John Huber (03:12):

So to the extent that you can take advantage of the macro environment, I try to do that when prices are down, but I think it’s really hard to predict interest rates. I think economists have a pretty poor track record. They’re in the business of predicting interest rates, and I don’t think the track record is anything to really write home about. So I figured if they can’t do it, then I’m not going to bother trying.

John Huber (03:30):

So I’m more comfortable. It’s just my personality. There’s more than one ways to skin the investing cat as I’ve often said, but for me personally, I’m more comfortable just focusing more on the microeconomics individual business, the individual economics at the business level and making my decisions on those factors.

Clay Finck (03:48):

Now, you wrote a piece that outlines that investors need to have some sort of an edge if they want to have above average returns such as beating the market. What investing edge do you believe that you have relative to others?

John Huber (04:03):

I think the biggest edge that investors have today, and I would include myself in this cohort, is the ability to think long term. So I know this is a phrase, long-term thinking, there’s a term out there called time arbitrage, which is basically being able to capture the spread between the current conditions and maybe the conditions five years out or seven years out. The term basically means being able to look out further and most market participants have the ability to look out.

John Huber (04:32):

The reason why it’s so difficult for people is, number one, I think it’s just human emotion, human nature. People want results now. They want results quickly. So there’s an extreme amount of emphasis on catalysts and things that might drive stock prices in the short run. Obviously, if you can make money now, it’s better than making money later, but that game has become so difficult.

John Huber (04:51):

So I think the informational advantage that once was out there has now been marginalized, and there may still be informational edge in certain pockets of the market, and at certain times, perhaps, it’s possible to gain small edges here and there, but I think the biggest edge in the market is just the ability to behave in a way that’s very difficult for other investors to behave, whether it’s due to their own impatience or more often is due to just the institutional constraints that so many investors have meaning, the career risks that they have.

John Huber (05:27):

I’ve talked a lot about investors who, for a variety of reasons, are forced to try to produce a result this year because they’re worried about their bonus, they’re worried about their job security, and it’s very difficult to do that. If you’re trying to compete in that space, you’re competing with an enormous amount of resources, an enormous amount of talent. It’s a hard game to begin with.

John Huber (05:47):

For me, I think the edge for me is the way I’ve structured my firm is, number one, I don’t have career risk. I have my own money invested. I think of Saber Capital as my firm, as a family partnership of sorts that happens to have outside investor capital, but I’m under no constraints when it comes to being forced to try to make money this year. I can look out five years, seven years, 10 years, and not worry about what happens to my portfolio in a downturn, what happens if we hit session next year. Those types of things I try not to think about or worry about because it’s outside of my control.

John Huber (06:22):

So I’ve tried to structure it in a way where those institutional constraints that are part and parcel to the industry don’t impact me as much as they do other investors. So I think that’s the biggest edge. For individual investors that aren’t in the profession, it’s a huge advantage because you don’t have a boss, you’re not answering to anyone, you don’t need to look at your portfolio next quarter, you’re not going to get fired. So you can take advantage of that if you have the right frame of mind. So I think it’s an important advantage that individual investors have that is probably underutilized, but it is a big edge if you’re willing to use it.

Clay Finck (06:57):

Yeah. I totally agree. A lot of people say that retail investors, they have no edge. They should always just invest in index funds, but when you think about that idea you’re talking about where retail or individual investors can have that time horizon edge. I saw you tweeted about Nick Sleep’s chapter in Richer, Wiser, Happier by William Green. One of the lessons William pulled from Nick Sleep was to have that long-term approach. Nick’s been known to hold companies like Costco and Amazon for decades.

Clay Finck (07:28):

We live in a short-term minded world in terms of companies. They have a ton of pressure to think about that next quarter. Investors are always looking at the headlines, getting scared, “Oh, is a market crash coming?” So having that long-term mindset, I agree, is a huge advantage.

John Huber (07:43):

Yeah, for sure. I mean, I think, and you mentioned the constant flow of news, whether it’s CNBC, whether it’s Twitter, we have a barrage of information and some of the information is valuable, but a lot of it is just noise. So the secret is obviously to separate the signal from the noise, but the best way to do that, I think, is to oftentimes just tune that out.

John Huber (08:04):

So if you’re a professional investor or an individual investor, I don’t think it benefits you, not that there’s anything wrong, I’m not trying to pick out at CNBC, but staying off the news, staying off of Twitter. I use Twitter, I love Twitter, but I use it in a way that doesn’t detract from my ability to do my work and to think clearly. I think a lot of investors find themselves inside of that fire hose of information, and it can become very difficult to think clearly when you’re inundated with opinions coming from every which way.

John Huber (08:35):

So I think just being able to tune all that out, and you mentioned Nick Sleep. He, in that, I think it was either in one of his letters or in that book, he talks about time arbitrage and he noted he had this interesting observation where the average holding time for the stocks that he owned, I think it was 50 days, which is, obviously, less than two months. So the average holding period was less than two months of the typical investor in the stocks that he owned.

John Huber (09:02):

He said, “I’m trying to own stocks for five years, 250 weeks,” or something. So the implication there is if you’re competing against people that are owning securities for two months, they’re naturally looking at things that are not necessarily, they’re thinking about things that are going to drive the stock in the near term. They’re thinking about, “What’s going to make this stock go up in the next week or two or the next month or two?” and they’re inevitably going to dismiss factors that somebody like Nick Sleep view it as much more critical.

John Huber (09:30):

Those are the longer term competitive advantages that show up over time, but don’t necessarily drive results in the next three months, the next six months, even the next year or two. So that’s that waiting factors in a different way than the majority of market participants can give you that edge that we talked about before.

