TIP692: Reading the Signals: How To Identify Winning Investments w/ Andrew Martin
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January 19, 2025
TLDR: In this podcast episode, CEO of Fairlight Capital Andrew Martin discusses his investments, utilizing physics-related mental models, preferences for smallcap stocks, inflection point strategy, and handling technological disruption.

In this enlightening episode of The Investors Podcast, host Kyle Grieve dives deep into investment insights with Andrew Martin, CEO of Fairlight Capital. Andrew leverages his extensive background in physics and substantial experience in asset management to reveal key strategies for identifying winning investments. Here’s a concise summary of the key topics discussed in the episode.
Key Traits for Identifying Investments
- Physical Cues: Andrew discusses the subconscious cues he looks for when scouting potential investments, which help him quickly identify promising opportunities.
- Common Characteristics: He outlines traits that excite him about businesses, focusing on indicators of future performance.
Combatting Biases in Investing
- Awareness of Biases: Andrew emphasizes the importance of recognizing personal biases that can lead to poor investment decisions.
- Contrarian Nature: He shares how to leverage a natural contrarian mindset effectively, especially when the market sentiment is negative.
Valuable Mental Models
- Earthquake Analogy: Using a physics concept, Andrew explains how subtle shifts (or "hidden fundamentals") can precede significant price changes in stocks, akin to tectonic plates shifting before an earthquake.
- Inflection Points: Andrew’s investment strategy focuses on identifying businesses at inflection points, where a simple change can lead to exponential growth.
Preference for Small-Cap Stocks
- Andrew elaborates on his attraction to small-cap stocks, arguing that many of the most lucrative opportunities lie in overlooked companies that often exhibit tremendous growth potential.
- Concentrated Positions: He explains his strategy of maintaining a concentrated portfolio complemented by a few smaller holdings, enhancing both returns and potential risk.
Evolution as an Investor
- Transformation: Andrew shares his journey from being an asset-based value investor to adopting a growth-at-a-reasonable-price approach. He emphasizes the importance of understanding technological advancements and their impact on traditionally low-tech industries.
Technological Disruption and Its Importance
- Impact on Industries: Andrew discusses how technology is reshaping various sectors, particularly low-tech industries, and what investors should look for in these transitions.
- Investment Strategies: He stresses focusing on companies that are successfully integrating technology into their operations to unlock new value.
Key Takeaways from Andrew’s Approach:
- Focus on Hidden Fundamentals: Understand the potential of companies by looking beyond surface-level metrics and identifying underlying growth drivers.
- Be Adaptive: The investing landscape is constantly evolving; success requires an ability to pivot and adapt strategies based on empirical observations and changing market conditions.
Conclusion
This episode with Andrew Martin provides timeless investment wisdom grounded in deep analytical thinking and empirical strategies. By incorporating mental models, acknowledging biases, and adapting to technological changes, investors can identify promising opportunities in a complex market landscape. For those interested in elevating their investment game, the takeaways from Andrew’s experiences are invaluable.
For listeners and aspiring investors, applying these insights can yield significant advantages in decision-making processes, ultimately leading to smarter, more informed investments.
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You're listening to TIP. I think it's safe to say that today's guest, Andrew Martin, has crushed the S&P 500's total return since 2019. In that timespan, his fund Fairlight Capital has compounded at an impressive rate of 38% per annum, versus the S&P 500's rate of 16%.
Andrew first came into my radar for writing a piece on a business that we both hold in common. However, after taking a deeper look into some of his other holdings and finding his impressive track record, I wanted to learn more about what he was doing. We'll discuss the physical cue that Andrew uses to help him subconsciously identify when he comes across an investing opportunity with loads of potential. If you've ever found a physical cue to help prompt you to go deeper into an idea, you're definitely going to resonate with this.
We'll also cover some of the common characteristics that Andrew finds in businesses that get Andrew excited to go down the rabbit hole. Since Andrew has a PhD, I wanted to find out how he's used this to his advantage, specifically in the world of investing. And interestingly, he had this really novel mental model from his days in physics that have helped him think about why some of these excellent investment opportunities exist in the first place. He also uses mental models to help identify catalysts that can bring sudden movements in a stock price, both upward and downward.
This mental model can help you find hidden upsides in the market that hasn't yet been priced in, which is obviously a very, very valuable tool to have in your toolkit. Another interesting theme I want to discuss in some detail was technology. Andrew isn't the type of investor who's going to own the magnificent seven, but he's clearly thought very deeply about how the benefits of technology have helped reshape numerous businesses and industries.
We'll go over his thought process and he'll share a name that I think was thought of as a low tech business that is rapidly improving due to the adoption of new technologies. Now, one thing that I highly respect from Andrew's background is his success in investing in Asian businesses. Since I've personally managed to fail at that, I always find it inspiring to speak with others who have succeeded specifically investing in that geography. Andrew has a very particular strategy, which I think helps them rotate capital to the best possible global market opportunities.
While the strategy might not be for everyone, it has wide-ranging consequences as it will make you think about value and how it relates to capital allocation based on things such as geography and industries. Now, without further ado, let's get right into this week's episode with Andrew Martin.
Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Kyle Greve.
