) Overcame a Crisis and Emerged Stronger
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: We are live. This is Value: After Hours. I am Tobias Carlisle. Joined as always by my co-host, Jake Taylor. A special guest today is Doug of Andvari Associates. He’s on Twitter as @yesandnotyes. I know the reason why, because I remember you just telling that story a long time ago, but–
Jake: I don’t. So, let’s– [crosstalk]
Tobias: Welcome to the pod. Why is your Twitter account, @yesandnotyes?
Doug: Thanks for having me on. That’s a great question. I don’t remember our original conversation, however long ago it was. But even before that, I remember reading you way back when it was just greenbacks.
Tobias: Yeah.
Doug: Yeah. That was a long, long time ago. But anyways, @yesandnotyes, that’s an artifact of my law school days. I had this constitutional law professor who essentially began the semester, the class, with a question to everyone sitting down. The basic question was, I’m going to do a bad job paraphrasing this, but, “Try to think of what is the opposite of yes? What is a word that means the opposite of yes?” The goal of this instruction was to come up with a word that was as purely opposite as possible without adding any other meaning to whatever that word was. So, yes.
Jake: I have a headache. That’s my– [laughs]
Doug: You could choose a different word, but his answer and the way to explain it is not yes is the opposite of yes. But the overarching goal is that language has meaning, words have meaning depending on context, how you grew up, your culture, etc. So, that’s just a really interesting thought experiment. Definitely an interesting way to begin a constitutional law class talking about philosophy.
Tobias: Did you practice law?
Doug: I did not practice law. The investment bug bit me before that could happen. And so, law school, I began in about, yeah, 2007. About one year, one and a half year prior to the great financial crisis. Many of us in law school happened to be interested in business and economics. There’s a large number of older professionals that had been working at a prior career before coming into law school. There were a couple of people in the ex-military.
I had always been interested in investing, probably since high school, college, but especially when I got out of college, and started my first paying job, and had a little bit of income and deciding what to do and how to invest it. That’s when I got more interested.
Eventually, I met a friend of a friend who owned a small advisory firm in Georgia. We hit it off in 2007, 2008. My basic question to him was– I know I’m in law school now. I’m not really feeling it like I want to practice law at all, but I’m interested in investing, “Tell me, what do I need to be doing now to increase the odds of getting into the business after I graduate from law school?” His basic advice was he gave me three books to read. I bet you can guess at least two of them.
Tobias: Security Analysis.
Jake: Intelligent Investor.
Tobias: Intelligent Investor.
Doug: Yes. Intelligent Investor. Security Analysis.
Tobias: Making of an American Capitalist.
Doug: Oh, not quite, but that would have been another good one. But the third one he recommended was Margin of Safety.
Tobias: Mm.
Doug: He actually had a physical copy, which he loaned me. [Tobias laughs] Very trusting. Yeah, I was very thankful. I knew the importance of that physical book. I think I took about less than two days to read it as quickly as I can, not wanting to lose it, not wanting to spill any coffee on it. And so, I tried to finish it as fast as possible and get it to him safely.
Tobias: That’s an incredibly, clearly written book. I go back to that all the time and have a look. I don’t have a physical copy. I’ve got the PDF from the internet.
[laughter]Doug: Well, what it does best is that it has– Well, you compare it to Security Analysis or the Intelligent Investor, it takes that chapter from the Intelligent Investor gives more several different concrete, more modern examples, which definitely makes it a lot more accessible, I think. It removes a lot of excess verbiage, I think, which is to its benefit and why it’s so highly sought after, I think.
Jake: You didn’t relate to the Topeka six and three eights?
Doug: No, not the railroad bonds. No. Although, I am a student of history, I love reading about history. Some of it can be dry, depending on how it’s written, but I still enjoy the historical aspect of Security Analysis. The dryness definitely held back its impact on me, I think.
Tobias: I bought the original, like the reprint of the 34 edition, because I thought that that’s what you had to do. I think I own the sixth edition– [crosstalk] [Doug laughs] was the last one, but that was tough, that original one. I don’t recommend that.
Doug: Well, it gives us something all to talk about and reminisce over.
[laughter]Tobias: I can’t remember any of it. So, tell us a little bit about how you started Andvari Associates. Or, is that Andvari that you’re talking about?
Doug: Well, my old boss is whom I started working for when I graduated in law school in the Summer of 2009. Even though I did not finish anywhere near the top of my class, I was very proud at the time to be one of maybe a dozen graduates that had a job lined up for them in May. I think I started working September 2009. I think the valedictorian of our graduating class had to wait about a year or a little over a year before his employer, tops here firm in Atlanta, Georgia, would allow him to start working.
Jake: Wow.
Doug: So, I was really proud about that. So, I started working in 2009 from the bottom up in lots of different roles, but first, as an analyst. The firm that I worked for had a very much was a Buffett style kind of investor, followed a concentrated value strategy, owned I think 19 or 20 individual names in the equity strategy. My first two or three months there was to basically do a bond up research, review process over each of those 19 or 20 individual names, get to know them well.
And then, at the end, which was really quite interesting, I had to give a recommendation one name that I think should be sold and then an idea to replace it with, whether it was in the current portfolio or an entirely different name.
I was thinking about it a few weeks ago, I was trying to remember because I got a similar question from my intern that had been working for me this summer. I think the name that I picked that should be sold was, if you remember, International Game Technology. They were one of the big manufacturers of machines.
Tobias: Gaming machines?
Doug: Gambling machines in casinos, slot machines, have all the bright lights and video games for adults. That was my least favorite company out of the bunch that I looked at. Of course, there was a large position in Berkshire Hathaway. There’s a large position in Markel Corporation, Alleghany Corporation, Leucadia, like a who’s whose list of what a good value investor had in their portfolio at the time.