Clay Finck (09:48):

Yeah, and I think we can tie these two questions together of the time arbitrage and the macro environment. People have been looking at the macro for years, calling for a market crash year after year after year. If you were looking at the headlines and you might have got scared about the market being potentially overvalued in 2015 just to see it run significantly more.

Clay Finck (10:08):

Another one of your writings talked a lot about sports. I’m someone that enjoys watching and playing sports myself. I couldn’t help but recognize you were making this connection between the two. I love investing and I love sports, and you’re probably in the same camp. So how has watching and studying sports helped you become a better investor?

John Huber (10:28):

Well, I mean, I just love sports. So I talk about sports a lot because I love sports. Once upon a time, many years ago, I was a competitive runner in college, and I’ve always enjoyed the … Well, one of the things I’ve talked about this in my letters and in my writing at times, but running, for me, has a lot of similarities, and I manufacture a lot of sports analogies as you may have noticed in my writing, but one of the things that I think running, one of the similarities it has or the common denominators that it has with investing is you have to put in a lot of work now every day on a consistent basis, and the payoff happens many months later in the case of running, and many years later, perhaps, in the case of investing, I wrote about this idea I called long feedback loops, where investing is a long feedback loop, meaning the work you put in today, you’re not going to notice the result for maybe three years.

John Huber (11:17):

So you don’t get feedback on that unit of effort for a long period of time, and that can be a problem for many people. I mean, if you think about the difference between investing in let’s say a sales job where you have a certain quota to hit and you have to make a certain amount of phone calls, you get a certain amount of leads, you get a certain amount of meetings with those leads and you have X amount of conversion inside from those meetings. So it’s a very continuous instantaneous feedback loop, and investing, it’s the opposite.

John Huber (11:46):

So with running, it was very similar. I’m a long distance runner. Investing is similar, a long distance, long-term. So I think that patience and that mindset has helped me, but to answer your question, I just love sports. So I’m always trying to learn from people who are successful, trying to learn from people who have spent time trying to get better at their craft, and that’s how I view investing. It’s a craft. One of the things I enjoy most about it is the continuous pursuit of trying to improve. So that’s I think the satisfaction I get from playing sports and watching sports and also competing in the game of investing as well.

Clay Finck (12:20):

Your most recent piece in relationship to sports was talking a bit about Bill Belichick, how he made this decision to go for it on fourth down and ended up not getting it and losing the game in the fourth quarter. You pulled these ideas how he’s able to think for himself. He knows that every other coach in the league probably would’ve punted on that down and he just takes the emotions completely out of it.

Clay Finck (12:46):

I think that’s so important when it comes to investing is you need to take emotions out of your decision making, at least to the best of your ability because the market swings is going to induce those emotions and potentially make really bad decisions. Sports also can get really emotional. People put a ton of work into it. It just all comes down to these specific moments. I think you also mentioned that Belichick would just be such a good investor because he’s able to make decisions unemotionally.

John Huber (13:15):

Yeah, absolutely. I mean, I’ve studied Bill Belichick. I’ve made a study of a lot of the successful franchises, whether it’s the San Antonio Spurs, whether it’s the New England Patriots, and Bill Belichick, and Tom Brady or whether it’s the world’s best marathoner like Eliud Kipchoge. It’s just a lot of fun to study what led them to the success that they’ve achieved.

John Huber (13:33):

One of the things with Belichick that I’ve talked about is the fact that … So the play that you were talking about was something that I’ll always remember. I’ve mentioned it numerous times, but it’s always fun to repeat the story, but in 2009, he went for it. So you got to think 13 years ago was before the Moneyball revolution in sports, which now we’re very data-driven. I was talking to someone who works at the Denver Broncos recently, and they have databases worth of information that they use to crunch probabilities on all kinds of different scenarios.

John Huber (14:04):

So it’s a totally different game now than it was even a decade ago, but in 2009, Bill Belichick made a decision against the Colts, against Peyton Manning to go for it on his own 30-yard line with a leave late in the game. So if you know football, you can imagine that’s a very gutsy call because it’s fourth and two. If you don’t give it, if you don’t get the first down, you give the ball back to Peyton Manning in the short field, and like you said, 31 of the 32 coaches would’ve elected a punt in that situation because that was a conventional wisdom at the time, but Belichick intuitively understood, I think, the probabilities of that situation.

John Huber (14:38):

You have Tom Brady, you need two yards. The probability of you picking up that first down is probably greater than conventional wisdom would suggest, and even if you don’t get it, it doesn’t mean you necessarily lose the game because maybe your defense can stop Manning.

John Huber (14:55):

So long story short, he went for it, which I just thought was astounding, and I happen to think it was the right call, and I’m a Bill’s fan. So I remember to play well because I’m always rooting against the Patriots. So they didn’t get the first down and then they ended up losing the game. So it was one of those things where the outcome bad, but I thought the decision was the right call.

John Huber (15:13):

That led me to spend a lot of time thinking about Bill Belichick and why did he make that decision. I came to the conclusion that he made the decision because he thought it was the right decision, and he didn’t care what conventional wisdom was. He didn’t care what his players thought, what his front office thought, what Bob Craft thought, what the fans or the media thought. He thought it was the right decision to make and so he made that decision. It was as simple as that.

John Huber (15:35):

I think it’s also important to recognize that at that point in his career, he didn’t have much risk of getting fired. So he had the flexibility to make the decision that he thought was the right decision. So there’s some takeaways there when it comes to investing, and I think there’s some takeaways there if you are a professional investor like I am. It’s very important to structure your firm in a way, your business in a way that allows you to make the right decision without the career risk. I think that’s an important takeaway there.

Clay Finck (16:04):

Let’s talk a bit about business quality and managing a portfolio. Buffet is widely known for looking for businesses with an almost unpenetrable moat, which ensures that the company’s revenues and free cash flows are sustainable and growing for the decades to come. What are some things we should look for in a business to ensure that a company has a strong moat and a durable long-term competitive advantage?