Welcome to the Investors Podcast. I'm your host, Kyle Grieve, and today we get to bring on Andrew Martin onto the show. Andrew, welcome to the podcast. Thanks very much, Kyle. Thanks for having me.
So it's super rare that I get to speak with a fund manager who also happens to have a PhD in astrophysics like yourself. And I understand that you earned your doctorate from the University of Oxford. And one thing I think that's just so enriching about being a part of this podcast is that I get to learn about some of the backgrounds of the guests that I have, especially how those backgrounds relate to investing today. So I'd love to get to know a little bit more about how you've used your education background here in physics. Obviously it's quite extensive in how that's helped you become a better investor.
Yeah, I guess in terms of, yeah, because I did theoretical physics degree and then PhD in astrophysics, which usually stops or starts conversations when you mention that. But yeah, I think really what it kind of has helped my whole career, I guess, in terms of there's a technical aspect to that.
in terms of the technologies that you use in becoming technically literate. There's obviously a lot of mathematical modeling and analysis that goes into that to varying levels. Sometimes it's quite a high level of statistical analysis and modeling applied to physics. In the case of what I was doing, I was looking at all weighing low mass x-ray binaries. Binary systems are the star like a sun and a black hole and essentially just
measuring the orbital periods of those and weighing the black holes to try and determine if they are actually black holes above a certain limit, then you can theoretically prove that they are black holes. But yeah, I guess that kind of it does apply very.
It's a terrible guess to investing, but there's obviously a lot of analysis that goes into investing. Some of it can be more simple. You're looking at income statements, balance sheets, or the numbers that come out of a business. And other times it can be, you can apply a little bit more of a technical.
aspect to some of the investments you look at, and I did end up doing a bit of a, there's a Monte Carlo analysis, some statistical analysis on a particular stock, just because it seemed to be the best way to look at the particular piece of analysis. A lot of the time, it is a bit more simple, but it does kind of give you a bit more of a feel of the numerical side of what you're looking at when you look at investments. It does apply, even though it is a very different kind of feel.
So you did another interview where he mentioned that sometimes during your research process, you found an idea that was just so interesting that it made the hair on your neck stand up. This kind of reminded me of this, the reverse story of, sorry, of George Soros, where he was kind of talking about how
He would notice or observe that there were times in his investing career where he might have like a headache or a or a backache and this would kind of signal him that this things didn't feel right. He ends up selling. I love this because it's so interesting to get to know more about these unconscious signals that happen in investors going at a high level. So I'd love for you to tell us a little bit more about maybe some of the characteristics of an investment that make the hair go up on your neck and what that investment would look like.
Yeah, no, that's an interesting question. Yeah, I remember reading about that as well that, yeah, he'd get a back spasm sometimes when he would have a particularly good idea or wanted to get out of an idea that had passed its course. Yeah, I remember thinking that, oh, yeah, I wish I could find which part of my body was going to spasm or do the right thing to tell me to look at an investment or not. But yeah, as guess, it's the hair tingling thing that I kind of thought of myself, but
Yeah, and it kind of makes me think that the example I'm thinking of, I guess it was the ESET banks was a good example of that, where the smaller community banks, minority banks that had been given capital by the government to basically expand a bit more quickly and help under privileged areas and groups. And yeah, just what I read about it, obviously, not many people had kind of realised that's what was happening, that they'd essentially been given these
The preferred stock had been issued by these banks, and they were going to get a lot of cash out of that and a lot of investment through that, because they had very favorable terms in terms of interest rates. They had to pay and look at how to pay all those instruments. Well, that was one main thing. I thought, yeah, this is a really good investment idea, and we've had it in other things.
since then as well. I guess another one being McCoy global at last autumn, which kind of came a bit more slowly. So sometimes there's like a piffany moment, sometimes just more grad joy if do lots, lots of work. Usually anyway, but yeah, with that one, I kind of came across it. I was doing an A to Z kind of search through lots and lots of stocks.
And then it was in the end, so it was halfway through a little bit, halfway through, came across this. So when this one seems a bit cheaper and is growing, has been growing for many years and it just looked, all the metrics kind of looked much better than everything else. I've just been recently looking at. So it's one of those where you have to kind of stop and then dive a little deeper, go down the kind of rabbit hole of looking much more closely at business and it's a
oil drilling tech company. I've not really heard it. Many people talking about that business or anything relating to that. A lot of people are looking at oil stocks last year, even though a lot of value investors and garb investors, they really like those kinds of stocks. It made me think maybe there's a bit of a gap here that not many people might look at this. They might just throw it out because they don't want to look at oil or energy. The more I took into it, the more I realized there was a technology element to it, and a machine learning component to it as well, and the data they were harvesting still are harvesting.
for the oil drilling technologies that they've got, but it just kind of made me realise that this is a very special investment. I've not heard anybody talk about it. And so, yeah, the more I sort of dug into that, that became a kind of, yeah, I guess, hair tingly on the back of the neck kind of moment as well, although it was over and which we were gradually here. If there was no kind of back spasm for that one, it was a bit more gradual.
So one thing that I observed while reading all of your letters was that you mentioned a few investments, especially kind of earlier on, but you didn't say what the name of it was. So it's interesting. So I did, I did an episode this year about Nick sleep in case of Korea from the Nomad partnership and.