Jake: And did it do like a 10,000x after you?
[laughter]Doug: I don’t think so. I didn’t keep track with it, but I want to say it did poorly, and it was the right decision to get rid of it, but I could be wrong.
[laughter]Jake: Revisiting this history.
Tobias: I got a question here from the audience. I’ll just throw this out. There’s two, but the question is, “What do you think about Stock Market Genius, Greenblatt’s book?”
Doug: Oh, I read that one too, a long time ago. I remember my general perception. I think it was well written, lots of great concrete examples, and demonstrated his investment process and thought process really well. I think the only bad thing you could say about it is his investment ideas and strategies have been competed away in the marketplace. Maybe that’s the only bad thing I can think about it. I don’t think I can say anything else.
Jake: Terrible title.
Doug: Well, I think even Greenblatt… do that being a terrible title. He knew it was bad, but still I think he went along with his editor and publisher [chuckles] for a good reason.
Tobias: One of the questions that we have, somebody—Same, @Lotto Allocator. “Can you talk a little bit about your idea generation process?”
Doug: Oh, yeah. I don’t think it’s terribly different from what most other advisors do. Just to give you a little more background on Andvari. So, I got started in 2013 as a tiny, tiny shop. Started with a little over $3 million in assets under management and half a dozen clients. And now, we’re approaching $17 million assets under management, a little over that now. My clients have given me a very wide ambit in terms of what I can or can’t do. I manage separate accounts only. I don’t have a fund.
What’s also unique about Andvari is its all separately managed accounts. There’s a lot of retirement money in IRAs or 401(k), and a lot of taxable accounts and lots of different goals that people have when it comes to their investment accounts. Some might need 100% equity. Others might need a good mix of fixed income and equity. But the main point is I’m very flexible with what I can or can’t invest in. It can be micro caps, small caps, all the way up to huge mega caps. So, I think I already forgotten the original question now. What was it about?
Tobias: Well, it was about your idea generation.
Doug: Idea generation.
Tobias: But we might be getting ahead of ourselves a little bit. So, let’s talk about the portfolio. Do you have a different portfolio for everybody? We’re talking about your own personal portfolio. What does it look like if it’s [crosstalk]?
Doug: Yeah. So, when it comes to the equity portion of an account that I manage, that I do my best to make that look more or less the same for everyone. We’re all invested in the same individual stocks more or less, me included. But where it gets to be a little different is if you’re in a taxable account, you might be invested in some international securities that aren’t available to be traded if you’re in IRA accounts at a different broker. So, I’ve got accounts at Interactive Brokers and accounts at Schwab. Obviously, you can do a little bit more with Interactive in a taxable account.
===
Putting 100% Of Your Net Worth Into One Position
Tobias: What sort of concentration? How many names?
Doug: So, I think we’re about 18, 19 now, which is a little higher than average. But if you’re looking at the top five equity positions, those definitely combined make up more than 50% of that equity allocation. Probably upwards of 60%, 65% the top five.
Tobias: Because they’ve grown to that level or because you sized them?
Doug: I think it’s both. We have names that are 15% of the equity allocation of an account. Definitely, most of them did not start that way. They may have started 10% or 11% and grown into that 15%, 16%. It’s hard. In my 10 plus years of experience now, it’s rarely a good idea, even if you’re a self-described, concentrated investor to start out so high as 15%, there’s not much room for error. So, it makes sense, I think, to start a little bit less concentrated. 10%, 11% might be the highest I’m willing to go nowadays, initially.
Tobias: We were talking just before we came on about Buffett doing 40%. He can do that, because he’s got flows that quickly water down the 40% when he puts it on.
Doug: Right. But do we know or remember if he did that initially in the partnership days?
Tobias: I think he was pretty concentrated. I think he would have like three positions potentially. And they were like net-nets.
Doug: Yeah. I think it would make it easier if you, me, Jake knew we had millions of dollars coming in every year. We could afford to started off at a larger position.
Tobias: You might have to, just because you’re getting diluted all the time.
Doug: Yeah.
Jake: Munger said at one of the meetings. They were talking about like, what’s the most you’ve ever had in any one position? [Doug laughs] And he said, “Warren, there have been times when I’ve had more than 100% of my net worth in a single name.”
Doug: Yeah. Do you remember the story? I think there was an arbitrage situation that Munger went to the– going to the bank to take out loans to increase whatever that merger arbitrage situation was. That shows how extreme lengths he was willing to go on a sure thing.
Tobias: I don’t think Kelly gets you to more than 100% ever.
[laughter]Tobias: I think Kelly is definitionally limited to 100%.
Jake: You got a dream a little bigger, darling.
Tobias: Kelly’s 100% at certainty. I don’t know what you get beyond certainty that– Maybe there is some mathematical answer to that, I don’t know.
Jake: Oh. [laughs]
===
Tobias: Let me just give a quick shoutout to everybody playing at home. Pants in Petah Tikva, Israel. Santo Domingo. What’s up? Mississippi. We’ve got quite a few today. Cleveland. Bendigo. Early stuff here. Good job. Slickpoo, Idaho. Is that real? Porto de Mós, Portugal. Birmingham, Alabama. Toronto. Dallas. Valparaiso. Mac, how are you?
Lebanon. Gerrards Cross. Tallahassee. Chapel Hill. Tomball, Texas. What’s up, Tyler? Vienna. Bellevue. Boulogne, French. Lausanne, Switzerland. Lund, Sweden. Strasbourg, France. Yodfat, Israel. Winnipeg. Hyde Park. Boise. Mendocino. Hamburg, Germany. Stockholm, Sweden. Nashville, Tennessee. Mollymook, New South Wales. Good early stuff here. Blumenau, Brazil.
