Ep737: Jeremy Deal – Use Differentiated Insight to Evaluate an Investment

Andrew Stotz 00:01
Hello fellow risk takers, and welcome to my worst investment ever stories of loss to keep you winning. In our community. We know that to win in investing, you must take risk, but to win big, you've got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives. And thank you for joining that mission today. Fellow risk takers, this is your worst podcast host Andrew Stotz, from a Stotz Academy, and I'm here with featured guest, Jeremy deal, Jeremy, are you ready to join the mission?

Jeremy Deal 00:35
I'm ready. I'm ready. Thanks for having me.

Andrew Stotz 00:38
It's it's, it's I'm looking forward to talking to you. And you and I, you know, just had a really fun conversation talking on many topics. And so I'm really looking forward. But let me introduce you to the audience. So Jeremy manages the survivor, and thriver fun, a private investment partnership, for high net worth families globally, the fund makes multi year, investments in companies with substantial, unrecognized earnings, potential foreign investment criteria are rooted in four basic tenets around business quality, take a minute and tell us about the unique value you're bringing to this wonderful world.

Jeremy Deal 01:25
So the fund, I guess, I guess, you could start with a little bit of the history we launched in late 2011. And the idea was to when we started looking at micro caps that were really blown out, after the great financial crisis. 2011 was just a terrible year in general, for the market, maybe one of the most volatile outside of the GFC. And so when we launched the very end of the year, we just you could do a screen. And there were just tons and tons of small companies that were trading for less than cash or net nets, very, very low multiples. And initially, we thought, well, let's, let's know invest in here, but look for activist opportunities. And so the initial investments were mostly smaller cap companies trading cheap. And that was really the only criteria, hoping they would rerate. And the activist stuff went down the path a little bit, but realized over the course of a couple of years, that the better opportunity was just in owning the right companies, and not necessarily you know, the return on time and the return on brain damage, which is not there for activism. So it's kind of set that aside and, you know, started buying smaller, generally lower quality, cheap companies. And as they rerated, selling them, and looking for more things to do, so that was probably the first, let's call it to two years of the fund.

Andrew Stotz 03:02
And, you know, when you think about that, that sounds to me, like, it's building a portfolio of just many because, like, I have a friend of mine, that a client in us, and I was going to see him and bringing some of my model from Thailand and Asia. And he's like, I know your model. It's screening out all of these cheap stocks. And, and they, and they all look like crap for a reason. And I said, Yes, that's right. And then when you buy them all, they eventually go up. Is that what you're doing? Well,

Jeremy Deal 03:42
I think that's how we started. Because, initially, that's how I started. Because initially, you know, you have there was this tendency, I think, like a lot of value investors, we just know how to look at the balance sheet, the income statement and look at the 10k. And things like management quality, where a business is heading or a big shift. In technology, for example, it's just not part of the equation. So at least in developed markets, you know, absent a great financial crisis, what I started realizing was that when markets normalize, things are a lot more efficiently traded than maybe in other parts of the world. So cheap is usually cheap for a reason. And started to see that we were missing out on great compounders and great companies that actually had a chance to beat our index, which is the s&p 500. And it wasn't necessarily looking back at we can get into mistakes, but looking back the mistakes. Were looking back at what we sold and what we bought. It was because as a kind of an IRR investor or short term investor, you're setting yourself up when it's only valuation you're setting yourself up to forced be forced to sold just set When something hits, you know, some kind of evaluation that's pretty much made up in your mind. And some investors say, Well, that's what the company would sell for if it was a private if there was a private transaction, but there is no private transaction. And that's just not the way it works. So unless the company is actually going to be sold. So we evolved the strategy, after making many mistakes of really missing out. And understanding over time that businesses that were cheap, were cheap for a reason. And those businesses were in structural decline. And even today, looking back at many of those early companies in our portfolio, and companies that I researched and followed many, many years before that even going back to high school, when I was going to the library to look at value line, cheap stocks, most of those companies are still small, most of them are still cheap. And they go through ups and downs, either because they're cyclical, but generally, they have a very, very low advantage, competitive advantage. And they're cheap for a reason. And it is really over the very long period has very little to do with interest rates, but it has to do with the ability just isn't there for them to grow. So we looked at what companies would we like to own? And how do we think about those companies. So the ideal company is a company we can buy, and develop some kind of an insight into why it could be much, much bigger in the future. And so it's not just thinking about, you know, ignoring valuation and saying, oh, there's we just hope that it grows. But really thinking about maybe a structural shift is happening, or a transition is happening. Value migration that's happening, you know, there's this Adrian's wellsky book on value migration that another investor recently brought to my attention, I had heard of it and thought about it, but written and so it's kind of fresh in my mind, a famous Indian investor, called Paul's sheath. And it was at it with him at a conference recently and listened to him talk about how he thinks about long term value versus short term value. And so a lot of these concepts that I make, he's fresh in my mind. And so his talks on mistakes are fresh in my mind. So I hope that all the viewers have a chance to look him up and listen to some of his talk. So we can put a link in the show notes.

