Clay Finck (03:00):

You’ve recently had a piece that discussed this idea of looking at key criteria to analyze a company. And this allows you to just quickly narrow down the universe of investible companies. And you used this idea and talked about how Buffett uses this. You can just look at a company and just quickly say, yeah, this isn’t in my circle of competence. It’s not something I’m interested in. And you mentioned that is something you take very seriously too. So what are some of the key things you’re looking for when you initially look at a company?

Alexander Morris (03:33):

Yeah, so the first one is a very easy one that knocks out a lot of potential investments, which is just being able to understand what the businesses and really being comfortable with how the economics have evolved over the past 10, 15, 20 years. So good examples are Chipotle, which everybody knows it’s a burrito chain that’s basically in the United States. Dollar General is another good example, a low-cost rural retailer in the United States. If you plot the numbers for those businesses and think about really the unit economics and what’s happening in those underlying businesses, it’s very easy to understand what does or does not determine their success over the long run. So that’s kind of what I mean when I say understandable, it’s not really for example, Microsoft’s been a big position for a long time. I’m not intimately familiar with the technology behind a lot of the things that drive the business, but I think I have a good understanding of what really drives the economics of the business over the long-term.

Alexander Morris (04:27):

So understandability is a really important one as first filter. And then as I get into the research process, the filter I’m really most focused on is business quality and business quality and management quality are very tightly tight at the hip. I think there’s an approach to investing where you do things like screening and you find stocks that meet certain criteria, which could be quality criteria or evaluation criteria. For me, I’ve never really found that particularly helpful, especially on the evaluation front. I really think it’s most helpful for me to start with this idea of where are the really great businesses, where are the really great managers. And then as the final step, just getting comfortable with evaluation of whether or not the expected IRs are reasonable.

Clay Finck (05:12):

I also wanted to pull in a Charlie Munger quote, who I know you are a huge fan of, and his quote is, “If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return. Even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.” Now with that, how are you able to balance buying businesses that earn a high return on capital without paying too extraordinary of a price?

Alexander Morris (05:49):

Well, the short answer is that it’s very difficult and let’s stick with Charlie Munger or Berkshire because that’s probably a good way to think about it. You know, Coca-Cola is a business that would probably fit in this bucket of willing to own at a high price because it has attractive returns on capital. I think what’s probably happened over the past 20 years or so, is that the returns on capital remain very strong, but it’s harder for them to generate attractive growth because just of the underlying dynamics in the categories that they really compete in and thrive in. So that’s basically a long way of saying that it’s very, very difficult to make long-term comments about the sustainability of a business and the sustainability of OIC and growth. At the DJCO meeting, Charlie was basically asked this question as it to Costco.

Alexander Morris (06:37):

And I think his answer was really interesting. He basically said in a roundabout way, for me, Costco fits the definition of that quote. And I think the underlying logic for that belief is I’m going to get these numbers wrong off the top of my head, but they have roughly 600 warehouses in the US, which is a small number relative to most retail concepts obviously, it’s a different animal, but they have 600 warehouses in the US and a couple of hundred outside the US, two or 300. They’ve shown a proven ability to get that warehouse concept to travel internationally, which is massive as you think about the ability to grow for not the next five or 10 years, the next 20, 30, 40, 50 years. So I think he’s effectively saying I think the growth algorithm that they have call it this three to 4% unit growth low to mid single-digit comps, really attractive unit economics and an ability to return capital to shareholders as they’ve primarily done with special dividends over the past 10 to 20 years.

Alexander Morris (07:36):

I think he’s effectively saying to you I realize that you think the headline valuation looks expensive, but I see a path for this business to continue to grow its per share intrinsic value by something north of 10% per year for a very long period of time and with a very high degree of confidence and anybody can go run the numbers. Pulling these numbers out of my head, the multiple going from 40 to 20 in five years is a huge headwind to IRs.

Alexander Morris (08:03):

The multiple pole going from 40 to 20 in 50 years is a much lower headwind to IR. So and again, this is incredibly difficult to do and you have to be very picky in order to find even five or 10 businesses that really pass that test for you. But when you fine them it makes it very difficult to, I think it’s an error of even a little bit more affirmative in this belief. It’s an error to look at a business like that and go, well, it trades at a PEF 30, the market’s at 20, it’s expensive, that’s faulty logic in my opinion, if you’re truly a long-term investor.

Clay Finck (08:37):

Yeah, I really like that. You know, it makes sense that quality businesses are going to be trading at a higher price and that gives us as long-term investors the opportunity because we’re giving the company that opportunity to compound over time and continue to reinvest in the business and grow. And I saw that Markel is a holding of yours, which is a company run by Tom Gainer. And he is a huge fan of just not being afraid to pay a little bit up for quality. And also has that long-term approach. I found it interesting that you hold Markel and Berkshire in your portfolio. Now, I wanted to ask you, do you use return on invested capital to measure the ability of the business to generate returns? And why is that, or why not?

Alexander Morris (09:23):

I do, but I might not use the same label or the same definition of how to calculate it as the standard textbook definition for thinking about it. I really think about it more in terms of the unit economics. Let’s stick with retail because that’s an easier industry to walk through. I really think about it in terms of the unit economics and especially the incremental unit economics. Buffett made a great point about Craft Heinz when the investment wasn’t working too well. He said something along the lines of the business generates fantastic returns on capital. The problem is we didn’t pay the cost of the capital base, we paid the price that the equity traded at, and if there’s no incremental investment… The incremental investment you’re getting at that base. But if there’s no incremental, then you’re just getting what you paid relative to what it generates.