I think I got everybody. Thanks, everybody. Denmark. Jalalabad. Limerick island. What’s up, Colm? I think I got them. All right. Let’s go back to that question that we didn’t answer.
===
How Forced Divestitures and FTC Actions Spark Investment Ideas
Tobias: What’s your idea generation process?
Doug: Yeah. So, it’s the typical thing, is you look at the 13F, see what other great investors are doing. You got other great investors you followed for 10 years. I think one of the interesting things I think I do, I don’t know about other people, but I think– They rarely happen, so it’s still a good place to look. Forced divestitures are always interesting to study or even just keeping tabs on the FTC website, see who they are suing or launching an investigation against, whether it’s a publicly traded company or a private company, because you still might learn something about a specific industry.
I was prepared for a question like this. One of the most interesting examples of an FTC action against a company I’ve ever read about involves a company called Charlotte– what is it? Charlotte Pipe and Foundry Company. So, this is a private company. Their specialty is they made cast iron soil pipes. Very niche industrial business. Can you guess what market share they had with their number two competitor in the US for cast iron soil pipes?
Jake: No.
Doug: It was over 90% of the market share. [Tobias chuckles] The mind-boggling thing that they did– So, they had this dominant market share, these two companies, and Charlotte Pipe fires this new entrant into the market called Star Pipe that operations in China work. Their headquarters in Texas. They were undercutting and trying to take market share from Charlotte and this other company.
Charlotte bought Star Pipe in 2010 or thereabouts, a blatant action to prevent a competitor from upending the monopoly position they had. Part of the purchase deal, they had a six year non-compete with Star Pipe employees, and they literally destroyed the manufacturing equipment of Star Pipe.
Jake: Wow.
Doug: Just so blatant. Obviously, somehow word travels up to the FTC for this insignificant market that no one cares about. It was probably some disgruntled employee. Charlotte Pipe gets in trouble. Even though it might not be an actionable investment idea, reading stuff like this over the years or decades, you might learn something that is useful, whether it comes to your investment process, your investment philosophy or countering a similar situation in the public market somewhere.
===
Tobias: Would you take a look at the handbag action– I forget who was involved in it, but it just struck me as funny, given there are a few more obvious monopolies around. But what did you think of that?
Doug: The handbag, Louis Vuitton or–
Tobias: I forget who it was. Do you know what I’m talking about, JT?
Jake: I remember you complaining about it at one point.
Tobias: I thought it was funny.
Jake: Yeah.
[crosstalk]Doug: I don’t memorize.
Tobias: Coach. I thought maybe somebody was being acquired. That’s not–
Doug: It could be Tapestry.
Tobias: Tapestry. Thanks.
Doug: Formerly known as Coach, trying to acquire– I forget the other name of the company.
Tobias: Capri? Michael Kors? The hive mind has got us today. Good job, everybody.
Doug: It’s an interesting case. You read the news and think to yourself– of the luxury goods market really needs to buy–
Tobias: Doug’s gone into the matrix, a little bit. Hey, Doug, you’re just breaking up a little bit. Just while your screen is unfreezing itself. Can you talk about where you are, JT?
Jake: I’m in Seattle for a little trip up for an investment conference, but I’d probably rather not.
Tobias: All right. Fair enough.
Jake: Give the details.
Tobias: Looks like Doug’s back. Doug’s back. We’re saved.
Doug: Am I back to normal? I’m sorry.
===
FTC Overreach in High-End Fashion!
Tobias: You’re back to normal. So, let’s go. It was Tapestry, Coach, Kors. Capri, I’m not sure which one it was, but can you tell that story again?
Doug: Yeah. I was just reading the news, thinking to myself, having studied the FTC a little bit. But as a consumer, the basic question is, who really cares about this type of market? Are they really protecting consumers? Because these are upper end luxury goods, not as high tier as Hermès or Louis Vuitton, but it’s a voluntary purchase. People want to spend a lot of money to feel good about themselves or to broadcast a certain message to other people. I don’t see what FTC is protecting consumers for in this particular area.
Jake: Think of the widows and orphans.
Doug: Yeah.
Tobias: Maybe Lina Khan had a particular bad experience with one of those bags. I don’t know. [laughs]
Doug: It’s still– [crosstalk]
Jake: The sales lady was a real bitch to her.
[laughter]===
Is Visa Really Abusing Its Market Power? FTC Takes a Closer Look
Doug: It’s a less cut and dry kind of action. Compare that to a very blatant protection of a monopoly position with the example I was giving about the cast iron soil pipe market. I think Tapestry is less cut and dry or even there– I think there’s news today about FTC going after Visa for their– [crosstalk]
Tobias: Yeah. What do you think about that one? Because that seems to be thesis for most people, isn’t it, that it’s a monopoly or it’s a duopoly at least.
Jake: Yeah.
Doug: My basic understanding, and I haven’t seen anything official from the FTC yet, but abusing their position that they’ve rightfully, legally have built over generations. Four or five decades, they’ve built this great business model. It’s to be debated if they’re abusing their power or not. But it’s people’s choice. If they want to use a credit card, they’ve got two or three options, Visa, Mastercard, American Express, maybe Discover. But people have choices, they choose to use credit cards. Why not allow the people who built the network in rails to dictate how they are used if you want to use a Visa, Mastercard branded credit card, but I don’t know, maybe that’s too simplistic minded.