They mentioned in a couple of their letters how they didn't want to talk openly about some of the names that they had for one very specific reason. And that reason was to combat commitment bias. So, you know, commitment bias can keep you in a name maybe longer than you ordinarily stay to, due to your signaling of your commitment, whether that's, you know, from writing to your shareholders or even sharing it in social media.
So I want to just hand it over to you. Are you avoiding talking about names that you're accumulating, maybe just to avoid getting more and more eyes and interest on the stock or the business? Or is there a bias angle or perhaps it's kind of a mix of the two?
It's a good question. It is a psychological effects. You do notice it in yourself when you talk about a name. You've put it out there and you're talking about it and then you start to defend your position and you might get somebody argue against it. You might get some of the agrees with you and you almost get defensive that I've got to argue my chord or talk about it. It's creating a bias in your own head which can be damaging.
And so I guess we do talk, I mean, in the quality letters, I talk about stuff, but then you're not getting direct feedback. So I can't think that kind of helps with that, that it's a bit more of one move. We don't kind of have a lot of kind of back and forth on X or any of the social media platforms in that way. So I think that helps alleviate it a little bit. I don't like to kind of get involved in.
Discussions with people in that way, and I like to hear what people think, but then I just let them have their opinion. I have my opinion. I keep that set, but maybe that helps with the commitment bias. I've almost noticed the opposite effect, if there is an effect where names like McCoy Global is probably a good example where
We'd done a lot more work and more analysis to defend and we'd put more money into it than some other positions. So maybe it is the kind of the anti-commitment bias that because we'd done that much more work and we needed to become more convicted to have a slightly higher position in it. That kind of had the opposite effect, but we'd obviously done more work and it worked out better for us.
Whereas maybe a name where you kind of think it's a bit cheap, it's maybe in a more risky kind of position. So you don't want to put lots in it. Maybe there's some, you know, bit more hair on a particular name. So you don't do as much analysis. We still do need lots of analysis on it, but maybe those ones don't work out quite so well. I've kind of found the opposite effect. The ones where we've done the most work convinced ourselves the most have tended to be the best ones. But yeah, that's the opposite effect here.
And so just in your investing world, what kind of biases do you find that are the types that you need to combat on a regular basis or maybe ones that you're susceptible to or ones that you've had to strategize as you learned more and more?
Yeah, I think for me, I'm quite good at being contrarian and perverse. I'm quite happy to disagree with everybody else. And if I find something that's really cheap, quite happy to buy it, if it's cheap, I'm not thinking. There is often a reason why people aren't buying that stock, so it's good to find out. But then you've got to come to the conclusion that you disagree with them for whatever reason. So we've been talking about gold stocks recently, and I disagree with the market in terms of those that I
agree with why they are as cheap as they are at the moment. But then I think the bias I personally have that fight is kind of always price movement by us. So if a stock starts to go up or starts to go down, it's hard to fight those animal spirits of, oh, you found a cheap stock and it's going up. And you don't want to be stopped to panic by and chase the market up, especially if you're trying to build a position in something that's called a moderately liquid or.
You know, it's going to take you a few weeks to kind of build up a position if the price starts to move for you or against you. It's trying to stop that from biasing what you're doing. I think you just have to look at the absolute level and say, this is still cheap. This isn't still cheap. It's maybe a bit less cheap than it was yesterday or it's a bit cheaper. But that shouldn't really bias you in terms of it's very hard to guess why price has moved in any particular direction. I don't even remember one time. I think somebody on Twitter went back when it was Twitter.
was arguing why a stock had moved, and it was literally because I had sold it that day. I may have pushed it down slightly, so I was arguing all these reasons why I would have gone down or up that day, because I'd sold the chunk. You can tie yourself up in knots in that. I think it's price movements right on price level. I have to be careful of in terms of biases, but there are so many biases that you do have to keep your eye out for all of them and look inside.
It's difficult to look inside your own emotions of what you're doing and why you're just trying to be rational, which is to fight down the emotional side of things. You mentioned there about being a contrarian here, so I had a question for you specifically on that. You probably, maybe you don't see this because you're just a naturally a contrarian, but I think a lot of other investors see that being a contrarian is good in the markets, but it can be really hard if that's not how you are.
you know, by nature, because it is a lonely proposition, right? You know, humans are our tribal beings and we enjoy being part of a herd. And, you know, we want to agree with a lot of people rather than maybe disagree with a lot of people. And so, you know, kind of differentiating yourself can be hard, even if you want to do it. So I'd love to know more about you, you know, how are you kind of differentiating yourself the most? And, you know, are you naturally, do you think you're naturally a contrarian or do you think that it was kind of a conscious decision to kind of move in that direction?
Yeah, I think it actually am. Yeah, just in terms of the way I am and you must be born. I think there's certain elements and traits of the way investors are. You're kind of born with it or born with certain elements. I'm sure there are lots of elements I maybe don't have enough of, but the contrarian side of it, I've got that.
Yeah, and it's almost being proven right. I kind of enjoy that more than being with the crowd. So if you see what I mean, so times when you pick an investment, nobody agrees with you or not many people agree with you, and then they start to join or then there's sometimes a group of people who are investing in a particular stock or name who do agree with you, and then maybe the majority doesn't. So yeah, that's kind of happening in different ideas we've got at the minute.