Alexander Morris (10:12):

So I really think about it in that regard and that’s where again, a company like DG or a company, which I own or Chipotle, which I don’t know, let’s stick with the one I don’t own, because that way I can talk more kindly about it. A company like Chipotle, they’ve very effectively shown that they can spend, let’s call it $800,000 to put another box in a strip mall somewhere. And at run rate that business can generate call it roughly $200,000 in operating income. So obviously, you don’t need to run very detailed calculations to the decimal point to recognize that’s a pretty attractive return on investment. And they’ve shown an ability to increase the store base fairly significantly for a long period of time and now management’s guiding to something like eight to 10% annualized unit growth, which is significant. That’s very significant growth.

Alexander Morris (10:59):

I think it’s important to understand what the output is on stuff like ROIC, ROA, ROE, whatever it may be, the margins, et cetera. But it’s also important to think about what does the incremental look like and how realistic is that companies going to get there and what are the potential shortfalls in terms of them making it there? Because that’s really what you’re paying for in a lot of ways. It’s what’s going to happen in the future and if the legacy business has great returns on capital, that’s fine. But if the future doesn’t look like that, then the stock is not going to be a strong perform over a long period of time.

Clay Finck (11:33):

I really like how you’re digging into the details and looking at the actual unit economics, rather than just looking at the high level ROIC that comes up just on a stock screener. Are there any flaws for someone that just wants to look at the return on invested capital, maybe in a case like Chipotle or just your standard run of the mail type business, are there any flaws that investors should be mindful of?

Alexander Morris (11:56):

Absolutely. And that’s a problem with using these things too bluntly. Retail is an industry where the investment given the nature of leases as opposed to always owning the real estate and the box, the investment can be something closer to just fixtures working capital and the like, so the investment can be very small relative to the economics of what that box generates. The problem of course, is if you go out and over-build your chain by a thousand, 2,005,000 stores, and the economics on those incremental boxes are not attractive, you’re left with a very difficult situation to navigate because you’ve signed leases. You know, it’s a good example of how the headline numbers can look very, very good until they don’t. On the other side of the coin, you can look at something like Microsoft or really big tech generally. If you look at the return on assets, as an example, it’s a bit of a flawed number because if there’s 150 billion in net cash sitting on the balance sheet that they don’t really need, it’s kind of, they don’t need that to cover any real business needs.

Alexander Morris (12:57):

You have a significantly deflated return on assets when the core business is something much stronger than what it appears to be. And that’s really important in terms of really building conviction and owning something for the long-term, it’s returning to Dollar General, because I think it’s a really good example. It’s understanding why the unit economics have been so good, particularly in an industry that’s very competitive. And I think when you dig in, what you start to realize on that name specifically is that yes, it’s a retailer and it’s a very well run retailer, but there’s a unique feature of their strategy that enables them to effectively have a very strong business operating in markets where competitors can’t just go into a lot of these places and just build a one-off store because it doesn’t fit into a broader system. So they have a differentiated approach to their business and their strategic vision that in my mind gives them a sustainable competitive advantage. So for me, that’s a lot more important for me than understanding whether headline ROIC is higher or lower by 200 basis points.

Clay Finck (13:58):

How do you think about the objective of your stock portfolio? Do you set out to achieve a certain rate of return over a long time horizon, or is your goal to beat the market, or how do you think about that idea?

Alexander Morris (14:12):

My goal is definitely to outperform over the long-term. Otherwise, being an active investor is, well, I still enjoy it. It probably wouldn’t be the best use of my time. Maybe I could find something better to do in life. So I’m certainly hoping to outperform over a long period of time. As I think through overall portfolio construction process, there’s a couple of layers. So first start at the asset allocation level. I’ve personally decided in this choice between structural and tactical. And we can dig into that if you’d like. I’ve decided personally that I think a structural allocation makes sense for me, it really removes the market timing component of the game. And in my prior life at an RIAA, I’ve seen people try to play this market timing game many times and it rarely works out well. So I’ve effectively taken that decision out of the process. I’m structurally allocated to equities at something in the 90 to 100% range, which I think makes sense given my age, my expectation for future savings, et cetera.

Clay Finck (15:07):

For those not familiar. Could you dig into the difference between a structural versus a tactical allocation?

Alexander Morris (15:13):

So a structural allocation, as I see it is something like you sit down and you essentially come together with a financial plan, something based on your ability and willingness to bear risk over a long period of time, generally speaking. And obviously, this is not financial advice, but if you’re very young, you have a very long time horizon and you’re going to save for a long period of time, that would indicate that you have the ability to have a higher allocation to equities versus someone who’s say 65-years-old and planning on drawing on their portfolio and they can’t accept certain levels of volatility effectively. So that would be setting that either pinpoint number range. Let’s say you went through that thought process like I have, and you say, okay, 90 to 100% make sense for me as a structural equity allocation at this point in time in my life.

Alexander Morris (15:56):

The tactical approach is to then go, okay, well, 90 to a 100 makes sense, but I’m going to try to pinpoint times where I think stocks are an even better use of funds or an even worse use of funds and I’m going to expand that range from 90 to a 100 out to 70 to 120, if I want to get levered long. Or some people go even crazier than that and say, I’ll go to 50% cash when stocks are really expensive, and when I think they’re really attractive and willing to go 150% levered long. I view it simply as introducing a component of market timing to the game, and I’ve seen many people do it, and it’s not only that it doesn’t appear to work very well. The decisions tend to be marginal.