Jake: They really don’t take like a huge chunk of GMV. I don’t think pretty reasonable to make your economy run.
Doug: Yeah, it’s much better than cash. How else are you going to do– More transactions are shifting online away from in person transactions. And that’s slightly riskier. So, you have to charge a little bit more. But the general interchange rate is it ranges from 1% to 3% of the total transaction value. These are Mastercard’s cut is like 14 basis points.
Jake: Yeah.
Doug: They enable our economy to go like– I think they’re charging something that’s pretty reasonable, I think, but maybe not in the eyes of the FTC.
Tobias: There’s been a lot of cash elimination post-COVID. I’ve noticed no coffee shop would accept coins or– I only use cash for drug deals these days. There’s no other need for it.
Jake: [laughs]
Doug: Yeah, cash or bitcoin for ransomware, I guess.
Tobias: Yeah. Ransom and drugs.
Doug: Yeah.
===
Steer Clear of Oil, Gas, and Financials for the Long Haul
Tobias: So, what’s your model for the company that you like to buy? What are you looking for? You’re looking for something that you can hold for a very long-time compounds over time, is that the–?
Doug: Yeah. I constantly try to evolve the way I think about the types of companies I’m interested in. In terms of answering that question, I think you said it very well. Whatever company it is, regardless of industry, regardless of whether it’s small or large in size, I think that is the holy grail I think for most people, and for me as well, is something you can hold on forever, if you can, knowing, of course, that it will fluctuate between being overvalued and undervalued over the years.
I think that’s a great place to start. And then, you can get more particular when it comes to business model or the industry types that you prefer or understand better than other industries. But I think starting at looking for ones that you can hold forever is a good place.
Tobias: So, what does that rule out commodity type businesses?
Doug: Yeah. I was listening to some of your more recent episodes. I think, what’s his face—Barry [unintelligible 00:27:17] I think he gave the answer that I’m going to give– First, what do you rule out? Anything that has a commodity product, whether that’s oil and gas or the financial sector, they’re all selling commodities that are pretty undifferentiated.
I think with the oil, and gas and the commodities that you have to dig up and unearth from the ground is probably, slightly worse than the financial sector, given it might be a little more cyclical, and the prices can swing up and down much more. But on the other side, with the financials, insurance companies and banks got so much leverage. Both are bad qualities.
With that said, it’s still really interesting to me. Every now and again, maybe three or four times a year, I look at some of the small, tiny community banks that exist in the country. There are some really, really well run community banks that have done well in the past and probably going to do an above average job relative to the sector and keep up admirably well with the S&P 500, which– Those are just interesting stories.
We don’t own any banks in our portfolio, but it is fun to try to look for those needles in the haystack or the diamond in and rough situations. That’s the general fun part about being an investor.
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The Case Against Investing in Metal-Based Industries
Jake: Toby, do you remember who was– I forget who it was, but they wouldn’t invest in any company that produced anything out of metal, because that could always be delayed in a CapEx cycle. That metal is not going to go anywhere.
Tobias: Mm.
Jake: It’s too non-perishable [chuckles] to be relied upon.
Doug: That’s interesting. You don’t remember who said that? It was a fund or a person?
Jake: No. I want to say like Terry Smith sticks in my head, but I don’t think that’s right. It’s like, for some reason, that’s where my head– [crosstalk]
Doug: That’s a unique way of putting it, I guess.
Tobias: Does that rule out Nvidia?
Doug: For Me?
[laughter]Jake: Are you saying [crosstalk] are cyclical? What? No.
Doug: Well, there’s a lot of things I wish I could have done in hindsight. Very early life as a young kid into video games, I’ve known Nvidia for a long, long time. Not from an investor’s standpoint, but as a consumer’s standpoint. I don’t think it was originally called Nvidia or something else. And then, they acquired 3D effects and it’s building out there.
Jake: I remember buying my own first GeForce and building a computer probably 25 years ago. That was an expensive part. You really spent a lot of time thinking about like, “Oh, what graphics card should I get?” It’s like, “Which [crosstalk] games?”
Doug: It’s amazing.
Jake: Only for playing Counter-Strike.
Doug: Yeah, exactly. [Jake laughs] So, that’s originally how I know Nvidia. Maybe I should have been more open to the idea of identifying a cyclical bottom for the company. I knew the product well. I knew why people liked it, bought their products.
Jake: What’s the inverse of signing a [unintelligible [00:30:56], because that would be the bottom, if you kind of– [laughs]
Doug: Who know?
Jake: If it’s been invert.
Tobias: It would be the Berkshire annual meeting, wouldn’t it? [Doug laughs] That would be the inverse.
Jake: Yeah, exactly. [chuckles]
===
Why Arthur J. Gallagher & Co. (AJG) Is a Key Insurance Brokerage Pick
Tobias: Doug, can we talk about some of your names? Are you happy to talk about your names?
Doug: Yeah, I can happily do that.
Tobias: Lotto Allocator has a few questions here.
Doug: Yeah. Do you have any one that’s– [crosstalk]
Tobias: After Jake Gallagher?
Doug: Yeah. That’s one that I’ve mentioned before. That’s a new one we got in this year. The very first insurance broker I remember looking at was Brown & Brown back in 2011, 2012. I don’t know why or what prevented me from recommending it to my former employer, but I do remember as a market consolidator, it’s a very–
The insurance brokerage business is highly fragmented. There’s probably tens of thousands of small, medium sized brokers in the US and around the world. So, you’ve got Brown & Brown and Arthur J. Gallagher focused on the small, mid-sized. And then, you have the larger players that focus on the enterprises like Aon, who are the other big ones. Marsh, Willis.