John Huber (16:30):

Durability is one of the things. It’s top of my list. When I think about it, I have a four or five-point checklist that’s very general, but durability is at the top of that list. So what I mean when I think my own personal definition of durability is being able to look out 10 years or some point in the future and being able to visualize the company still, number one, it’s still in business, but ideally, it’s doing more volume, it’s got more customers, it’s having more success than it is now. So that’s durability.

John Huber (17:00):

So I try to restrict my investments to companies that meet that general definition of durability. When it comes to thinking about the moat, there are numerous competitive advantages that can create a moat, and there are a few that I tend to look for. I think these are advantages that a lot of investors look for, but I tend to place a lot of emphasis on economies of scale.

John Huber (17:21):

So I do like companies that are often larger. They don’t have to necessarily be large cap companies, but they have some sort of scale advantage in their industry that gives them the ability, and the economies of scale very simply put is it’s a cost advantage. It’s the ability to spread a certain amount of fixed costs over a growing revenue base. So the great thing about economies of scale is as the business grows, that cost advantage grows with it.

John Huber (17:46):

So the unit economics of a business are really critical to think about, and it’s probably helpful to use an example, but if you think about a retailer, a lot of large big box retailers have economies of scale. So Home Depot did $4 billion in revenue in 1990, and it grew to $45 billion in revenue 10 years later in 2000. So the trajectory of that growth gave that business a huge amount of economies of scale because if you think about a retailer, there’s a certain amount of fixed costs that go into each store. As the business grows its same store sales, they can spread that higher amount of revenue over the fixed costs at that store level.

John Huber (18:22):

What great businesses like home Depot and Costco and, of course, Amazon’s famous for this, what they do is they oftentimes use those scale advantages to pass a portion of those advantages to the customer in the form of lower prices. So Home Depot is great because it’s very difficult for a local hardware store to compete with the pricing that Home Depot can get because of their large scale and their buying power.

John Huber (18:46):

So Walmart and Costco and Home Depot and Amazon are famous for that, and the scaled economies shared, to use another Nick Sleep term, the ability of these businesses to pass those savings along to customers leads to further growth and further economies of scale. So those are advantages, and it’s not just retail. I mean, if you think about a business like Netflix, there’s an economies of scale advantage that I think that company enjoys that smaller competitors have a harder time competing at the unit level. So Netflix has 222 million subscribers, and if they go out and spend $300 million on a piece of content, which is a huge amount of money, it’s only around $1.40 per subscriber. That same piece of content would cost HBO $4, right? Three or four times as much. It would cost Peacock, which has 10 million subscribers, it would cost them $30.

John Huber (19:38):

So Netflix has the ability to spend more money and still at a per subscriber level or at a unit level, if you think about it that way, the costs are lower and that’s in a nutshell economies of scale, and it’s great because, again, as the business grows, the economy, the advantage of that scale grows with it. So I think that’s a big one.

John Huber (19:57):

Network effects is another advantage that I spend a lot of time thinking about and is a theme with a number of the companies that I own. I think network effects like economies of scale grow as the business grows. Network effects are pretty self-explanatory so we probably don’t need to spend much time there, but that’s a very valuable advantage if you can find it in a business.

John Huber (20:18):

Barriers to entry is really important. That’s something I spend a lot of time thinking about. Copart is a company that I really love, and Copart actually is a business that exhibits all three of those advantages, economies of scale, network effects, and barriers to entry, and it’s got a network effect because what Copart does most people don’t know, it’s not a household name, what they do is essentially they operate junk yards. That’s the easiest way to think about it. So if you can visualize a junk yard, that’s what Copart does, and they run salvage auctions.

John Huber (20:47):

So if you crash your car and you total your car, Geico will take the car and send it to Copart to sell on Geico’s behalf. So Copart works with insurance companies to sell these salvaged vehicles to dismantlers and other dealers, and in some cases, the general public that might want to buy these cars. Oftentimes, these cars get shipped overseas to different buyers and they get repaired and then they go back on the road, but Copart is a great business because it owns the land, and so there’s economies of scale because it can spread its growing revenue over a fixed cost of the land, and that leads to attractive unit economics that increase over time as the business grows, and it also has a network effect of buyers and sellers, and insurance companies go there because it has the most buyers and buyers go there because there’s the most sellers.

John Huber (21:34):

Then most importantly I think with Copart is the barrier to entry, and that’s because no one wants another junkyard in their backyard, right? So it’s a NIMBY, not in my backyard concept there, and it’s very difficult for a competitor to develop the relationships. It’s not just the fact that no one wants it in their backyard. It’s very difficult to get the zoning permits to set up, even if you wanted to, to set this up. So Copart has, I think, some natural advantages there, and it’s a business that enjoys relatively low competition.

John Huber (22:05):

There’s one other main competitor, but it’s not a business that gets a lot of attention from VCs. There’s not a lot of people that want to go into the junkyard business. So there’s just some natural advantages that I think a business like Copart enjoys. So those are three things that I spend a lot of time thinking about.

John Huber (22:21):

I think the fourth thing on the checklist of durability would be just the adaptability to change. So this is a softer, more subjective feature, and culture has become a buzzword, but again, like hard work, it’s the concept of hard work. Everybody talks about hard work, but it doesn’t mean that hard work is less valuable or not valuable. Everybody talks about culture, but it doesn’t mean that culture isn’t valuable.

John Huber (22:45):

So if you have a great culture, if you have proper incentives, if you have great human capital, all of those things are critical to a company’s competitive advantage, especially in a day where we live in such a fast-changing world where I think adaptability to change is a critical variable. It’s crucial to be adaptable, and a lot of that has to do with management and the foresight that they have and the flexibility that they have, and the talent that the company has. So I think all of those four areas are what I try to think about when it comes to durability.