Alexander Morris (16:37):

And I don’t think even if you had the ability to be right over a long period of time, I don’t think the bets are usually big enough for them to even have a meaningful impact on the long-term performance. So again, it just becomes a time suck that takes away from the primary goal in my mind, which is finding high-quality businesses and then looking across the universe of those stocks to find the 10 or 15 that are at a price where you can justify holding them in the portfolio. So that’s kind how I think about the structural versus tactical decision. And then from there, so if I say, okay, I’m at 90 to a 100, I have to put these dollars to work, I effectively think about it from there on opportunity costs, not really an absolute hurdle rate. So when I build models, financial models, I typically include an absolute hurdle rate, which gives you some estimate of fair value or intrinsic value.

Alexander Morris (17:28):

But that output is something of a fallacy because at the end of the day, I’m just judging that price to fair value equation. I’m just judging that to the rest of my opportunity set. So if everything’s north of a hundred, I’m not going to say, okay, I’m not owning stocks. For me, I just have to choose the best amongst what is available to me. So long story short, structural allocation within the equity bucket allocations based on opportunity cost. And then, yeah, the idea is to own very roughly 10 to 15 names for a long period of time. And the goal hopefully, is to do better than the market performance over the long run. The past few years have been very interesting. Mr. Market has been a tough competitor.

Clay Finck (18:08):

Your largest holding is Berkshire, and a lot of people say that Berkshire isn’t likely to outperform the market. Not because Buffett has lost his touch or anything, it’s just due to the size that Berkshire has gotten to. It’s much easier to grow a billion dollars in capital than it is to grow hundreds of billions in capital. So I’m curious to hear why Berkshire is your largest holding.

Alexander Morris (18:32):

That’s definitely a fair point. The days of compounding book value or intrinsic value at 20% a year are long past. The trade-off to that return part of the equation is the risk side of the equation and it’s an incredibly well-capitalized business, the largest enterprises, whether it’s Berkshire Hathaway Energy or BNSF for something like the equity position in Apple, I view all of those as very high-quality differentiated businesses that should be able to degenerate adequate rates of return over a long period of time. I think BH Energy is a really interesting one which Buffett dug into in this year’s letter a little bit more than he has in the past. And they also put out a slide deck that’s on Berkshire’s I guess you would call it their IR page, their very bad IR page. You can see a deck that BH Energy put together.

Alexander Morris (19:15):

I think it was late last year because they have to do these things every once in a while for debt holders. I presume that’s the reason why. But it really lays out nicely how unique BH Energy is and how well of a job it’s done serving all of the stakeholders that it services at the end of the day, shareholders included. The short answer is you’re right of the days of generating very attractive returns are gone, at the same time, I think Buffett is waiting for hopefully, his last opportunity to do something really big, and I’m very happy with the collection of assets that I own there. So I think on a risk-adjusted base, it’s kind of a balance to my portfolio and it’s something that I expect to continue to deliver strong results. But as I did hear somewhat recently, as I find new ideas and things that I think are really attractive, it’s a place for me to at least look to source capital from, especially during a period like this where the market’s done quite poorly and it’s managed to hold up fairly well.

Alexander Morris (20:06):

So obviously, on a relative basis, it’s attractive. This is probably diminished slightly. But also, considering this is a millennial podcast, this is probably also a point worth making. I’ve been doing this for over 10 years now, but my portfolio even today still has, and I’m happy with positions for the reasons that I own them, but it still reflects some of the decisions I made five, 10 years ago. And when I was a younger investor and still learning the ropes, I naturally moved towards some of the mega cap things I could really understand well where there was some safety. I mean, this is my life savings, this isn’t play money. So I was very focused on the return side of the equation, but also on the risk side of the equation, ensuring I was making intelligent bets.

Alexander Morris (20:46):

So a lot of it is really just progressing and evolving as an investor over time. And what makes sense for me today? Something like Spotify or Netflix, two names that I’ve bought relatively recently, they’re names that I would’ve looked at five or 10 years ago, and I wouldn’t have had the experience or the knowledge to even get to a conclusion really on the investment thesis so I can come to the decision that I ultimately did. So some of it’s just continuing to learn and still being. I’m 32, I’m still relatively young and this is a decades-long gain. If we’re lucky, I’ve continued learning in evolution. There’s definitely a component of that in as well.

Clay Finck (21:21):

Yeah. I can understand how an experienced investor like you can be more comfortable holding something like Berkshire rather than an S&P 500 index. And I also noticed that in your portfolio, you included the first time you purchased the positions in Berkshire and Microsoft were positions you first added in 2011. Are those positions that grew to be the largest positions in your portfolio, or is it just a factor of these are your highest convictions and you’ve continued to add to them over time? I’m curious how those played out over time.

Alexander Morris (21:57):

Yeah. So it’s a combination of the two and as part of this service, I show returns going as far back as I have them for my broker, which is fidelity, which for some reason they have not been able to figure out how to give me my 10-year returns. They only have them back five years, which is weird because I’ve been with them for well over a decade. But in another way, I also think it’s good that’s the case because it wouldn’t give a false indication of what has happened historically. So it’s a good chance for me to explain. When I started investing in 07, 08, 09, 2010, with a very small amount of money, I was still in college. So when these were very large positions at that point in time, it’s not really representative of what my portfolio looks like today. Right? So that track record would be somewhat misleading.