And then over time, the stock price might start to go up. And the best part is really when what you have predicted or estimated will happen in the future. If that starts to happen, that's really gratifying because that's where all the estimation and analysis from what we're talking about at the beginning comes in. And that's what the hardest thing to do, I think, is that you've got a position now.
In a company, maybe it's going through any kind of inflection point or the business has changed its strategy, which you think or estimate is going to make X, Y, Z changes in the future and push up. But if you're going along the EPS or the free cash flow, and if that then starts to happen, it's roughly along the lines of what you're predicting, then that's very gratifying. And then people start to believe that. And I think the gold stocks
Based on what I'm estimating are in that position now that less gold crashes off, but a large amount of cash flows will keep coming in for these stocks. People I think are starting to look at them a little bit more. Again, they're a bit like the McCoy example, where they're not the kinds of stocks. A lot of garlic or value investors would look at because people don't like commodity stocks. I agree with them 99% of the time, but this 1% I think maybe it's worth a look at.
So the other side I guess of that whole contrarian equation is, you know, obviously the herd can be wrong very often, but sometimes it's right. So, you know, how do you kind of fight that contrarian nature to be different maybe than other people when maybe the herd eventually becomes correct?
Merse, that's a good point. It does happen, has happened, and it's often if the Kurds is right or some part of your thesis breaks or you were wrong, you know, it was going to be right. And you just have to try again, forget the emotions a little bit a bit and look at the analysis. So the X, Y, Z facts have just happened. You were maybe wrong in whatever you thought. And then you have to then start agreeing with the herd. And yeah, maybe you have to sell out of position at a small loss or
Yeah, reduce the size of your position. Or, you know, sometimes you might miss out on an idea as well that, you know, that human that's, you know, that sins of the mission, I guess, that there are some stocks you look at and you just can't quite get to grips with why they're cheap. And sometimes you're wrong. So, I mean, it's not. That's one of the least bad ways to be wrong. I guess that you're then just missing out on making money rather than losing a leap up.
You know, lots of times I read tcs from different people. I don't quite quite fit into what we do, but it ends up doubling in a year's time. Okay, that guy was right. And the analysis they did was right, but it's not the kind of thing that we'd normally do. So again, yeah, you have different kinds of crowds doing different things that I think you just have to kind of stay in your lane for one of a bit of phrase and do what you do and just keep following a process. I think it's one of the most important things.
So you had this really good metaphor in the markets concerning earthquakes that I want to ask about. I really liked it. So the metaphor at its core was that, you know, you said the market is generally static. It doesn't move very much, but there's obviously these kind of periods where they can enter a dynamic position such as, you know,
Large scale changes happening relatively quickly. Maybe earnings go up very quickly or they release a new product or the market starts understanding it. The stock can frequently be anchored to its past, which is great when you see that there's this new information accumulating before everyone else.
But obviously, sometimes you get this new information that accumulates more and more. And then once enough of that information accumulates kind of moving to your earthquake metaphor, it reaches this kind of tipping point where things happen, such as the stock price can shift very rapidly up or unfortunately, it can also sometimes shift down. So
You know, I'd love to know more about this, this, this metaphor here, especially in these, you mentioned these kind of hidden shifts. So what are some of these hidden shifts that you think you like to look for? Or maybe that you think that the market tends to overlook.
Yeah, glad picked up on that, because I did not many people wrote to Sparth afterwards, but I thought it was a good example. It's from my physics past, I guess, that kind of made me think of that. In earthquake physics, there's static and dynamic friction, so dynamic friction is less powerful than static friction. So you have tectonic plates rubbing against each other, the pressure and forces build up.
And it reaches the tipping point or point where the static forces can't stop the plates moving as each other anymore. So they start moving and they switch into the dynamic friction regime, which is a less strong force until they move a lot. So it's kind of an analogy where when something starts moving, it's like anchoring in the case of stops, forcing the stop to stay where it is.
And you can imagine why that might be in terms of psychological age and kind of theory that people are looking at stock prices, the stock hasn't moved to weeks and weeks, and then suddenly it goes up 5%, everybody's going to start, well, you know, a lot of people are going to start looking at that and start, why did that go 5%? And then you realize there's a piece of news or, and then it moves up another 5% another fight, and then before you know, you've had a 20, 30, 40, 50% move.
So yeah, I started to observe that in different names, and it's kind of around the time. I think it was Cypher farm suit schools. There was a little small piece in one of their calls where they just said that it obviously bought this new business line and the CEO kind of casually says, so this has doubled our revenue and earnings for next year. That's from nobody really picked up on that. That part of what he said is, well, quickly as they maybe should have done, and the stock price moved just a little bit that day.