Clay Finck (23:16):

Could you talk a little bit about how you manage new capital that’s coming into your fund? Do you continue to just invest in your best ideas or are you looking at the opportunity costs of all of your ideas and allocating that way?

John Huber (23:34):

Yeah. It’s the latter, Clay. It’s the opportunity cost. So that’s the easiest way for me to think about cost of capital. I have a general hurdle rate in mind when I’m thinking about new investments. I have a general return on capital that I’m looking to achieve over the very long run with stocks, in general, but from a practical standpoint, the way to, I think, make proper decisions if you think about a decision tree is just take your best idea and just use that as a guidepost when you’re thinking about adding to a new stock or buying a new stock or adding to an existing stock, weight it against your best idea.

John Huber (24:08):

Obviously, within the confines of a portfolio and some common sense rules where you’re not going to have 100% of your portfolio in one stock, so there’s a practical limitation there, but the way I think about it is I have my best idea and I have the second or third or fourth best idea, and if the fifth, sixth, seventh, eight, as you go down the list, you’re waiting, if I have 10 stocks, do I want to buy an 11th stock that I’m looking at or does this 11 stock, would it be better to add this incremental capital to one of the other 10? So that’s a common sense way to think about portfolio management. That’s my own personal method.

Clay Finck (24:45):

As I’ve studied many great investors over the years that are buy and hold types, they often mention that one of their biggest mistakes has been from selling one of their best ideas because they felt like there’s better opportunities elsewhere. Do you ever sell some of your best ideas if you feel that they’re trading far above their intrinsic value?

John Huber (25:07):

I do. Yeah. I think the reality of running a fixed portfolio, and it’s not necessarily fixed because there’s inflows and outflows and, ideally, there’s inflows as the business grows. So if you’re fortunate enough to have continuous cash flow, one of the advantages that individual investors have is they essentially have what Warren Buffett has at Berkshire, which is assuming that you have net surplus, so if you have a job and you have income coming in that exceeds your monthly expenses, then you have surplus cash, and you can decide on what to do with that cash. You can put it in the bank, you can invest it in a stocks or in a real estate or in anything else, but the nice thing about having residual cash flow is you don’t necessarily have to sell your holdings. You can let your cash build up, and then you can slowly add to a new idea or to an existing position.

John Huber (25:56):

It’s a great advantage to have. If you have a fixed amount of capital, then this comes back to the opportunity cost idea where when I think about selling a stock, yes, I’m selling stocks if they reach a certain level where I think my going forward return is going to be mediocre. Through a significant, painful learning experiences, I’ve learned that if you have a strategy where you own quality companies, I think you’re better off keeping those companies. I’ve sold stocks too soon. I’ve sold stocks that I’ve watched continue to rise, and that can lead to a significant opportunity cost.

John Huber (26:29):

Oftentimes, you know the company that you own a lot better than the stock that you’re about to buy, and I’ve made that mistake as well. So I think over time, I’ve learned through empirical observation and my own mistakes that it’s better to hang on to these quality companies and let them compound, unless you have a really great idea.

John Huber (26:47):

So for my own general mental model here is it has to be significantly better. It has to be pound the table better than the existing idea. So when I get an idea that’s significantly better than the stock that I own, then I would consider trading those two, but if you own a business that’s producing say 15% returns on equity, even if the stock gets a little ahead of itself, so to speak, that’s still a pretty attractive rate of return.

John Huber (27:11):

If the business is still compounding value over time, you’re almost always better off holding that business and letting that value continuing to compound for you rather than replacing with cash, which as we know earns very little in today’s world. So that’s my general philosophy on that. I’ve become more reluctant to sell a stock unless I have a better idea, and I tend to be fully invested most of the time because you’re better off owning a business that’s compounding at 15% than owning cash that yields 2%.

John Huber (27:39):

Obviously, there’s exceptions to that as we’ve learned that in recent years with some of the exorbitant prices that we’ve seen. So I certainly would sell a stock if it got significantly above fair value, but those times are generally I think rare.

Clay Finck (27:52):

Yeah. It just brings me back to Nick Sleep and Warren Buffett. Nick’s known for holding Berkshire Hathaway, Amazon, and Costco for many years and having very concentrated positions in those, and then Buffett, very concentrated in his Apple position. He bought it in 2016 at a great price, and I believe you bought it around the same time as well.

Clay Finck (28:11):

To my knowledge, he hasn’t really sold any of his position, and in reading a piece of your work, I noticed that you purchased Apple at call it a 10x free cash flow and scaled out of it at 30x free cash flow. So it’s pretty obvious today that Apple was much closer to a fair value, and in retrospect, it’s pretty obvious that it was a bargain back then.

John Huber (28:33):

Yeah, I think if you think about your returns to just think about in very common sense terms, your return in a stock as an investor, your return in a stock is the product of a few very simple factors. It’s three simple factors, really. It’s the earnings growth during the time that you own a stock, it’s the change in the PE multiple during the time that you own the stock, and it’s the change in the shares outstanding during the time that you own the stock.

John Huber (28:57):

So if you own a stock for 10 years and the stock goes from let’s say 15 times earnings to 30 times earnings, then you get a 2x return earn from the multiple, right? The multiple goes from 15 to 30, that’s 2x, and if the earnings double, if they grow 7% a year over 10 years, that’s a double. So you get a 2x on the earnings growth. So two times two is four. So you get a 4x right there. Then if the company bought back half of its shares, then you might get another 2x on the reduction in the share count. So you could earn an 8x return in that simple example just through a combination of those three factors.