But Brown & Brown and Arthur J. Gallagher I think are very unique, because there is hoovering up dozens of these firms every year. They are gaining benefits of scale. They are pitching themselves as the forever home to the businesses of these entrepreneurs. Margins have gone up and up and up over the last 10, 15 years. As Gallagher likes to say, “Insurance is the lifeblood of the economy. You cannot do business without insurance.” There are more and more new and different risks every year that need to be insured.
The insurance carrier industry, on the other hand, is, I think, a below average business. Buffett and Munger have said the same themselves many, many times over the decades. I don’t think I can say much else about the industry, but it’s definitely worth looking at. Evaluation might be getting a little long in the tooth. I don’t have it right in front of my screen, but 20 times, a little over 20 times free cash flows is my rough idea of where the valuation is now for Gallagher. But comparing that to other businesses and other industries, I think it’s pretty reasonable.
===
Tobias: There are a few more here, but we should—It is the top of the hour. JT, I know you’re on the road. Have you got some veggies?
Jake: I wouldn’t be here if I didn’t have veggies.
Tobias: [crosstalk]
Doug: Yeah.
Jake: Yeah. Let’s do it. Hopefully, maybe a little bit shorter this time to reflect my being on the road.
Tobias: Feel free to spend as much time as you like.
Jake: -stretch it out. [chuckles] So, we’re going to be talking about the now legendary 3 body problem. If you’re a fan of science fiction, you might have watched the Netflix show that came out, I think, maybe last year or earlier this year. It’s based on a popular science fiction book. But we’re going to be talking–
Tobias: [crosstalk] Chinese.
Jake: Did you? Wow, man, you’re a legend.
Tobias: I read it in English. [laughs]
Jake: [laughs] Did you? Did you like it?
Tobias: I did. I love the books. Yeah. Yeah.
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The Three-Body Problem: Chaos Theory in Investing and the Economy
Jake: Okay. Cool. Well, we’re not going to talk about that at all. [Tobias laughs] We’re talking about the real-world mind-bending physics problem that’s really been puzzling scientists for centuries. What exactly is the 3 body problem? Picture this. You get like three celestial bodies floating around, let’s say the earth, the moon and the sun. They’re all pulling on each other with gravity.
The next question is, can we predict their motion? Can we project out into the future? Now, if you tried to solve a two-body problem, let’s say, just the earth orbiting around the sun, it’s actually pretty straightforward. We can thank Sir Isaac Newton for a lot of that.
It really is a stop for a second to appreciate really how Newton was able to use math to then predict the future. Before that the future was like the entrails of chickens and whatever else. But he came up with mathematical reasoning to then tell you where something was going to be. You think of like Halley’s comet, for instance, and knowing when it’ll next arrive and then being right about it. Like, could you imagine how that must have blown people’s minds? The answer of when it’s coming back again, by the way, is 2061. So, hopefully, we’ll all be there. We’ll be old man together.
Tobias: I saw it last time. So, I’ll be seeing it again.
Jake: Beautiful.
Tobias: I was about five.
Doug: Nice.
Jake: Nice. Yeah, I remember. So, Newton was solving these two-body problems. But then, if you throw in a third body, it’s suddenly this cosmic juggling act goes wrong. You can’t just write down a nice, clean formula that predicts the paths of these things. Instead, these bodies influence each other in chaotic and unpredictable ways.
So, if I try to think of analogy of this, let’s say, you had a boardroom meeting, and maybe there’s three high powered CEOs who are negotiating a deal together amongst the three of them. If there are only two of them in the room, it’s fairly straightforward to figure out maybe where things are going to end up. Like, one will make a move, the other responds. Eventually, you find this balancing act.
But the moment you add a third person in, it’s like a whole new game. Like, alliances can shift, the strategies that you would go with all of a sudden are suboptimal and a single decision for one changes and negotiates for the other two. And so, this is the three-body problem in a nutshell. You get this really unpredictable, sensitive to initial conditions, starting conditions, and a total mess, most likely. So, scientists have been trying to solve this puzzle for centuries.
One of the most famous attempts came from Henri Poincaré, I think is how you say his name. Late 19th century mathematician, statistician. He discovered that the system was chaotic. It was like this is the early work on chaos theory. The tiniest tweaks to the initial conditions, like the position of one body being off by a hairbreadth totally changed the future path. And so, this is the early, early steppingstones for chaos theory came from this three-body problem.
So, let’s get back to our world of investing and finance that we always try to bring it back to. We are at home right now having some landscaping done in the backyard. I was having a friendly chat with the owner of this small business. I was asking him, what his margins typically look like, what kind of returns on capital does he see labor inflation, what’s it been like, usual stuff that you discuss with your landscaper.
We got onto the topic of the Federal reserve, and were they going to lower rates and by how much? It became very clear to me– He was waiting to buy some new equipment for rates to go down. It was really obvious that he was following along super closely with what Powell was up to. He probably knew what Janet Yellen had for breakfast that morning. [Tobias laughs] It struck me as fairly preposterous. Here we are, me, a citizen, and him, a small businessperson, we’re trying to affect a commercial transaction here. We have this third body who’s playing us with its own gravity. [chuckles]
So, the original mandate of any central bank is really to be the lender of last resort, just in case. If they should provide liquidity, ample liquidity, but at punitive terms, you shouldn’t want the money from them. It should be very expensive. And now, we end up with this fed that wants to steer the economy, unemployment, interest repayments on federal debt, consumer protections, I think all this stuff is way beyond the initial bounds of the starting mandate that they had.