And then more people noticed the move a little bit more a little bit more people realized there was this fundamental change to the business is already a very good business, but it was kind of reinforcing the fact that the CEO is doing very good stuff and they just made a big change to the business and that's happened in lots of other places a few stops of the moment that we're looking at where this is also happening. And it's it's a few names that we're not going to mention yet because we're still building a position but probably mention it.
early next year, but similar kind of thing where the kind of stocks that we like are inflection stocks where there's a change to the business or some strategic shift or something that's kind of fundamentally affect the business or there's a new deal or some kind of interaction, some financial change that's going to kind of prove out that the strategy is working for a business and you kind of see it playing out. And that's kind of what we look for ideas where the thesis has kind of already started to play out like those kinds of ideas that
You don't have to predict that this competitor will do this, or this market will do this, or this product will work. It's already started to work, but maybe people haven't quite picked up on that fact. And the tectonic plates have only just started to move. Those are some of the best ideas, I think, because you've got a lot more certainty and less risk than other ideas. We've tried to predict markets that are very complex two to three years out. So yeah, that's kind of where the thinking colour came from. Let's take a quick break and hear from today's sponsors.
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Another thing I noticed is again, this was like a couple years ago. So maybe it's changed by now, but you talked about mainly being fully invested. So I wanted to discuss just a couple of potential problems with being fully invested that I've observed that and I'd love to get your thoughts on that. So, you know, being fully invested makes a lot of sense. I personally also tend to be fully invested as well, but I also don't have to invest other people's money or field calls from angry partners. But some of the possible issues are for you, you know, getting people who want to redeem their money after
maybe you've had a tough point or, you know, from your standpoint, maybe the market goes down and you see that a lot of the businesses that you already own are really attractively priced. You want to add more or maybe there's some ideas that you're looking at and, you know, they're ripe for the taking, but you don't have any capital to buy them with. So, you know, I would love for you to discuss a little bit more about how you think about this problem, you know, how do you find raising capital when you think you have a bunch of new ideas and yeah, so please I'll hand it over to you.
Yeah, and it is a tension when you're running a fund or managing other people's money that, yeah, you can't control what everybody wants to and needs soon. And it can be independent of the market sometimes that somebody just needs to make a redemption for their own reasons. It can be things that are happening and it can be a business person who's
Having to generate some liquidity or whatever the reason or it can be when the market is going down or it can be when you say that the fund has done well badly and the timing of new investments or attention to necessarily come when you want it when you're finding new ideas. Yeah, I think we kind of try and manage it holistically so you don't have.
single investor that's too large in the fund. So it's kind of the opposite side of the fund manager, and I say management side of the business that sometimes people don't talk very much about. I don't think that you've got to manage the liability side as well, that it's much better to have 100 ideally 1% investors, or you know, rather than one or a few, say three and a third percent investors, because they could cause you some difficulties if they suddenly redeemed all the money. So we have to manage it on that side.
And we haven't really had any really large investors come in who've kind of changed the sort of structure on the liability side, but a couple of times there's been a couple who got close to kind of put in some gating mechanism, just a very mild gating that would just help us a little bit if they needed to withdraw it all at once and they would get the money out in two or three months anyway, but it would just help if they needed to do that some of the liability side.
And then I guess on the asset side, again, it kind of comes down to liquidity if you're investing in S&B 500 stocks, then you could quite easily just liquidate with very little effect on that near any A, B of the fund. So again, you've got to obviously have a portfolio of different names and kind of manage that whether things are going well or badly with a stocks, stock does well and becomes a large percentage of the fund. You can run that up to a point, but I think still have to manage that a little bit because
Yeah, you've got the kind of liability side of it. So I think it's kind of a liquidity management question that, yeah, it's kind of interesting that not that many people talk about it, but it's fundamentally part of what you do because you don't want to end up in the position where you have to sell the stock. The new thing is very cheap and the business is very cheap because you're having to manage that against maybe another position that's more liquid, you have to try and balance all those factors. So yeah, that's kind of how we look at it, kind of liquidity, holistic management sort of exercise.
So we haven't really gotten the chance to talk here that you tend to invest in smaller businesses. You mentioned that generally you look for businesses that are less than $1 billion in market cap for the most part. So there is some interesting problems that you also outline specifically with small caps, for instance.
If a small caps price shrinks, that often means the price and evaluation can decrease, you know, quite violently and liquidity can can dry up pretty quickly. So I love to just know, you know, why, why did you end up settling for looking at businesses kind of in that market cap area? And also, you know, how has has looking at the smaller market cap area contributed to your outperformance here over the past few years?
It's an interesting point, I guess. We don't set out a rule that says we will only invest in ideas below a billion. There just tends to be where most of the ideas are. We've had a couple, or in my history, I've had a few as well, that have been multi-billion dollar names, they're very liquid household names, but they just go through a certain point in time where they become good investments that kind of fit inside the framework of what we do.
But it tends to be the most are a billion. So yeah, you do end up sometimes having less liquid names, but it's kind of surprising that just a stock at a particular market cap level, some will be liquids and some won't be as liquid, even at the same size, and it varies by market and region.
of course, an overtime. But I think one of the things we've found is that a kind of lucky element of if you are writing what you're looking for and you find an undervalued stock, and again, you're investing against the crowd, which is possibly or probably causing some of the illiquidity. People don't want to invest in the particular lanes. And then if you're right and the stock appreciates in the ideal case, then they tend to become a bit more liquid.