John Huber (29:33):

So the trick with investing is getting those three engines to be working in your favor. That’s why valuation is sometimes ignored in real rampant bull markets, but it’s always critical to think about if you’re a long-term investor because the price you pay today is going to have a direct linkage between the price you pay today and your ultimate return over the course of the time that you own the stock.

John Huber (29:55):

I can give you a simple example. I was looking at Domino’s Pizza recently, and it’s not a stock that I own one that’s on the watch list. That stock has grown its earnings at 5x over the last 10 years, and it’s one of the best stocks of the last decade. So it’s an interesting case study, but I think the stock has returned about 12x even after a recent decline. It’s returned about 12x over the last 10 years. So that’s north of 30% a year. It’s been a phenomenal stock.

John Huber (30:21):

If you think about those three factors, you can easily see that if you bought the stock 10 years ago, you paid 20 times earnings, now it’s 30 times earnings. So you got a 1.5x there. The earnings went up fivefold. It went from 100 million to 500 million. So you got a 5x there. 5x times 1.5 is about 7.5, and then the rest of your return came from the fact that they bought back 40% of their shares. So there’s 60% of their outstanding stock left now that there was 10 years ago, and one divided by 0.6 is about 1.6. So you get a 1.6 multiplier on the buyback, which simply means you have a 60% greater ownership of each share that you own is 60% greater share of earnings.

John Huber (31:04):

Those three simple factors, five times 1.5 times 1.6 is about 12x. So that’s what you want to think about when you’re thinking about investing is if you pay 30 times earnings, is it going to go to 60? Probably not, right? Most likely, if you’re paying 30 times earnings, maybe it stays at 30 if it’s a great business, and that was the logic I had with Apple. At 10 times earnings, I thought it was the business that should trade at 30 times earnings. I talked about this in letters six years ago that it didn’t make sense to me that Apple wouldn’t trade at a multiple like a Starbucks or like a Nike. It’s the world’s greatest consumer brand. It should trade at a PE multiple in line with some of the world’s greatest consumer brands, and it’s got an incredible business, and a very sticky ecosystem and all of that.

John Huber (31:45):

So trading at 10 times earnings didn’t make a lot of sense. Now that it trades at 30 times earnings, it’s a different story. The interesting thing about Apple is the earnings growth during the time that I owned it was not significant as you might think. The majority of the return came from the 3x that I got, the multiple expansion, and I think the earnings went up about 50% so you got another 1.5x there, and then you got another maybe 1.3x on the buyback factor if you think of that in terms of a multiplier. So that’s how you get 6x.

John Huber (32:14):

So it’s interesting. If you pay a cheap enough price, you can earn 40% returns over a six-year period in a stock like Apple that is huge and not growing all that fast. So going forward, Apple’s a business that at 30 times earnings I think it probably falls into that bucket of still a great business. I don’t think it’s overvalued, but it’s probably more fairly valued at this level.

Clay Finck (32:34):

It’s pretty exciting that as a retail investor myself, I’m able to find some of these great deals. The FAANG companies, for example, many of those are considered more value plays today, but since the 2008 financial crisis, we’ve seen the emergence of these massive companies. Everyone knows about them, but a decade or so ago, they were considered these overvalued growth companies in many ways. So I’m curious what your thoughts are on how these companies emerged from being overvalued growth companies to reasonable value plays for many of these Warren Buffett style type investors.

John Huber (33:12):

Value is not what a company earned last year. So the PE multiple has nothing to do with value. It can be used as a guidepost. I mean, we were just talking about PE multiple. The change in that multiple will determine your … It’s one of the three factors that will turn in a stock, but the value of a business is what it will earn going forward. So if you go out and you buy an apartment building, doesn’t matter what that apartment building earned last year because that’s what the other guy earned. All you care about is what that thing is going to produce in cash going forward, and that’s where you derive value.

John Huber (33:42):

So when it comes to the FAANG stocks or any of these stocks that appear overvalued that have had these great runs, I think it’s just simply that the market and people in general, myself included, for many of these stocks, underestimated the growth and the durability and the sustainability of these business models, the longevity that they’ve had.

John Huber (34:01):

So all of these companies, the common denominator is they have huge competitive advantages and they have huge markets. The value of a business is probably going to correspond to those two factors, the moat that the company has and the size and potential of the market that it operates in. When you have a great competitively advantaged business in a massive market, you’re going to be able to grow for many, many years.

John Huber (34:27):

I think that’s one of the reasons why stocks have done so well. I think the other thing that I’ve noticed with stocks like Google and Facebook, for example, in digital advertising, I think many people looked at Google. I remember back in 2004 when Google IPOed. People were talking about comparing the size. There were some pundits that were talking about the newspaper advertising industry as, whatever it was, 20 billion or something, as if that was the market that Google competed in.

John Huber (34:54):

So I think very quickly people realized that Google was creating a new market, right? Google was mobilizing this army of small businesses that could now advertise because they could never afford to take out a full page ad in a newspaper, but they could certainly afford to spend $50 on Google keywords. So Google and Facebook created a huge amount of advertisers that did not exist before those two companies were started.

John Huber (35:22):

Facebook has 10 million small businesses as advertisers, and I would bet the vast majority of those small businesses were not advertisers before Facebook, and the value proposition that these big platforms have provided these small is significant. So I think when you have great value proposition, great economics, great competitive advantage, and a big market, the result is what we witnessed over the last 10, 15, 20 years. These companies have continued to defy base rate expectations.

Clay Finck (35:53):

Yeah. With regards to just the moat and the network effects of these companies, it’s like you can’t deny just the power that they have and the durability they have in their cash flows. With that, my biggest question with many of these FAANG companies, is there ever a point where they just become too big? The regulation side is the biggest concern for me. What’s the government going to do when they get so big that they just essentially have a monopoly on the markets they’re in?