My argument is that the fed is supposed to be this stabilizing mechanism in the system, but due to the three body problem dynamics that you find in physics, it’s actually a source of chaos, because now, there’s two parties who want to transact, and you have this third body who is changing all the outcomes potentially. It becomes impossible to predict. So, these small changes, a little tweak in the interest rate, they have these massive, unpredictable effects that no one can really model out, because physics says that you can’t model it. This is how you end up with chaos theory. So, investors, they might get spooked, and maybe they cause a sell off or maybe they cram in due to FOMO. Who knows?
But meanwhile, these companies are also reacting to it. They’re cutting back on their investments or maybe they’re ramping up expansion, like my landscaper was considering. Just like the celestial version of the three-body problem, these interactions, they’re nonlinear and they’re unpredictable. At the end of the day, it’s just a man behind the green curtain in the Marriner Eccles building.
So, I think sometimes our trust and our faith should be examined a little bit in some of our monetary mandarins, as Jim Grant would call them. So, there’s a three-body problem, and what the problem results in economically.
===
Doug: That’s an interesting metaphor. I didn’t read the books, but thankfully, I watched the Netflix series the first season whenever that came out. As you were talking, Jake, I think the decision trees expand exponentially due to all these other factors. But I think also you can look at localize that to yourself or localize it to the fed, they have their dual mandate, but it sounds like over the last several years, there’s some other new issues creeping in. We mentioned ESG, and probably some other things, and diversity, equity inclusion might be there.
Tobias: They seem to have climate change as their third.
Doug: Climate change is another thing. Thank you. And so, they’ve got now their own three body or five body problem. And how does that affect?
Tobias: Three is too easy. Throw in a few more.
Doug: Becoming less focused because of these variety of external factors that have their own gravitational forces on you, pulling you directly or indirectly, pulling you in ways that you might not even know about or realize. Yeah, I can see that–
Jake: Well, and really, it’s probably some of an overconfidence that comes from– Their job is quite a bit easier than it could have been being the world’s reserve currency and exporting really a lot of inflation, like, we imported a lot of deflation. A lot of people working low labor and sending us goods kept our inflation under control, yet meanwhile, our deficits and low interest rates are pushing in the other direction.
So, you didn’t really have to pay for the pipe– Like, it’s an easy game when the rest of the world wants to send you stuff and you send them pieces of paper. It’s not that hard to play the game on that mode. But is that a sustainable path? I’m not so sure.
Tobias: I got a good comment here, JT. Bryan says, “Broke: asking your taxi driver. Woke: asking your landscaper.”
Jake: Sorry, my privilege is showing– [laughs]
===
The Never-Ending Fed Roadshow
Tobias: Doug, do you think about interest rates, or the inversion or China? Or, do you think of any of the macros’ stuff?
Jake: Objection. Leading the witness.
[laughter]Doug: What is the answer you want me to get?
Tobias: No, I’m just interested to know. The pat answer from value guys is, I don’t worry about the macro at all. And I am at that point– [crosstalk]
Jake: Or, the dog ate my homework.
Tobias: Or, the dog ate my homework. Yeah.
Doug: Yeah.
Tobias: I’m just interested. Do you have any thoughts?
Doug: I do have a little bit of thoughts, and it might not be that different. I think generally, yes, I try not to think about it, but at the same time, it’s hard to avoid it. It is important in the near term, medium term. I have individual clients who clearly care about that type of stuff. And if they care about it, I need to care about it. That’s part of, I think, my job of being a good investment advisor to individual clients. I’m not managing endowment funds or family office money, which are different types of clients. I’ve got people at retirement age. I’ve got young entrepreneurs.
Jake: I know they’re actually probably not as far apart as you might think. [chuckles]
Doug: Well, to be determined, I have yet to enter that stratosphere of fund management. I think some of their concerns are different. So, it’s something I have to care about and clearly will affect some of the companies that we own in the near term, but over the long-term, we’re going to be fine wherever interest rates may go.
Tobias: Reed Spencer said that, “If anybody had understood what he said, then they hadn’t understood what he’d said,” because he was speaking to be impenetrable. Somebody posted on Twitter today the upcoming schedule of Fed governors and board members, that speaking schedule. It’s like a wall to wall. They spend so much time talking. It’s at every month. There’s an FOMC decision. It seems like there’s so much Federal Reserve talk all the time, interest rate talk all the time. It just seems bizarre to me.
Doug: Do you have the schedule in front of you?
Tobias: I don’t, but it seemed like it was–
Doug: Like, every other day, someone was talking.
Jake: You’d be run out of paper.
[laughter]Tobias: It was like looking at the TV Guide on ESPN and seeing wall to wall coverage of whatever event was going on that day. It’s like, there’s somebody talking every hour.
Doug: Yeah, it’s going to–
Jake: That’s a good analogy, Toby, because this is the thing that drives me crazy about ESPN, nowadays, is like, it used to be in the off hours. ESPN would show you like, “Hey, here’s random bull riding mixed with ocean–
Tobias: Roadshow.
Doug: [laughs]
Tobias: ESPN Roadshow.
Jake: Yeah, we’ll see these really brand off market sports things. A lot of times, they’d be really interesting. And now, all it is talking about whatever happened in a game, and people just arguing back and forth and being salacious about it. Or, it’s gambling related like, should you betting the over under?
Everyone’s focused on derivatives of the game as opposed to like, there’s entire different swaths of games to be looking at. That’s what we ended up here with the Federal Reserve talk is like, “Hey we could be talking about all these different businesses, but instead, we were focused on this one little thing, and then it’s just all this narrative around it.”