So they grow, so a $50 million market cap stock will become a 500 billion in an extreme example. And that's going to become a lot more liquid. And then it's much, much easier to sell. And then if there's an idea that doesn't really go anywhere, then hopefully you've got a bit more time. There's often times we'll
have an idea and it doesn't quite pan out the way we predicted. And so nothing necessarily bad happens to it, but then you just kind of sell out of it over time. Yeah. And so I don't think that that kind of helps your outperforms that kind of effects that things will become more liquid as they appreciate if you're right. But then you do get obviously the converse problem where you might be wrong, but then I guess the opposite to that is that that can often increase liquidity as well. People will be suddenly selling and maybe the buyers disappear, but suddenly there'll be a whole new cohort of people you want to buy at this stock.
And maybe it's dropped 23% but then you can perhaps easily sell out of that if you need to. So yeah, it's kind of worked out on both directions really in terms of the liquidity side of things. And I think we try and impose a limit as well in terms of liquidity. So there's been a few really good ideas that if we, if I was only managing like a few thousand dollars, then they would have been fantastic investments. But we could only invest a small amount because they were so illiquid, end up doubling, of course, and then you sell out of them.
But, yeah, you kind of have to limit to yourself to, I think, ideas where you can kind of sell out of them in a reasonable amount of time, like say a few months, something like that. It's kind of beyond that, then you kind of, there are some good investments, but you're kind of a bit more stuck into them. And I prefer to have a bit more liquidity in that.
So you mentioned in one of the previous questions a little bit about looking for these inflection point businesses. So I like to actually just kind of dive into a little bit more into that topic. So someone I've I've interviewed before on the show, Paul Andrew, he also looks at inflection point businesses, but probably a lot earlier in the inflection point than I think you might be looking at them. But you know, tell me like, are you looking for businesses that are already decent businesses that might have an inflection to make it
much, much better, or are you looking at businesses that maybe would be considered turnarounds, for instance? Yeah, we don't look at so much a turnaround, so yeah, I think probably we are slightly later stage than investors like Paul. Often, they make sure that in terms of how long a history a company has had, sometimes the stocks we look at have maybe IPO'd say five years ago, and they've grown steadily, but then they hit the inflection point and something big changes.
Other stocks might be two, three years old in terms of the journey along the markets and then hit an inflection point. But then again, maybe come back to McCoy Global is a much older idea in terms of coming to the game for decades and decades has been listed for a long period of time, but then has come to a point where
It was very cheap and was growing more quickly and had inflected in terms of its business strategy. So it changed fundamentally in various ways, what it was doing. And it just happened. And when you track back through the history, there are lots of very complicated reasons why it got to it, where it had in its journey. So yeah, so yeah, one by that they're a bit longer in the tooth, as it were. But then there's a couple we're looking at at the moment, which are much more recent.
And you kind of see what they've only just started inflecting now because really, you get obviously the operational leverage effects start to kick in. So some businesses, they just started off very, very small of growing and then hit an inflection point. People start to most of them and bigger customers come along. So, and then that can be a good inflection point, but maybe the market hasn't kind of noticed that yet. But the growth is still there. So you have to make sure of those things, I think.
So let's talk a little bit about diversification here in terms of position sizing. So you obviously outperform the market here for quite a long time. And you look generally, as you said, just said at smaller cap stocks, but you're probably not owning the magnificent seven. So it's safe to say here that you're not closet indexing, for instance.
Tell me a little bit more about how you like entering a position. At what point are you thinking of adding, for instance, to an existing position? In an optimal world, how many positions do you usually want to own in the fund?
Yeah, it varies. It's sometimes been the case that we've had, say, between 8 and 12 kind of core positions and then a smaller tail of positions we're kind of going into or out of, but we're probably well into the 20s at this point. And it's partly a function of what the market's doing, although the market is expensive in lots of regions at the moment. It does seem there's quite a few ideas out there because a lot seems to be changing to me. So things like AI,
And a lot of the new technologies are coming out. People are starting to talk about quantum computing, but that's even more perhaps in the future, but maybe not as much as I think it is. Yeah. So there's lots of different ideas that come up at different times. And then it's a balance between that and how diverse you want to be. But yeah, I think somewhere between 10 and 20 core positions or maybe as low as eight, if you have like the period where you've got some very high conviction ideas for the majority of our positions, that's kind of where we've
being in terms of diversity, I hate to have much more diversity than that. It's hard to track everything and be on top of all the businesses in the details you need to be. And often they're in completely different sectors, which makes it hard. If you're trying to understand unit 10, 12, 15, 20 sectors or sub sectors, that's kind of hard, especially when a lot of them are quite technical. And there's technical elements to every business trying to track that is difficult. So I think that would then start to hurt your app performance.
So I think, yeah, kind of keeping it at that level, I think is best in terms of a little bit more laser focused on what's happening with those stocks. And as you say, if you need to add to a position that's kind of gone nowhere, but the business is doing well, then we would do that. I've had situations where stock we liked went up a lot, sold out of it completely, and then it dropped for various emotional reasons and things that were happening in the market again.
from a contrarian point of view, I didn't agree with why it had fallen. Then we bought back in and it's gone back up again, so you get these weird situations. Do you get a lot, but sometimes you get situations where you can buy into a stock twice and make money out of it, depending on what happens with the emotions and what Mr. Market's thinking about things.