Alexander Morris (22:36):

And I don’t know if it would be misleading to the good side or the bad side, I would assume. I mean, I own Berkshire and Microsoft and they’ve both done fairly well. So it’d probably be misleading to the good side, but it’s not really representative of what a true investment portfolio looks like. DO You know what I mean? But, yeah. So those positions were very large as a percentage of the portfolio early on as I started working in the industry and started to save more money and adding to my portfolio, they naturally became smaller, but I’ve also added to them at points in times. For example, recently, when I rolled 401k into my IRA, I walked through with subscribers exactly how I thought about allocating those funds to the portfolio. And the deeper point of your question in terms of how the position size today reflects decisions made in the past.

Alexander Morris (23:18):

You see a lot, especially when you’re working with individual clients in IRA world. People letting that tax consequence get in the way of the investment decisions that they’d want to make if they started with a fresh piece of paper, if they had a 100% cash today, what they would buy and what size the position would be versus what they bring in from a legacy holding. I work pretty hard to ensure that the impact of that on my portfolio is very small. I want to be able to look at my portfolio on any given day and say this is a rough approximation of the waitings that I would have if I was starting with a brand new pile of cash. Obviously, the tax consequences are there, they’re nonexistent, but I try hard to make sure that this does not overly influence the investment decisions that I make.

Clay Finck (24:04):

I saw this week that Berkshire purchased another insurer, Allegheny. Not sure if I’m pronouncing that correctly. They purchased them for 11.6 billion, which is Buffett’s biggest purchase since 2016. I’m curious if you have any thoughts on Buffett’s recent deal?

Alexander Morris (24:20):

Well, the short answer is I have not had enough time to look closely at that, but even that answer think tells you something about the way that I invest in the way I think about these businesses. And I think the lesson probably is I’m purposely looking to partner with people and in businesses that I don’t feel the need to watch your decision-making like a hawk. I fully trust Warren Buffett or Satya Nadella, Todd Vasos at DG. I fully trust these people in terms of the operations in the enterprise, the capital allocation of the enterprise, and there’s a certain component of trust that verify that comes with all of this, but I’m not the kind of person who sits there and wants to nitpick each individual decision, especially when 11 billion dollars is a lot on one scale, but relative to Berkshire size, I’m not going to sit there and say, well, there should [inaudible 00:25:05], something like that.

Alexander Morris (25:06):

So I try to make sure that I don’t nitpick the decision-making too much and I accept the fact that managers are going to make errors. But what I am tough on is ensuring that management is transparent and honest with shareholders, and they are interested in our line, things like that. Speaking about Buffett, it’s kind of an interesting example of some of the things he did earlier in his career when he bought Washington Posts and I believe he did the same at Cap Cities.

Alexander Morris (25:28):

I think he wrote a letter to Kay Graham, where he effectively said the voting shares that I have from this position, I’m basically giving you control of that. You voted as you see fit because I’m investing in this company because I trust you. And that was a very large position and I think the commitment was for something for the next five or something along those lines. So I’m sure I got the specifics of how that work screwed up, but that way of thinking is very similarly to how I approach it. I am fully entrusting these people across all facets of being a leadership team.

Clay Finck (26:01):

Yeah. I really like that. It’s kind of the approach of you’re obviously judging the business, but you’re putting a huge emphasis on the management and that you’re hiring them to take care of your money for example. You’re hiring Warren Buffett to manage a portion of your capital for you because he’s the one doing the day-to-day operations and you don’t want to have to not sleep well at night wondering, okay, is he going to make the right decision? You can just look at his track record and understand does he have that high level of ethics, and does he treat the shareholders’ money like his own and such?

Alexander Morris (26:35):

Yeah, absolutely. Absolutely. And I think we spoke about Markel before. I think it’s an interesting example where some of their decision-making throughout the pandemic, they sold a fairly significant amount of their equity portfolio. Part of the thinking was they need that capital to help fund growth and insurance premiums. You know, that’s a situation where I’ve trusted management for a long time and I continue to trust management, but it’s an example where I think they’ve done less than a complete job in terms of communicating how that has worked and whether or not the decision was right or wrong. And again, it’s not even whether the decision was right or wrong really isn’t my main focus. It’s obviously important if you make a number of mistakes. But my concern is whether or not they’re really being honest with me and whether I can continue to trust them and I continue to think that their thought processes is sound.

Alexander Morris (27:18):

It’s a small ding and they’ve built up a lot of reputational equity with me, I guess you could call it. So it’s not something that is a make-or-break situation, at least at this point in time. But that’s one example of how as I continue to follow the companies that I own, or the companies that I watch, something I take notice of. Those are the things to me that really stand out. I often thought back to BNY Mellon, a company that in the shareholder letter, I think it was in 2011 or 2012, they had a massive loss in the business from something that at least from my understanding was kind of non-core and maybe shouldn’t have happened. It seemed like a pretty clear mistake. And in the shareholder letter, the CEO didn’t mention it as far as I remember.

Alexander Morris (27:57):

Instead, there was a paragraph about how employees had donated I think it was $50,000 following a hurricane and I believe it was Haiti, but it was just one of those things where it’s an important example of that needs to be clearly addressed and it’s an opportunity to share with your shareholders to help them understand why the decision was even made. And again, does that really impact forensic value of the enterprise? The answer’s probably no, but for me, it’s knowing that you have one chance to communicate with me a year and you didn’t take the chance to talk about something that seems at least notable from the outside. I’m just constantly thinking about trust and ability to execute in terms of those kinds of developments.

Clay Finck (28:37):

You mentioned that a recent new position of yours is Spotify. This one I’m personally really curious about. Our podcast is on Spotify and I’m a daily user myself, and they seem to be pretty well-positioned against their competitors. So I’m curious what your investment thesis is on this company, as it seems to a bit different from many of your other holdings in terms of where it’s at in its life cycle.