Andrew Stotz 07:18
But yeah, and also the value migration is how to think several moves ahead of the competition.

Jeremy Deal 07:27
Yeah, so value migration. And so there's a the way that the Adrian's walski, the writer of the book defines it is he said, Well, there's the reef definitions of flow of economic and shareholder value away from obsolete business models to more effective designs that are better able to satisfy customer's most important priorities. So I just read that. And so when you think about that, it doesn't necessarily mean that you're going to be disrupted by some massive shift in technology, and you need to constantly chase that technology. What value migration covers is everything from manufacturing changes in manufacturing processes, or just becoming maybe a shift in a business model within a sector. Learning how, you know, culture, shifting culture. And so if, for example, you could think about maybe a transition that Nikes going through from selling shoes to retailers to a direct to consumer model, or the shift that maybe Autodesk went through from selling licenses to like a SaaS model 30 plus billion dollar value that was unlocked through that transition. So. So value migration is just, it's really about the where, where, where value is seen. And, and in closing that gap. So there's obviously really famous big examples of that. And there's all visually very, very small examples of that as well. But it's really about the customer and following the customer, and what is most beneficial to the customer. So it could be for example, the transition from in music that happened from having to go to buy a CD to being able to press a button and listen to music on Spotify, or YouTube. So that's an example where there was a tremendous amount of value migration. So we kind of look at the world. Of course, still valuation rooted. But we look at the world in terms of kind of four, look at businesses in the form of core four core qualities that really circle back to in different ways back to competitive advantage and quality. And the first one we want to understand is we want to know that the business model is adaptable and relevant in tomorrow's economy. So when we make an investment, investing is about the future that's different from trading. So trading is this doesn't apply to But making an investment is about making a bet, essentially, on the company's ability to grow and evolve at a time in the future. The past is only there to serve as a reference of where they've come from. But it does not the past does not guarantee at all or in a lot of times reflect where a business is going. So then we're looking for durable pricing power that's protected by a competitive advantage. And again, that competitive advantage can be intangible. It can be culture, it can be a shift that's happening, it can be like a transition happening in the company, a transition happening in the sector can transition happening, even even bigger than that the way people think. And the third thing, we're looking for his capital allocation and a balance sheet strategy that supports the company's moat. And so leverage is fine. If if, if the leverage supports the most you think about a dealership, for example, not that we don't own dealerships, but in certain types of companies like a dealership use, you may see debt on the balance sheet, but the debt is not necessarily recourse to the parent, it's really a form of fleet financing. And so that actually helps protect the business's moat by that type of financing that type of debt. And the third thing we look for is a significant alignment of interest between management and equity holders. That probably is pretty obvious. We want to have management team that cares about the minority holders and is not looking to take advantage of them. So. So that's that's kind of in a nutshell, we're looking for things that could be potentially a lot bigger in the future. Not necessarily because of really big trends. Maybe there are positions in the portfolio that reflect that. But also just smaller transitions, the value migration transitions that are happening within a sector that we think are really interesting. And we feel that the business is in a position with the right management team to be flexible enough to see those out and create a lot more value than then maybe it seems today.