And so, you know, since you like these inflection point businesses, I guess, you know, sometimes you might enter a position without maybe necessarily having 100% conviction. I don't know. Maybe, maybe you do that. The inflection will play out exactly as you, as you want it to. So, you know, are there some times, you know, I guess it's completely situation dependent, but other times where there's certain inflection point businesses where you, you know, maybe you make, you make kind of a smaller starter position than you want to see how that thesis plays out over time before you start adding to the position.
Yeah, I think it comes down to a lot of the time, the kind of inflection points we're looking at, they're not a long way out in terms of time. So they're not years and years out. They're probably in the next year, 18 months, there's lots of times where you look at a business and you can kind of see in the next few quarters, I'll know whether this is working out or not. So you don't have a lot of time in the kinds of businesses and inflection points we're looking at anyway.
So, yeah, you have weeks or probably one quarter. You usually need to do all the analysis that you need to do as much as you can. So, it's really a question of kind of diving into the business, trying to understand it as well as you can, often there's technical and technological components to it. Again, which makes it can be a little bit more challenging, but you just have to kind of do the work. Yeah, and some of it relates to software and there's a lot of businesses relating to the internet and how that wouldn't have existed 30 years ago, 20 years ago.
And so I think it's really you've got to try and get to the point where you have more certainty as quickly as you can. So you dive into the business, you try and understand, you think there's an inflection point, you try and stand as much as you can to prove to yourself with enough certainty as you can. You're never going to be 100% certainty, so it's probabilistic.
You know, if the inflection occurs, that might mean you double or triple your money. So you've got to be, if you can become 50% certain, then that's good expected value kind of payoff, but it can become more than that. And that's obviously even better. So you don't necessarily have to be even 90% convinced. You have a very good idea and you spread it across multiple ideas, of course, that we've got some good examples out of the moment. We're just trying to get as much confidence as we can that these things will play out the way we think they will. And if they do,
You probably will make two or three times your money in the next quarter or two because what we think is going to happen will happen and it's kind of started to happen. So these are actually fairly early for us by a few weeks and months. Yeah. So you haven't actually seen the financial results come through, but you start to see some of the business results. So it's kind of those two elements as well as the business element kind of worked through of the inflection and as the financial results come through in the very rare cases, the business inflection has happened. Nobody's really picked up on it. And then the financial inflection has also started to happen.
And if it's still cheap at that point, then that's usually can have a lot of certainty at that point. So let's talk a little bit about your evolution here as an investor. So I'm not sure how you came exactly into investing, but I think a lot of value investors come because they're attracted originally from Benjamin Graham, just via Warren Buffett. And then some of them have a couple of years of experience and then they tend to either stick to maybe a
very value-based focus that, you know, Warren Buffett or Benjamin Graham, obviously in probably even the more extreme manner chose to do, or they decide to expand and kind of move somewhat in other directions. So I know that you kind of discussed your evolution a little bit as kind of more of a value focus investor. And now you're probably, I know you're talking about buying things for cheap. So you're still a value investor at heart, but maybe I know you're also looking for growth at a reasonable price. So maybe could you discuss that evolution in a little more detail?
Yeah, I think one thing that I wrote is Bill Ackman was saying, you either breathe the materials from Ben and McGrym and Warren Buffett and you have an epiphany or you don't. You're more of those two camps and you kind of get it and I did. It kind of made sense to me.
And I was kind of surprised at myself and the rest of the human race that there are other people who don't invest that way that come into investors and different things, obviously, that make sense in different ways and do make money. But yeah, the whole value investing idea kind of made sense to me that I did. I think what a lot of people do went back and read.
The writings of buffet are like most of the partnership letters when he was dealing with small amounts of money and doing sometimes quite esoteric things and things that people don't associate with him like short selling and he was much more activist back then as well. So yeah, that was all fascinating. And then I read through over time his letters and the manga became more of a kind of.
growth investor, I guess, looks more at the business side of things. I don't think that's kind of the evolution. A lot of investors go through it. I've gone through as well that I was probably more kind of asset focused in the early days. I would look at the assets of a business, whether it's cheap price to book, but still kind of a healthy business. And some of those worked out. Some of those didn't work out so well.
And then I think for me, that's probably a lot of investors, if not all investors have one or two stocks, maybe that they have a success with very early on, that then lights them up and you think, maybe I can actually do this because that worked out really well. I made some good money out of that. So yeah, one of my ideas was Bank of America in 2011. So I was very early on for me in terms of what I was looking at.
And it was just very, very cheap name at that point. It was kind of coming out the back of the credit crisis, but it was still having problems with its mortgage book. It took years for that to all kind of play out in a lot of banks in Bank of America to suffer particularly. And they're also waiting to find out the results of a fine. They're about to get intensive. They're handling of the situation.
I think of the very bottom trading somewhere along the lines of if you normalize their earnings and worked out that business was really worth and couldn't they were trading in about three and a half four times earnings. And there's bank America and they were going to grow obviously over time, because some banks have not survived the credit crunch there's going to be more of an open playing field regulation is also going to have a growth a little bit but there's still a lot of growth kind of built in there.