Alexander Morris (29:02):

That is a fair point. My thesis effectively rests on a few things. The most notable one is their market leadership position, they don’t give this number consistently, but they gave a statistic a few years ago. You can see the user base obviously, but they gave us data engagement that suggested their average user was much more engaged in that of their competitors. And to me, as I thought about that, it really reminded me of how I would think about in hindsight if someone had told me in 2013, 2014, 2015, what are the key metrics on Netflix that lead you to believe it’s going to be a winner long-term? I would think it’s outsize user base and a more engaged user base would’ve been two very important metrics for me to get my arms around. That’s one thing of the market leadership position, the other is a thoughtful long-term strategic plan.

Alexander Morris (29:46):

I think they’ve done a good job over the past five to 10 years of taking what was really a music business to now becoming more of an audio business and that can have meaningful impacts on the P&L long-term. And then I think it’s a really effective and focused management team. It’s not the some of their competitors who are the big tech companies are running around and doing dozens of things at any given time. And I don’t know how much time Andy Jazzy at Amazon or Tim Cook at Apple really spends thinking about their music strategy and how it fits into their long-term strategic goals.

Alexander Morris (30:16):

But I know Daniel Ek at Spotify spends basically all of his time thinking about that. For me, that’s an important point of differentiation and you can look at the results that Spotify has delivered over the past five to 10 years, where they started from a position that is much, much weaker than where they sit today, and I’d argue that they outperform those big tech companies over that period by a pretty wide margin. And if they continue to execute on the vision that they’ve laid out, I would expect that to continue over the next five to 10 years.

Clay Finck (30:44):

Recently they’ve had substantial subscriber growth after a lackluster early 2021. Does the negative-net income line concern you at all? And I’m curious what your thoughts are on their profitability going forward.

Alexander Morris (31:00):

Yeah. And in the short term, it really doesn’t bother me much. Again, I just spoke about Netflix a second ago. I think you need to really think about what these types of businesses what happens as they get to higher positions in terms of scale and what that means for the steady-state unit economics. Those two companies are certainly not perfect comps for a number of important reasons, but I think the journey that they’re on is somewhat similar. So they each require really effective execution and a thoughtful vision about how to turn their leadership in terms of a subscriber base into a sustainable and highly profitable business. So that’s going to take many, many years, but I’m confident. Netflix is already well on that journey and I think if people look closely they can see what’s happening. I mean, just look at the EBIT margin progression over the past five years, or look at the FCF margin progression. You’re clearly seeing improvements in the margin profile. Spotify is still early on that journey, but I think it’ll ultimately have a similar trajectory.

Clay Finck (31:59):

Could you talk a little bit about your valuation process for Spotify? These companies that aren’t yet churning out these free cash flows? I always have a hard time figuring out, okay, is today’s price a fair price to pay, or should I wait for it to come back a little bit? How do you think about the valuation of a company like Spotify?

Alexander Morris (32:18):

Yeah. So anytime I think about looking at the future I always kind of start with what’s happened in the past and try to understand if I was starting five years ago, what led to the results over the past five years? So in Spotify, one really important development over that period has been the improvement in gross margins. Gross margins are up north of a thousand basis points over the past five years. So it’s understanding what got them there and then thinking about how that can continue for the years to come. An important addition to that point is it won’t be a straight line, and honestly, as a long-term investor, there’re scenarios where you shouldn’t expect that it should be a straight line or shouldn’t want it to be a straight line, you want management to aggressively invest when they see good opportunities to solidify and expand their market position.

Alexander Morris (33:02):

So I think that’s part of what’s going on right now and the response by the market has been black cluster and management probably should take some blame for that too because it’s really important to communicate that in a way that you’re not disclosing competitive information, but in a way that helps your investors and your shareholders to clearly understand the decisions that you’re making. You know, that’s just an important starting point as I think about it. As I think about the valuation over the next five to 10 years, I’m just really focused on how those unit economics are going to evolve. So again, you’ve seen the gross margin improvement in over a period like the last five years, management’s laid out their own investments of what the long-term margin profile should look like. I think as you do the work to understand how they got there, I think it’s logical, but it requires them to continue to execute in a meaningful way and to continue to grow the subscriber base.

Alexander Morris (33:55):

The subscriber base has doubled in the past three years or north of 400 million MAUs. They think there’s a path to a billion over time. And I think the current trajectory suggests that’s not a crazy idea. So you can start playing around with some numbers to see how that works. I think about it as I wrote back in April 2021, I got to a number that’s roughly at four to 5 billion in EBIT. Call it 2025 to 2030 timeframe. So then you need to look at the stock price and think about what’s a reasonable multiple in regards to that level of steady-state income or what I’d view a steady-state income and a crude valuation tool that I use as part of that, if I’m thinking out five to 10 years is throwing something like a 10X multiple on the high end, just because I think that’s a level whereas you get to those out years, even assuming some reasonable equity rates of return, you have a multiple that’s in the call it 20X range at that point in time.

Alexander Morris (34:56):

If this business becomes what I think it can become, and the ensuing impact on the financial will come with that, I think 20 times will probably look like a pretty reasonable multiple. So it’s nothing too scientific, but it’s just thinking about, hey, how do I find a reasonable starting point on something that has a long way to go on this journey to having attractive economics. In the short term, it can be really tough. I don’t know if you remember, but I can certainly remember five, six, seven, years ago, people were going crazy. Like how the hell is Netflix worth… I can’t remember the numbers now. Let’s say 30 billion dollars or 50 billion dollars. I mean, how’s that anywhere close to reasonable? And the answer ultimately was you had to have the ability to see how the business could scale over time, how they could change the business profile a bit in order to get some fixed costs in place.