John Huber (36:20):

Yeah. They are monopolies for the most part, at least in certain aspects of their business, and they all will point to, I always think of the famous Peter Thiel quote, where, “Monopolies will always tell you they’re not monopolies. They will always point to how competitive they are.” Google has always, whenever they’re dragged in front of Congress, they’re always saying, “Our competition is a click away.” Amazon’s always talking about the fact that they’re a 2% share of a global retail market.

John Huber (36:44):

So they’re always understating their competitive position because they’re monopolies. Of course, the opposite with companies that don’t have monopolies, they’re always talking about how great they are and how competitively advantaged they are and so forth. So these companies are monopolies, perhaps not necessarily by the technical definition in each of their businesses, but they have monopoly. They’re certainly extracting monopoly like rents.

John Huber (37:05):

Yeah. I think that’s the biggest risk is some legislation that comes out that ends up handicapping either the growth rate or the way that they do business. So whether it’s being forced to open up the app store, if you’re Apple and you’re no longer allowed to charge 30% or you’re forced to open it up to competing app stores that’s going to chip away at the monopoly that is the app store, which is a phenomenal business, there’s potential risks there, but I think these companies, and you could go through each one of the companies and there are different risks and there are different advantages, but they all, I think, they’ve proven to be successful at navigating some of these challenges thus far.

John Huber (37:42):

The other thing about regulation that’s interesting is you could look at something like GDPR in Europe, which has really entrenched some of the advantages that a company like Google enjoys or Facebook. It makes it harder for smaller competitors, and we saw the same thing in the banking industry where the large banks were much more able to deal with regulation than the small banks.

John Huber (38:03):

So after the financial crisis, right now, everybody’s focused on tech. 10 years ago, everybody was focused on the banking industry. We have to regulate the banks. They should be regulating utilities. They’re too big to fail. So the regulators instituted a suite of regulations and legislations that certainly had enormous impact on the banking industry, but what it did is essentially entrenched the large banks, J. P. Morgans, the Bank of Americas of the world, to the detriment of the smaller banks, which were forced to either see a much lower returns on equity trying to compete or in many cases, they were ended up being forced to sell out to some of the larger competitors that could deal with the costs of the regulations. So it’ll be very interesting to see, but yes, that is a risk. I think that’s the number one risk to any of these companies is what does regulation look like going forward.

Clay Finck (38:50):

I noticed that your allocation to Amazon over the past year went from 0% to your biggest position. Could you talk about what led you to making this drastic shift in your portfolio?

John Huber (39:04):

Yeah. I think Amazon is one that I spent some time. So I’ve owned Facebook for a number of years, and I’m always studying the digital advertising industry. So I’m always trying to talk to people who are advertisers. I’m always doing a bunch of research just whether it’s talking to advertisers, whether it’s talking to people who work at ad agencies. I just like to stay up-to-speed with what’s happening in the advertising market, generally.

John Huber (39:28):

One of the things I was thinking about last summer is I happen to be talking to someone who was talking about how a lot of the dollars at this particular firm was shifting from Google to Amazon. So Amazon, in this case, with this particular customer was taking share essentially. So if you think about Amazon, if you are a merchant or you’re selling something, a product, you can advertise on Google, you can advertise on Facebook. You can advertise on Amazon, but Amazon is such a great place to advertise because the only reason people are really going to Amazon is to search for something that they want to buy. So they have specific intent.

John Huber (40:05):

So it’s a very high return on ad spend business for advertisers because if you can get your product in front of a customer, the conversion rate is going to be higher perhaps than you might find for the same type of product on Facebook or Google, although both of those platforms are very valid sources of return on investment, return on ad spend as well, but Amazon, I think, for that particular use case is probably the best and they are taking share. I think over 50% of the product searches begin on Amazon.

John Huber (40:33):

So as I started to do more research, just started to think about that specific situation, Amazon taking share from Google in search advertising, product-related search advertising. It got me thinking how valuable the digital real estate that Amazon owns is. Then I started just thinking more about, and this coincided with a decline in the stock price. Stock price going down makes the company more valuable and it doesn’t make the company more valuable, but it makes the stock more attractive.

John Huber (41:01):

Thinking about the value of the digital real estate that the company has, the enormous growth runway, and the potential for growth in advertising, and being very familiar with digital advertising is a great business. It’s very profitable. It’s very high margin. Then coupling that with just the enormous amount of infrastructure spending that the company has engaged in over the last two years, I think they’ve doubled the size of their square footage in their fulfillment network in just the last two years.

John Huber (41:28):

So if you think about back to the economies of scale, the infrastructure that Amazon possesses is essentially impossible to recreate because it’s not just the capital that would be required, which is north of a hundred billion, but it’s the operational expertise that the company has. So the ability to couple the software with the infrastructure, robots running around in these warehouses now and just the operational expertise that that company possesses, the human capital combined with the physical capital, and the infrastructure that it owns creates a very durable, very valuable moat.

John Huber (42:04):

To me, I think it makes it very predictable that we can look out 10, 20 years and that company is still going to be providing the services and the products that they are today. I think it’s a very predictable business. It’s durable, and there’s a huge amount of growth in some of these higher margin businesses, whether it’s the enterprise software business, AWS, whether it’s the advertising business, whether it’s third-party logistics, whether it’s video games. There’s so many businesses tucked inside of Amazon that make it a very interesting business.

John Huber (42:30):

Then couple that again with the increased earning power and the decline of the stock price is essentially a reason why I decided to make it a big position. I think it’s one of those stocks that offers attractive risk-reward with very low downside over time. It doesn’t mean the stock can’t go lower. The stocks can go anywhere in the near term, but I think there’s very low risk of losing money in a stock like that over the long run.