Andrew Stotz 12:07
And what is your universe? Are you looking globally? Are you looking in the US? Are you looking US dollar markets?

Jeremy Deal 12:14
Yeah, we have we've, we've invested a little bit in emerging markets, but generally US, Europe as well, we're not looking for many things, you know, if we can find one or two things a year to invest in, that's great. We find nothing to invest in, that's also fine. So run a really concentrated and what did

Andrew Stotz 12:35
you tell us a little bit about? Like roughly how many stocks? Or what's your turnover? Like? What's your behavior in the way that you manage

Jeremy Deal 12:44
the top five stocks generally, and this ebbs and flows, depending on time, but the generally can be 50 to 70% of the fund.

Andrew Stotz 12:54
Wow, that's pretty concentrated. Yeah.

Jeremy Deal 12:59
Sometimes top five are only 30% of the fund. Yep, just depends on what's happening, how far a position is run, what the opportunity at the time is. And so we're generally running 10 to 12 positions in total, so there'd be a lot of smaller positions, or toeholds, that I think could become more interesting. But we're still in the evaluation process or just don't haven't developed the conviction to make it a full position. And we also run kind of a special, we also still have special situations of place for special situations in the portfolio. So those are generally you know, maybe four or 5%, where they're not long term investments, per se, but more shorter term, there's a catalyst, like an acquisition or restructuring or something, and I still can't kick our roots. So, you know, for example, during during periods of real stress, sometimes the special situations can really offset in a positive way, the other, the others, and they could also be a drag during other times, so it's not necessarily a hedge, it's just every now and then, you know, there's just special situations, which feel like we have to do, but usually those aren't, those aren't large, rarely,

Andrew Stotz 14:10
I'm assuming your turnover is extremely low.

Jeremy Deal 14:15
Yeah, it is, it is fairly low. It is fairly low on our core positions, it's extremely low, right? So usually, we're definitely positions we go in for four or five years. Not as long as the fund has been in business, but core positions are many, several years old. And the smaller positions can turn we have a you know, the starter position. doing the work realize like this is just not what we thought. The Competitive Advantage isn't there. We just see some we don't like or as I talked to, somebody talked to management and realize the culture here isn't isn't great, or there's something about it that I missed. We'll just sell the position. Or maybe the price is run up and realize like yeah, this isn't really this is kind of all at all it's ever going to be in the next three or four years or five years. And so let's just sell it now and reallocate somewhere else. And a little bit of a little opportunistic.

Andrew Stotz 15:09
For a lot of guys like you. The key risk management strategy really is the research that you do on the company. Right? There's also some, you know, looking at some correlations and thinking, I don't want to be too overexposed to any particular I don't know, sector or country or whatever. What is your strategy for risk management? Do you have any explicit tools that you use or anything like that? Or is it really based around, you know, the research,