Alexander Morris (35:43):

You also need to see that some of their competitors would continue to delay on the transitions that they clearly needed to make so that was also helpful. But I think it’s really helpful to think about how to do case studies like that and to understand how these things can evolve in a certain way. And maybe another way to say that is there’s a lot of people who run around saying like, well, this stock ABC is clearly overvalued and in a lot of cases they haven’t really done deep work I don’t think, they just kind of look at some of the headline metrics and valuation stuff that we talked about previously. And the short answer really is Mr. Market is rarely that stupid. There’s a lot of people who concede things and say, hey yeah, 30 billion is a lot today relative to Netflix’s current economics, but I see a path for them to have 200, 300, 500 million subs.

Alexander Morris (36:29):

I see a path for continued improvement in ARPUs. I see a path for the cost structure to become more fixed cost in nature. And the people who did that work and saw it out early have been very handsomely rewarded. You know, we’ll see if Spotify can live up to that vision, it’s certainly a component of it that’s higher risk than something like the Dollar General where the business model is very well established. The growth opportunities are also fairly well established, but the returns you’re going to make on Dollar General are going to be capped that if you’re lucky, you’ll get 15% a year maybe. If Spotify truly executes for a long period of time, you’ll see something that’s quite a bit higher than that in my estimation.

Clay Finck (37:04):

Yeah. I like how you’re looking at what happened with Netflix and comparing them to Spotify, as it seems like Spotify is a similar business that’s earlier in their business cycle and they’re both hyper-focused on their industries and also going against the big tech heavy hitters, such as Amazon, Apple, and Google. Understanding spotify’s competitive position against these big tech companies, especially Apple music, I think is going to be really important and relating to the valuation on Netflix. I remember taking a look at them when I was just getting started. And of course, I was looking at the high level metrics like the price-to-earnings ratio and telling myself, heck, I’m never going to pay a PE of 300. That’s just ridiculous, who would want to do that? But now I know I shouldn’t have put so much focus on the price-to-earnings when looking at a business like Netflix.

Alexander Morris (37:55):

Yeah. And I probably did the same exact thing. I don’t remember. Well, I only shorted one stock in my career and it was Salesforce. And I got very lucky that the stock went down like five or 10% within a week and I covered, and it’s probably up 5X since then. I remember writing an article on Groove Focus saying this valuation makes absolutely no sense and the person who was wrong was me. As a younger investor, especially as you start building up some experience and you see example like this, maybe you’ll never be the person who invests in them because they’re a little bit too far out on the risk spectrum for you, but it’s still important to really understand how those stories played out. You know, Netflix for me is really a… I wrote about this a lot, or I thought about this a lot because I recently wrote up Peloton, which is where Barry McCarthy, the former CFO at Netflix and at Spotify, coincidentally enough, I really thought about what he lived through when he was at Netflix in the 2000s.

Alexander Morris (38:46):

And Netflix, even during the period where they were in the DVD business, they faced very significant competition from a re-surging blockbuster during a period of time and they actually took the pricing on the DVD product from, I think it was $19.99 and they cut the price to like $13.99 or $14.99. So obviously, a massive change in the ARPU for a business with a lot of fixed costs in terms of the distribution of DVDs and the like, so they lived through that. Then they also to live through the transition to streaming. When they first did it was kind of laughed off as Jeff Bezos famously said, he compared them to the Albanian army or [inaudible 00:39:25] who used to be a CEO of CBS. I saw a quote yesterday. He basically said we want Netflix to thrive. That’s great for us.

Alexander Morris (39:31):

So it was a quote from 2011, a decade later. I’m not sure if by com CBS shareholders agree with that sentiment, but it’s a great company to do a case study on, both just from a business perspective and a management perspective, but also from a stock perspective to understand how as they started to cement themselves, there’s people who still would basically be bearish on it today after having been wrong for a decade. I’m confident enough to say that they’d been wrong. I hope they would admit as much. So as an investor, you should look at those situations because someday it may be you, and try to understand what were the things that happened that could have been a signal that you’re on the wrong side of this bet.

Alexander Morris (40:06):

You know, some clear ones would be, for example, as I mentioned earlier, the massive user base and the significant growth that I was experiencing. A clearly better product than what was offered for entertainment programming through linear TV, a much more attractive price point than linear TV. You know, third-party data that suggests the engagement through Nielsen and others suggests the engagement among those users is very high. A proven ability to take price over many years in markets like you can. All these little things that should give you pause. And so anyways, yeah, it’s a great case study.

Clay Finck (40:38):

You also wrote an article outlining a few investments that ended up being mistakes, and I respect you for being open about some of these mistakes and sharing with others what you learned. In the article, you mentioned JCPenney, IBM, and Kraft Heinz two of which have been holdings of Mr. Buffett at Berkshire. Buffett no longer holds IBM, but is still holding Kraft Heinz. What were some of your biggest takeaways from these investment mistakes?

Alexander Morris (41:07):

Yeah, I mean, it’s probably important to start with the framing. I put this out as one of the first, I think it was… I put three articles out when I launched a service, essentially. This was one of the three, the other two was kind of about me and who I am as an investor and then another one was kind of a complete portfolio review. And I thought it was really important to have this as part of one of the first handful of articles because it really frames well, one that it gets across the point that transparency is a massively important part of me as I think about this service and what subscribers should expect from me, but it also speaks to the evolution I’ve made as an investor and the learnings I’ve had from my most notable investing failure. So as I say in that article, I think one really big takeaway on each of those companies is that even at the time of my investment, it had already become somewhat apparent that they were losing standing with their customers relative to emerging competitors.