Clay Finck (42:50):

Very valid points. I pulled up the digital advertising revenue for Amazon, and it was sitting at 10 billion in 2019, and it’s projected to be 31 billion in 2022 this year, and then 39 billion, 2023. So that’s just one of their revenue streams that is just growing very fast. AWS is another revenue stream that’s growing very fast, and the stock is still trading about where it was in the middle of 2020, so nearly two years ago. So very compelling case for Amazon, I think.

John Huber (43:19):

Yeah, and there is a huge growth runway for all of those businesses, and what Amazon does is it turns its costs into revenue stream. They have a hundred jets now, cargo jets, and what they’re essentially going to do is turn that into a business that they’ll have excess space on their trucks for whether it’s Target or I don’t know if Walmart will want to use Amazon’s fulfillment network, but they’ll be able to provide third-party services on the excess capacity that they’ve invested, whether it’s warehouse space, whether it’s space on the jet or the trucks, and they’ll turn that into very high margin revenue that in turn gets reinvested into further growth and further capex.

John Huber (43:59):

The great thing about Amazon is they can take money from the retail business and invest it into more servers so it builds out AWS, and they can take AWS cash flow and put it into logistics and put it into content, and there’s all different, there’s almost an unlimited appetite for that company to soak up its immense earning power into high return on capital investments that lead to further growth.

John Huber (44:21):

These are, again, building this flywheel, which is the buzzword that everyone talks about when they talk about Amazon, but it really is a buzzword that refers to economies of scale, and Amazon like Costco is famous for sharing those scale advantages with either their vendors or their customers, and that leads to growth over time.

John Huber (44:41):

It’s a great company, and I think there’s still a long runway ahead if you think about, and this is what Amazon would tell you is, again, 2% market share that they did about 500 billion or so in GMS, which is the volume that runs through the retail store, and that includes third-party retail. If you think about the size of the global retail market at 25 trillion, and that’s growing at 6% a year or so in nominal terms, which is one way to think about it is the global retail market is adding 1.5 trillion in new volume every single year, which is like three Amazons.

John Huber (45:13):

So there is, in theory, a huge potential for Amazon to continue to grow for many, many years ahead. I mean, this is a business that could, in theory, be doing two or three or four trillion dollars in GMS and still have all these other businesses that it owns. So I do think there’s a long runway for Amazon going forward.

Clay Finck (45:31):

Now, you do own some of these FAANG companies in your portfolio, and you also own what I would call maybe the potential next list of FAANG companies. Are there any up and coming companies that you would like to chat about for our audience?

John Huber (45:47):

There’s a few of that I’m looking at right now, which I’ll probably keep under wraps for now. Maybe on the next podcast we’ll come back and we’ll discuss some of those new ideas, but yeah, I’m always on the hunt for new emerging businesses, and when I say emerging, I tend to want some size. So I want the company to exhibit a track record of success, but yeah, I’m always trying to look for companies that I think have the potential to become some of next great long-term winners, whether it’s maybe not to the extent that FAANG has succeeded because those are very rare birds, but yeah, companies like we mentioned Copart, and I can use that as an example of a company that’s smaller, a company like NVR, which is a home builder.

John Huber (46:27):

The important thing to remember, I think, is although there are a lot of exciting companies in the technology space, there are all also some great companies outside of the technology space that I would encourage your listeners to think about because sometimes you can find a very attractive company in a business that is boring. Peter Lynch used to talk about this in his books that some of the best winners of all time come from these really boring industries like Auto Parts or Riley or AutoZone or in the case of Copart, it’s a junkyard. You think of like a-

Clay Finck (46:57):

You mentioned Domino’s.

John Huber (46:59):

Yeah, Domino’s Pizza, right? One of the best stocks of all time and they sell pizza. So sometimes it’s a business that, for whatever reason, is seeing declining competition. Sometimes it’s an industry where people don’t want to go into. So it could be like a company like Service Corp, which operates funeral homes. I do look for companies that have attractive economics.

John Huber (47:17):

My rule of thumb is I want it to be durable, I want it to be a business that is quality, which I would define as high returns on capital, and a business that has a growth mindset, so a business that thinks about … I like to think about, “Where is this company headed over the next decade?” So it doesn’t necessarily have to be a fast-growing company, but value is created through high returns on capital and some growth. You need growth, certainly, to create value over time and you need high returns on capital.

John Huber (47:43):

So the combination of those two things is what creates value over time, and it could come from a technology company that’s the next FAANG. It could come from some boring company that operates in an old world industry that doesn’t have a lot of competition. So there’s a lot of opportunities out there. In times when the market is stressed, that’s the time to be hunting, and I would consider this to be maybe one of those times.

Clay Finck (48:05):

Yeah. I agree with you. Now, in studying Nick Sleep’s work, again, I’m going to mention him, he mentioned that one doesn’t have to behave unethically to achieve spectacular success. With that said, I’m curious if you think about whether companies, what their impact is on society as a whole. For example, there are studies that Meta’s platforms, Facebook and Instagram have a negative impact on the mental health of younger people, especially children whose brains are still developing. Does the businesses impact on society factor into your process at all?

John Huber (48:40):

Yeah, absolutely. Yeah, it absolutely does because I’m a big believer in the idea and this predates the whole ESG movement, which has really picked up steam in the last few years. I think the core of that movement, I think it has a lot of things right. I think, unfortunately, a lot of it gets bogged down through marketing and through disingenuous motivations, but I do think that the idea in general is very valid, and I think the value of a business is going to be dependent on the ability of a company to satisfy all of the constituents.