Jeremy Deal 15:39
you know, it's really research driven. We're not managing for volatility, per se. I mean, if we have a very high conviction position, where we've developed some, like, good Paul talks about the Indian investor I referred to, if he talks about differentiated insight. So when, when you have differentiated insight into a business, and you've developed a thesis, and you're in the conviction is there, and you can also see the price, you can see that the thesis is actually unfolding as as you'd hoped, if not better. The last thing you want to do is try to trade around market conditions, oh, interest rates are going up, we need to sell everything and wait and sit on the side. I think that introduces an enormous amount of risk, to be able to try to trade around macro things. So I would say risk management is very much on trying to redefine the thesis and trying to kill the thesis all the time, saying, Okay, we like this in 2015. For these reasons. Are those reasons still intact? Every quarter that goes by? Do we see a little bit of progress? Do we see that the management team is fixing mistakes? Do we see that they're agile? Do we see that there, they spent too much in the fat years, and now in the lean years are able to cut back aggressively. We liked that we want to see the evolution, we want to see the flexibility, the resilience of the management team. So we wouldn't do is if they have a bad quarter or bad even a bad you know, two or three quarters wouldn't just sell the position. If we thought that if we think that things are still going in the right way, and the ultimate upside is multiples more than what we paid. So it is difficult because it requires holding on when others can't hold. And it requires being willing to underperform sometimes for long periods of time. But we can go into this. But you know, today, investing means you know, as an investor, not a trader, but as an investor. The disruption risks that every business faces is is very different today than it was even five years ago or 10 years ago, I think about when I started, the companies that I was looking at, you know, small retailers, things that just don't have an advantage of they had a little bit of an advantage back then. But today are just completely obsolete. So as technology finds its way into stable, steady businesses, there's just an enormous amount of disruption risk. And so to ignore that is just to only look at the past numbers and the past returns on capital, I think is the source of a lot of mistakes that I've made. And I think other investors make as well. And so it's more important than ever, to, to think about things in terms of competition, to think about a business model, think about the software things to think about the intangibles, to think about the culture of the business, think about where is the business going? Who is trying to disrupt them, and what is the prize for disrupting them. And you know, that in trying to keep your finger on the pulse of the value migration, because there's constantly value migrating in and out of a business and a sector and an ecosystem. So that's this, the, I think, more important to understand that and the root of that versus just saying, Hey, I bought this too. I paid too much for this. And now I'm selling it for a loss and I'm moving on because when you don't learn from the root of the mistake, you're doomed to fail and you're doing you're doomed to repeat it and repeating it over and over, I think has really long term effects that compound, again, going back to what what Paul talked about in his in his talk on mistakes, the compounding effect of mistakes is quite dramatic, and not in the sense of, you know, constantly selling for a loss per se, but in the fact that you're not learning so you can't evolve and you can't move forward. So when your framework for valuing issue or framework on what is value investing is just purely on price, you're always at a disadvantage, because you're not able to hold the business through its evolution.

Andrew Stotz 20:16
So, there's still it's interesting, because when we started talking before we turned on the recorder, we went for a while. And now we're talking. And there's so much stuff, you know, coming out, I just want to, you know, reiterate some of it to the listeners, and the viewers, you know, we're talking about these tools, these four, core, you know, basic tenets are four qualities. Number one, you are saying adaptable and relevant for tomorrow's economy. Number two, durable pricing power protected by some sort of competitive advantage. Number three, capital allocation and balance sheet strategy, meaning it could be debt, that's fine, as long as it supports the moat, and for was the significant alignment of interest between management and equity holders. So and when you're talking about food, Paul, you're talking about food, Paul, Chef, S H, ETF h am I correct? Yes.

Jeremy Deal 21:14
Okay. So phenomenal investor, yeah, that I have recently had the opportunity to meet at a conference. Yes.

Andrew Stotz 21:20
And I see he spoke at CFA society in India. And I've spoken at that many different places in India on the mistakes that I've learned, you know, in the lessons I've learned from all these mistakes, so that's been fun. But we're gonna we're gonna run out of time, and I just want to have you bring in a couple of, you know, rather than telling the story so much, you know, let's just review some of your thoughts about the mistakes that you've seen that you've heard, that you've been thinking about. And then after that, we'll wrap up. And I think we may have to do this again, and go through some more. Yeah,