Alexander Morris (41:58):

In the case of JCPenney, you could even say things like E-commerce, but you don’t even have to be that recent to find a problem. They had issues in terms of even companies just like Walmart and Target going back 10 plus years that they were losing mind share and market share amongst consumer base. IBM’s a bit of a different one because I think even to this day, a decade later, I still don’t entirely understand what they do, but you could tell from the financials that they were definitely losing standing relative to we didn’t know what AWS numbers looked like at that time, but you could have looked at Microsoft or other players to see that IBM was in somewhat of a difficult position. So I think that losing standing with customers was a big red flag that I basically completely overlooked, partly because I let valuation drive the decision-making process.

Alexander Morris (42:41):

You know, another major component of it, as you mentioned, was in the case of IBM and Kraft Heinz, Berskshire’s involvement definitely played a role. In the case of IBM, it was interesting. I can remember him being on CNBC and basically talking about how it impacts the decision making at somewhere like BNSF. So it was less just tailing him into the investment and more of, hey, he really understands how big enterprises think about managing their IT. I think it’s reasonable to tail him in that regard of the thesis, but subsequently, I guess that was not correct. So that was part of the problem.

Alexander Morris (43:16):

On Kraft Heinz, I had followed Heinz closely prior to Kraft Heinz merger and something I recognized fairly early on that I was just way too late to act on was the merger took what was a pretty attractive condiments business from Heinz that had dominant more market share and in my mind probably pretty good pricing power and it merged it with a company that sold lunch meats and cheeses and things like that, where it was clear, they were getting picked off on both ends from private label and then the kind of products you see at Costco that have a higher-end feel to them or products like you see at Whole Foods on that end and then trader Joe’s and all be in the like on the private label side.

Alexander Morris (44:00):

It was clear there that their competitive position was weakened and that the pricing power would basically be nonexistent or it would be very tough to improve their competitive standing. And when you looked at the mix between those two, the commons business was such a small part of the overall enterprise. And I can almost remember seeing that the first time they had investor presentation on the business and I let that just slip past me. And that was a massive mistake in terms of the subsequent investment. On JCPenney, it’s kind of similar to the first one. Bill Ackman put out one of his famous 300-slide decks and I let myself fall in love too much with his thesis and I relied a little bit too much on the recent financial results that JCPenney had reported in the run-up to the financial crisis, which probably had a pretty nice macro tailwind in those numbers.

Alexander Morris (44:50):

And I let my myself believe that would be kind of where they would return to when, again, even at that time, it was probably pretty clear that was more of an aberration than a place had ever get back to given how the customer preferences were evolving. You know, in all three of those cases, there’s a combination of just some lazy thinking and relying too much on the input of others. And there was also a little bit too much of something that I think I had more as a young investor that I hopefully don’t have as much today, which is a little bit too much overconfidence.

Alexander Morris (45:21):

And a willingness to say, when a stock goes down, I don’t care. I’m right, the market’s inefficient. That value investor belief, which is very important to have and to understand but as Seth Klarman puts it so well, it’s this idea of balance and conviction and humility. You know, there were markers along the way that suggest that I was probably wrong, but I was just too slow or too stubborn to accept. I’m happy that each of those three are somewhat in the distant past and not too recent. We’ll see in the current portfolio whether I’m finding any new failures to add to the list.

Clay Finck (45:53):

Yeah, it’s good to make those mistakes early and learn from them and put your money in a better place that starts compounding capital. And just from my perspective, I think looking at the revenue line, just as a high level indicator, what does the revenue line look like? Is the brand and customer base growing over time or is it declining? Whether it’s a business I’m looking to potentially purchase or just a business I’m analyzing, or maybe it’s a business that’s already in my portfolio, like has the revenue line started to flat-line or start to decline that I think that’s something important to look at. And another thing for me, I think is just looking at where the future is heading and not to pick on you, but JCPenney is an example as obviously being disrupted in my eyes by companies like Amazon and regardless of how cheap it might look, thinking where’s the future going is something I like to think about in my investment process too.

Alexander Morris (46:48):

No, definitely. And that’s two points on that. On the first one, Mark Mahaney, a very famous tech analyst, who’s made a number of great calls over the past call it 20 years, wrote a book recently called Nothing But Net. You pretty well summarized the entire book in what you just said. I mean, the book is revenue growth. That is what he’s focused on. Revenue growth, as you noted in the second point, usually points to something in terms of changes in the industry, changes in customer preferences, et cetera, and his belief is at least as I interpreted it, is something along the lines of what Netflix has kind of shown, which is with scale brings opportunities to do things that can take what might look like a tough business on one hand, it can evolve over time to become a much more effective business.

Alexander Morris (47:33):

So he’s effectively followed that approach and I think there’s a lot of merit to thinking that way. Maybe one other point on that, just because it gets to what you said. What you said about JCPenney is so spot on and I think sometimes we have a tendency as investors to say, okay, well you, I grasp that. Where’s the price where it still makes sense to buy?

Alexander Morris (47:52):

You know, you can look at Bruce Berkowitz and not to pick on him, but he had an investment thesis on Sears from a large number down to something closer to zero that there was support for the thesis because of the value of the real estate and it was a good example of what a value trap can look like and it’s a good example of the risk that you’ve pose to yourself when you start playing this game of business quality is part of the equation, but I’m willing to let price play as much of a driver in the investment decision-making process. And there’s people who that works very well for and I just think that’s a different style of investing. And I think that works less well if you’re going to be someone who’s very concentrated and very focused on the long-term, the business quality has to be the driver. You can’t let it tail like a dog.