Tobias: It’s important. It impacts business particularly, because I’m small and micro and the small end of mid. It definitely impacts those businesses much more than it impacts the big guys. They have customers who can’t buy, because now they can’t finance. They have debt that becomes more expensive, and then their own equity on multiple goes– is influenced by where the rates are. So, it has an impact. That doesn’t mean that you can predict what it’s going to be. It has an impact, but there’s nothing you can do. It’s a natural disaster that you just sort of watch happen whenever it happens, whichever way it goes.
Doug: Yeah.
===
Jake: You’re a house on the edge of the volcano. [chuckles]
Tobias: I live in Palos Verdes, so my house is on the edge of a cliff.
Jake: There you go.
Tobias: It’s falling into the ocean.
Doug: I hope there’s no landslides.
Tobias: There have been a few.
Doug: Oh, gosh.
Tobias: But it’s okay. It’s nowhere near me. That’s not my problem until it comes to my front door. [laughs]
Doug: No.
Tobias: I get a question from Tyler Pharis, who’s our unofficial producer. “Do you guys think the lagged effects of monetary easing will take as long as the lagged effects from restrictive monetary policy?” I think that’s a good question. I think it’s probably true.
Doug: So, the idea is it’ll take longer?
Tobias: Just that it takes. The old that was like two years before it really impacted the business, impacted the economy.
Doug: Yeah, I have no idea.
Tobias: It’s the end of the macro, guys. We’re going to get back to the–
Doug: Oh, Gosh.
===
Mettler-Toledo International Inc (MTD): A Case Study in Premium Pricing and Market Lock-In
Tobias: We’ll get back to some names. I saw on that list, Mettler Toledo.
Doug: Yeah, that’s another newer one. It’s a smaller position. It’s in the life sciences industry. They’re best known for making pipettes and weighing machines that can weigh stuff down to the micrograms or maybe even smaller. But then, they have this other more industrial business, large weighing scale business that it’s based in Cleveland, I think, Ohio. It’s weighs large 18-wheeler trucks. They sell the scales that you see in your local grocery store, Kroger’s or Publix or whatever.
Jake: I think you’re taking Graham a little too literally when he said, “In the long run, [Tobias laughs] it’s a weighing machine.” [chuckles]
Doug: Yeah, you could take it quite literally there. The other competitor to Mettler I think is Sartorius based in Germany. It’s a great business. Got good tailwinds to it, especially in their life science division. Super high operating margins. I think they’re above 30% and they have–
Tobias: Why is it so high? Is it hard to make a weighing machine?
Doug: I don’t think it’s hard. I just think it just has to do with the fact that they’re selling into a highly regulated industry, pharmaceutical companies, drug discovery companies, CDMOs. Once they start using particular equipment and consumables for drug discovery or drug manufacturing, they’re locked in for years and years and years. They probably advertise themselves as having a premium product. It’s literally these little plastic things that probably make a few cents to make, and then they sell for dozens of dollars. Quite a nice business.
But again, it’s another company with a very high valuation multiple. Not everyone’s cup of tea, I understand.
===
Doug: I think the only one slightly negative thing I can say about the company is that they have a regular share buyback program. They buy back shares every year, regardless of price, which is the only– might be the only knock against them as a company.
I think you hope a company that you’re interested in if they are willing to buy back shares might be a little more discerning, but it’s worked out fine in the past, and hopefully, we’ll continue to do well.
===
Companies Could Improve Share Buyback Outcomes with Dollar Cost Averaging
Jake: If the average tends to be very pro cyclical, the average company is buying back towards a peak usually, historically. So, if you can just dollar cost average, you’re already better than average. Of course–
Tobias: Reducing the error.
Doug: That’s a good point. Yeah. The amount of skill, and I guess swagger it takes for CEO and a board to buy a billion of worth your own shares in 2009. I think it’s non-existent. Like Jake said, given that most companies time it poorly, yeah, it does make better sense to dollar cost average. So, I think that’s fair.
===
Tobias: How about the voting machines? Who makes the voting machines, JT? [crosstalk]
Jake: [laughs]
Doug: The voting machines. Gosh.
Jake: Depends on which side of the aisle you’re on. [Tobias laughs] They’re complaining about that, right? [laughs]
Doug: Is there a public company that makes the voting machines? I would think that might be a– It could be a no-no. You don’t want to–
Tobias: Too much liability.
Doug: Too much liability.
Tobias: Too much downside.
Doug: Too much profit motive. I don’t know, that might be a thing a public company would want to steer clear of.
===
How Pool Corp (POOL) is Capitalizing on Relocation Trends
Tobias: I got a list here of names. How about Pool Corp?
Doug: Oh, Pool. Pool is another recent one. All the ones that you’re asking me about are the result of one of the– not the worst mistake I’ve made in investing, but one of the worst-
Jake: so far.
Doug: -so far.
[laughter]Doug: Thanks, homer. So, let me get back to my estate, because I think that’s important. I try to pick only good companies, but that never works out. So, the company I used to be invested in for a long, long time was another life science company called Mesa Labs. You can look them up yourself, but the gist was their life sciences business. They’ve got a sell into niche, highly regulated markets, high margins. I think there’s a lot of room for improvement when it comes to finding a new CEO and upgrading the board of directors.
All of that happened, they hired a guy out of Danaher, which I thought was great initially. Unfortunately, it made some two large acquisitions that turned out they paid too high a price for and the company has underperformed for a very long period of time. And so, I sold out of that, and reallocated capital into a handful of other companies that had been on my watchlist for a long time.
One of them is, like you mentioned, Pool Corp. Pool is the largest distributor of pool supplies in the US. They have 40% market share. If I remember correctly, they’re four or five times larger than their next closest competitor, which might be a little different now. I think Home Depot acquired another large pool supply distributor. Still a highly fragmented market. They acquire distribution centers and retail outlets year over year over year.