Jeremy Deal 21:57
I'd love to. Yeah, sure. Sure. So the mistake I want to talk about. And again, going back to what Paul said in his talk on mistakes, this was funny enough is very similar to the kind of the notes that I had on this before, before even meeting him last week. Was that, you know, mistakes don't show up. When you generally overtime, you know, they show up, they people forget about them. So looking back, you know, we think about mistakes, though, in terms of I lost, like I was saying I lost money, or oh, I should have bought that. And I didn't and it went down or I bought that and I didn't and it went up. And so the one of the biggest mistakes I made was earlier in my career. So 2012 We bought Tesla, for roughly what would be about $2 A share today and sold it maybe six months or eight months later, for maybe 50% More than we paid. And so the punchline is you sold $100 million worth of Tesla's stock for less than a million dollars today. And so I want to go back to kind of what I learned from that and why I bought it in the first place. And I bought in the first place at the high level, I know we're running out of time, but the bottom the first place, because there was a period in 2012, where I thought that if you looked at the OEM contracts, I think we thought it was a value investment. It was nobody believed that Elon could achieve anything. And that's fine. And I think that they were people were right to be skeptical, who would have known that what could be achieved was achieved. I'm not saying that. But you could buy it for roughly the value the present value of the OEM contracts that he had to supply drive trains, at least in my view, I looked at, you know, the market cap at the time versus what, you know, a typical valuation would be for for a tier one auto supplier, and you basically had a business that was trading at a discount to that at the time. And it didn't have necessarily traditional earnings. But it was easy to see that okay, this is how much the business will earn from supplying these contracts. But I didn't have a real differentiated what would Paul calls a differentiated insight. And I didn't also didn't understand what Reed Hoffman talks about of the value of of choosing bad competition when you're as a business. So I didn't understand just how bad the competition was for Tesla, and for looking at next generation platform cars, that platform, the next generation of the platform of cars, electrification of cars, the connected car, so it's not just about stamping out electric cars. It's just another version of a car, but the technology, the software behind it, etc. The demand for for EVs as it would go forward, and I misunderstood or didn't even think about Elon as a leader, his ability to raise capital when things got bad when things got hairy. The ability to for him to inspire people that continue believing in him continue to do allowing to convincing consumers to continue buying, even though the product was, you know, kind of mediocre to low quality in the beginning was falling apart. All that was differentiated insight that it would have taken to hold the company to where it is today. And so read often talks about bad competition, and these are the, you know, the competition. You know, they were operating in an industry where the mindset of the industry had pretty much died, there was no innovation, it had been consolidated decades before, and it was just sort of a dead industry. And that insider that combination of insights, we're going to culture, the business, Elon 's ability to raise money Elans ability to inspire people, just wasn't even on my radar. So I sold it because it looked too expensive. But the real root of the mistake was not thinking about the business in the bigger picture, not looking at the business for what it was. And now when I go back and read the letters now, with hindsight, I think about God, what an enormous mistake. So I want to try to learn from that. I made many mistakes where I sold and lost money for the firm. And those are kind of plain vanilla. But the magnitude of what was lost and what was missed out in the early days of Tesla are the root of that is really, I think, the most important and look, what am I one of our investors asked would you have been able to hold all this time? And I said, I don't know, I don't think so I probably wouldn't have been able to hold. But I guarantee that if I would have had, the better the insight I would have had into the business, the unique insight, the differentiated insight, the more conviction that I would have been able to have if I would have thought along that path. The longer it could have been able to hold as that value started to reflect the much greater opportunity that was in front of the business and not behind the business.

Andrew Stotz 26:58
So maybe you won't would have only had the guts to sell it for 70 million, not 100 million.

Jeremy Deal 27:03
Yeah, yeah. So like, and again, I don't want to sound like I mean, there's tons, you know, in this business, you can't hit everything you can't hit, although we all have these stories and that we missed out on 100 bagger, you know, 38% of the s&p 500 or 100 baggers, and they're 100 baggers, most of them that have happened in less than 50 years. So they still would have beat the s&p 500. We can't blame ourselves for missing these things. But I want to talk give a story about something where I feel like there was a lot of learning in the root of the mistake was just simply not having any kind of insight in the business other than why I think the OEM contracts make this business look relatively cheap.

Andrew Stotz 27:44
Actually 100 baggers, well, that was episode 249, Chris Mayer, and his great book, 100 baggers, which is he's an old old friend of mine that I met when I was on the sell side here in Thailand when he came. Well, we're running out of time. So listeners there you haven't another story of loss to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. Now as we conclude, Jeremy, I want to thank you again for joining our mission and on behalf of a Stotz Academy, I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the audience?

Jeremy Deal 28:28
When you think about a business over multiple years, think about the intangibles. Think about the competitive advantage of the business, the ability to evolve. And think about the disruption risk for the business that you're competing with.

Andrew Stotz 28:46
Fantastic. I want to have you back to talk about some of those things. But that's a wrap for today on another great story to help us create, grow and protect our well fellow risk takers. Let's celebrate that today. We added one more person to our mission to help 1 million people reduce risk in their lives. This is your worst podcast host Andrew Stotz saying. I'll see you on the upside.