Clay Finck (48:35):

Yeah. That is definitely one thing I respect about your investment process. I saw in one of your recent writings, you mentioned one of your friends, Bill Brewster was bugging you about special situation type investment and while you might recognize that it’s a really good deal or might be a really good value, you stick to your guns on what your investment process is and you know there might be a hundred different ways to make money through investing and you stick with your expertise and what your approach is, and you’re playing your game and you’ll let others play whatever game that they want to play.

Alexander Morris (49:06):

Yeah. I mean, again, and as I said in there, that’s even just in the world of publicly trade stocks that there’s a million people finding ways to play the game that’s effective. That is not how I play. There’s also the rest of the world where people are doing tons of things with private businesses and real estate, et cetera. You know, I just think for me, if I really drill down on my core opportunity set, I think I can be successful long-term. And as I also try to delude to in the post, there’s a real value that comes from cumulative learning and following even if it’s 50 or a hundred companies very closely for a long period of time.

Alexander Morris (49:35):

When you go through those rough patches of someone who looks at the name for an hour a year, their reaction to those difficult periods might be different from yours because you go, hey, wait a second, I saw some version of this five years ago, and I remember how that played out and how the concerns prove to be shortsighted. So I think there’s a lot of value that comes from cumulative knowledge, both with businesses and with the people running them.

Clay Finck (49:59):

Again, since I’m just such a big fan of your work and your investment approach, I got to ask, is there any investment-related required reading that you have that helps you develop as an investor? And it can be something that you reread maybe every year or just some sort of publication or book that helps you develop.

Alexander Morris (50:19):

Okay, well, let’s start with the easy ones first. Obviously, the Berkshire Hathaway shareholder letters are a must. I really think, and again, it’s more of a novice investor. It’s obviously for more of a retail audience, but I’ve always found great value in the Peter Lynch books. I think it’s a very business-first approach way of thinking about investing. And again, just that simple idea of hey you work at the mall or you work in retail and you’re out here trying to buy pharmaceutical stocks. You should stick to the areas that we really have knowledge in and not even so much for differentiated insight necessarily, just for the ability to actually have conviction in something and the ability to stick with it for the long-term because if you own any stock for the long-term, you’re going to live through periods where it’s down 20, 30, 50%.

Alexander Morris (51:04):

So if you don’t stick through those periods, it’s all moot point. So I think the Peter Lynch books are well worth reading. John Hempton of Bronte Capital’s done a handful of posts that are fantastic. Wind average down is a must-read, or it’s either wind average down losers, average losers, or both. Those are fantastic posts. The art of not selling a blog post by [inaudible 00:51:25] capital is another fantastic read, for a certain type of value investor, it might make their head explode when they say something like valuation does not play any role in our sell decision making process. Some people’s heads will explode when they read that. And the might pushback to them would be go look at [inaudible 00:51:41] portfolio and look at their track record and think about what they’re doing.

Alexander Morris (51:44):

It’s a slightly different variation of the game from what most people are trying to do, but I think they got the decades-long track record to show that there’s a lot of merit in the approach that they’ve chosen. So I’d go read those things. Like a lot of business books I think the Spotify play, even if you’re not interested in investing in the company is a very interesting story of how this company, this small company from Sweden was able to negotiate with the record labels. These massive record labels was able to navigate artist boycot’s at times how they’ve managed to compete with the apples and the Amazons of the world. I think that’s a really interesting story. Yeah. I guess it’s a good starting point.

Clay Finck (52:20):

Yeah. I’ll be sure to link those in the show notes. I’m probably going to order the Spotify play right after this meeting. Before we close out the episode, Alex, where can I and the audience go to connect with you and learn more about your work?

Alexander Morris (52:33):

Yeah. So if you go to thescienceofhitting.com is just where my Substack’s at and just for anybody doesn’t know, I’m sure you’re going to mention this probably in the introduction, but I worked in the IRA industry for about a decade. I left in April 2021 to launch a TSOH investment research service, which is essentially all the work that I did as an equity analyst now made available to subscribers. So it’s deep-dives on companies. It’s updates on things that I currently own or watch. It’s investment philosophy discussions, stuff like the tactical versus structural asset allocation. And then anytime I make changes in my portfolio, I get disclosure the day before I do so and the clear explanation for why I’m doing it and the change in the portfolio waitings basically.

Alexander Morris (53:15):

So I publish that every Monday and every other Thursday. So you can find that at thescienceofhitting.com and then on Twitter [@tsho_underscoreinvesting 00:53:22], as clay knows, I just throw up a bunch of random charts and random quotes from things and people ask, why are you tweeting this article from 1997? What does this have to do with anything? And it’s just a place where I like to show, or just throw up interesting charts or old articles and things that I find interesting.

Clay Finck (53:42):

Awesome. Well, thanks, Alex. If anyone’s interested in learning more about his work on Substack, they let you read a lot of his articles for free. So you don’t even have to subscribe to check out some of the things he’s working on. So if anyone wants to learn more, I highly recommend checking that out. So Alex, thank you so much for joining me today.

Alexander Morris (54:00):

Thanks, Clay. I had a great time.

Clay Finck (54:02):

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 (54:39):

Thank you for listening TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday we teach you about Bitcoin, and every Saturday we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to the investorspodcaster.com. This show is for entertainment purposes only. Before making any decisions’ consultant professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.