They had a big run up after COVID with everyone putting in new pools in their backyards, pulling a lot of supply forward, and the share price got knocked around over the last two years because of that. But in terms of the mix of the revenues, about 60%, 65% are the basic maintenance supplies recurring revenues. Another 40% are more supplies and material related to the construction of new pools or the renovation of pools out there.
It’s definitely one of the slightly more cyclical businesses I own. The good thing about the business is that once you have a pool, you have to maintain it forever, unless you want something green and nasty looking in your backyard which will affect it.
Tobias: [unintelligible [00:55:48]
Doug: [laughs] That’s a nice way of putting it.
Tobias: Organic.
Doug: Organic pool. Yes, that’s funny. But once you have your pool, you got to maintain it regularly, or it’s going to affect the value of your home or things are going to get a little nasty.
Tobias: What drives the cyclicality, the people installing new pools?
Doug: I think there’s some lag, mostly related to new home builds. I forget what the lag is. Management may have said there might be a 12- or 18-month lag, but don’t quote me on that. But it follows that, which makes it somewhat cyclical, in my opinion. But it’s not hugely cyclical.
This gets back to white paper, Lawrence Hamtil and I wrote about the great southern migration. Pool Corp is one of the companies that we identified as the obvious beneficiaries of people moving from the north to the south whether it’s retirees or whether it’s– There’s lots of businesses that are picking up shop from the northeast or the West Coast and moving to Texas and Florida and Georgia, where I’m based. So, you’ve got that as a tailwind. People like pools down there. It’s a nice thing to have.
My in laws, that was probably one of their happiest purchases they made. They moved from Illinois down to the villages Florida. The villages, I think, is one of the largest retirement communities in all of the US, retirees up the wazoo and they come from all over the country. They put in a new pool that was the first big thing that they wanted to do when they moved into their home. Have a nice-looking pool, because everyone else has one, and they want their grandkids and kids to have fun, and visit them and enjoy their pool.
===
St. Joe’s (JOE) Finally Coming of Age? Lessons from a 15-Year Journey
Jake: This St. Joe’s fit in to your southern thesis?
Doug: [chuckles] No, I’m not much of a– Yeah, they’re really just a real estate company. They’re selling land or doing developing communities down there still. It’s been forever. I know Berkowitz is still big into that probably, right?
Jake: Yeah. He’s chairman now. It’s a huge chunk of the– [crosstalk]
Tobias: It had a pretty good run recently. I was just looking it up. I lost some money in it, a long time ago.
Jake: [chuckles] Congrats.
Doug: [laughs]
Tobias: Yeah. I tell a story all the time, but I went to one of those value congresses and I think I bought it at $17 and it was trading at $22. You only see the headline of who’s going to talk. And it was Einhorn doing. If they build it, they will come.
Doug: Oh, gosh. I remember that short thesis.
Tobias: Einhorn had driven the streets. It’s like a hundred-page presentation driven the streets and taken photos. Berkowitz who was manager of the decade and they had him up at the end of the thing and they said, “Hey, Einhorn’s shorts on St. Joe’s and everybody knows you own it. What do you think?” And he went, “Ah, it’s going to work out.”
Doug: Well, it took I think 15 years before it worked out, started to work out.
Jake: They were both right. Just over different time horizons.
Tobias and Doug: Yeah.
Jake: Berkowitz said he was buying it for his grandkids.
Tobias: Yeah. It’s probably five. Not quite five bagged, four bagged since 2017. Oh, no, no, no. That’s literally true. That’s true. It’s the same price. It was the same price from 2010 to 2019.
===
How H & R Block Inc (HRB) Overcame a Crisis and Emerged Stronger
Doug: Oh, that reminds me one of the– Going back to my former employer when I got there, we got into– This just reminds me of an example of an idea that took a while to work out, and we had to endure a lot of volatility was H&R Block. Before the great financial crisis they had gotten into, I think, mortgage lending-
Tobias: I know.
Doug: -which was an awful idea. But post-crisis, they still had this liability on their books. I remember the name. I think the entity they had was called Sand Canyon. From 2010 to 2013 or 2014, every quarter, analysts were asked– That’s all they asked about. It was a pretty large liability, but they did have a large tax business, tax prep business in addition to that, [Tobias laughs] but no one cared really.
Yeah, I remember that was being a, I wouldn’t say harrowing, but just a hair pulling investment. It did eventually work out, but not for the reasons that we expected. There is somehow news that the new healthcare laws would somehow benefit H&R Block, because it’s tax related and you get your refund anticipation checks. Somehow H&R Block was going to benefit because of these new healthcare laws, which was not at all on our radar, but we were happy to finally see the stock go up.
===
Tobias: Hey, Doug, we’ve come up on time. If folks want to follow along with what you’re doing or get in contact with you, what’s the best way to do that?
Doug: Yeah, there’s a handful of ways. So, if you’re interested in Andvari, the investment advisor, you can visit the website at andvariassociates.com. You can follow me personally on Twitter, @yesandnotyes. I’ve got a Substack for myself. That’s andvari.substack.com. And I also have a podcast I do with Lawrence Hamtil and Devin LaSarre called Preferred Shares. You can find that at preferredsharespodcast.com.
Tobias: Good stuff. JT, as always, any last words?
Jake: Nothing smart to say. Let’s shut it down.
Tobias: Nothing further to add.
[laughter]Tobias: Thanks, Doug. Thanks, everybody.
Doug: Thank you, guys. Thanks for having me.
Jake: Thanks, Doug.
Tobias: See you everybody next week.
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