John Huber (49:10):

So if you think about the different parties that touch a business’ ecosystem, obviously, you have customers, you have suppliers, you have employees, and you have shareholders, and maybe you have the community at large that the company operates in, right? Those four or five different constituents all have competing motivations. So the trick with a business is to delicately balance those conflicts, those inherent conflicts of interest.

John Huber (49:35):

I think the best businesses do a good job at keeping employees happy, keeping customers happy, and over the long run, if they’re able to do those two things, then they’ll probably keep shareholders happy, and if a company is … because you think about keeping customers happy is simply offering something of value. So if you’re a business with a great value proposition over time, you’re likely going to be able to keep some of that value proposition for yourself.

John Huber (49:58):

So I think it’s really important to think about all of those things, and I do try to think about how no business is perfect, and there are, like I said, the conflicts of interest. Some businesses prioritize employees over shareholders. Some businesses prioritize perhaps customers over employees. Some businesses are focused purely on profit. I think businesses that are focused purely on profit can lead to situations that degrade the competitive advantage if there is one over time.

John Huber (50:27):

I remember reading articles in 2004, 2005. You mentioned Nick Sleep. He’s famous for investing in Costco for many years, and Costco got a lot of criticism from shareholders early on, 20 years ago, for not exercising the pricing power that it had. So shareholders said, “Look, you guys have this enormous buying power. You’re getting all of these economies of scale. Keep some of it for us. Keep some of it for yourself.”

John Huber (50:51):

Jim Senegal, the founder, was famous for always keeping a certain fixed gross margin at 14% and not extracting anything extra because he knew that over time, passing those economies of scale onto the customer would lead to growth. So Costco is the poster child for keeping employees happy. They’ve always had slightly above average wages. They certainly keep customers happy, and in the long run, they keep shareholders happy. So I think that’s important.

John Huber (51:16):

When it comes to things like Meta, like Facebook, the problems that that company has, number one, I think the way I think about that company specifically, and a lot of the companies in today’s world fall into this, whether it’s a social network or technology in general, there are a lot of issues with social networks. One thing I would say, I mean, I’ve spent a lot of time thinking about this as a shareholder of Facebook, and there are certain issues that I think are significant, and the company should be working on these issues and should be addressing these issues.

John Huber (51:47):

In my talks with a variety of different engineers at Facebook, I’ve become convinced that the company is genuine. The people that work there are genuine. They do want to fix these problems despite what you might read in the paper. One thing about the newspaper, Wall Street Journal, the Facebook Files, and all, newspapers are direct competitors to Facebook. Facebook has devastated the newspaper industry in many ways. So you have to sometimes have that. You have to be cognizant of that when you’re reading these articles. It doesn’t mean that the arguments that the newspaper is making are invalid, but you just want to be aware of these incentives, but I’m a big believer in the idea that communication in general is a net additive to stability.

John Huber (52:25):

So I think a lot of the attention on Facebook has been focused on the costs of these platforms and not the benefits. So when you think about communication in general, it’s always been a net positive for society, right? Communicating with your fellowman, communicating with people across borders, traveling, I think a lot of the ills in our society, whether it’s racism or anything else, is a whole different discussion, but a lot of the problem are often rooted in the idea that people that do things differently than the way we do it.

John Huber (52:55):

I’m a big believer in the idea that traveling and talking to people and learning about different cultures, when you boil it down, it’s another human being. We have more in common with people that are different than us than we might realize. So I think communication is a way that solves some of those issues at a very general level. I think if you’re a business that provides communication tools, I think in general you have the opportunity to be a net contributor to stability, to peace, to economic growth, to all of the things that we all want in a civilized Western society.

John Huber (53:30):

If you think about it, there’s a reason why Putin doesn’t want Facebook in Russia, right? There’s a reason why China doesn’t allow Facebook because Facebook and social networks in general lead to people communicating with each other, and communication leads to informed individuals, and informed individuals, that leads to a liberated society. It flies in the face of the agenda of an autocratic leadership.

John Huber (53:53):

So I think in general, Facebook, it has positives and negatives, but I think if you’re analyzing a company with an unbiased lens, putting aside any biases that you have toward the negative problems that the company certainly faces, and I’m not trying to dismiss those problems, there are problems, but I think it’s important to look at the benefits as well as the cost, basically.

Clay Finck (54:17):

Yeah. So many good takeaways from what you mentioned there. I think it’s important just to be mindful of the incentive structure and it’s just so good to find those businesses that have those positive feedback loops. Tying back to Costco, they provide low costs. They’re able to build new Costcos all across the US and the world, and those costs are distributed amongst more and more people as they build more and more stores, and it’s just this positive feedback loop and flywheel that there’s really a self-fulfilling prophecy where it’s almost like an unstoppable force.

Clay Finck (54:48):

So John, before I let you go, thank you so much for joining me today. I really, really enjoyed this conversation, and I truly think the audience will as well. Before I let you go, I wanted to give you a handoff to let the audience know where they can find you and connect with you.

John Huber (55:05):

Sure. Yeah. Well, you can find my company’s website is sabercapitalmgt.com and the name of my firm is Saber Capital Management. So you can go to my website and find a lot of the historical writing, of the archives that I’ve posted over the years. I’m on Twitter as well, JohnHuber72. So yeah, those are the two places. You can find my email address on there as well and feel free to reach out and would love to connect.

Clay Finck (55:30):

Awesome. Thank you so much, John.

John Huber (55:32):

Yeah. Thanks, Clay. Appreciate it.

Clay Finck (55:34):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app so you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it if you left us a rating or review on the podcast app you’re on. This will really help us in the search algorithm so others can discover the show as well, and if you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There you’ll find all of our episodes, some educational resources, as well as our TIP Finance tool that Robert and I use to manage our own stock portfolios, and with that, we’ll see you again next time.

Outro (56:11):

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Outro (56:32):

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