And yeah, it was one of those situations again where it was Bruce Berkowitz, I was reading all the stuff that he'd written about that name, and it just really kind of made sense to me. And obviously the market didn't think so, thought that Bank of America was going to get a very large fine. And the price that it was trading meant that the mortgage business was going to blow up completely and the rest of the business didn't exist. Basically, he was making a huge amount of money out of credit cards and
the rest of its businesses on the commercial side and retail banking, huge amounts of cash flows coming out of those businesses, and once the market effects of the mortgage business faded away, it was obviously going to make tens of billions of dollars, which is what then started to happen gradually over the next couple years, but the market
Realized within probably a year that that was the inflection point is happening and the fine wasn't as big as people thought and it's kind of staggered. And then the price that tripled within about two years. So that's another example where you do the analysis, even with a big name like that worth billions that being kind of contrarian and that kind of made me think that that's a good way to kind of look at businesses and.
Yeah, I guess they're not getting a bit more earnings focused and then the latter years, focusing more on the growth side of it as well. But it's kind of the balance of all those things. Let's take a quick break and hear from today's sponsors. I've been playing prize picks recently and I have no idea why I waited so long. There are several reasons I enjoy using prize picks to get some football action. First off is the ease of use. I can quickly deposit money into my prize picks account with my MasterCard. Second is the opportunity set. With prize picks, I can win up to 1000 times my money.
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All right, back to the show. So there was another interesting paper that's on your site that you wrote titled the three body universe. And so in that you mentioned that simplicity is a key part of your investing strategy. And you mentioned that while owning a business that maybe is like some sort of unicorn disruptor or a business that has some idea that can cure cancer, you know, story stocks,
just aren't really what you're trying to achieve because of this goal for sticking with simplicity. Ultimately, you're trying to find odds business that has odds of success with minimal odds of failure. I'd love to know a little bit more. Obviously, right now, you're talked a little bit about things like AI and quantum computing. How are you maintaining a focus on that?
vision of simplicity in some of the businesses that you own, especially when you go out and you see some of these just insanely speculative names that are clearly very low quality businesses that are essentially, they're just story stocks and they're zooming up in price.
Yeah, I think the probability angle is an important one. And I read something that, yeah, there was an investor who's talking about it on X about Buffett being a very good kind of probability odds maker. And again, that's not something people associate with him, because he probably doesn't talk about it as much. He kind of makes off the cuff comments, but if you go back, some of his early stuff is obviously doing a lot of kind of probabilistic waiting of things and everything invested in worked out. So Berkshire Hathaway itself didn't do very well.
And yeah, I think that's one of the things you have to kind of force yourself to do, because I mean, you're asking in one of your previous questions about inflection points and being certain that they're going to happen. You're never going to be certain that it's just the probability that you are going to be going to have that inflection point and being as certain as you can. So yeah, there's a lot of odds making and it's a difficult way to force your brain to think. So there are some things I do in terms of, I guess, almost like a checklist of certain things that look at in different stocks.
And depending on what kind of situation it is and what kind of estimations you're making in the future, trying to work out probabilities of those would happen. So, I mean, you can do things, for example, like coming up with different scenarios is kind of basic one, that there's a kind of the middle coin to what you think is going to happen, the low end and the high end. And if you kind of force your brain to then think about the probability that's going to happen and the bad case and the good case, it forces you to think in a slightly different way. And I think you come up with a better estimate of what will happen.
because it's forcing your brain to not say, I think the valuation of this stock is X. I don't think that's very helpful. It's saying, well, it's somewhere between X and Y, and then these kinds of bands of good, bad and fantastic. But what are the problems with those will happen? So what's the probability that the inflection doesn't happen at all? And then your brain can go through that. You basically create a scenario of
I don't know, I guess like the gold stocks. That's one thing we did with that. So the gold price is somewhere a little over $2,600 at the moment. For the bad things to happen to these stocks and for the price to drop precipitously from where they are now, gold would probably have to fall down to $1,600.
or $1,800, and that's probably being generous, but what's the probability that's going to happen? Then in my mind, that's fairly unlikely. I have very unlikely. Then if the gold price stays in the range of this, and then maybe goes up or down a few hundred dollars, sake is just down a few hundred dollars, then the stock price will still be very, very cheap. Again, you signed up the probabilities of that.
And then the high probability that gold kind of drifts upwards, then in that case the stocks are even more cheap than I'm estimating they are. And if you put that kind of probability weighting against those different scenarios you come up with, what your estimate is of what you think is going to happen. So I think it's a good way to kind of force your brain into that odd-making kind of process, not just go, is a lot of investors, some younger investors, I think, try and estimate a price and say this is undervalued by 60%. And that's, I think, somehow the wrong mindset of what you should be trying to do is trying to say, what's the probability that
This doesn't work out. This does work out. So in that same paper, you wrote, and I quote, in investing business and life, random events have much to do with the pace of success. The best you can do is put the odds in your favor, set up your life so that you can be patient and reduce the number of dumb decisions to a minimum. This is tough, unquote. So this kind of is goes hand in hand, what you were just talking about with, with odds and probabilities and using that. But
I want to focus more here on the points about patience and then the points about reducing your exposure here to dumb decisions. How have you set up your life, your investing analysis, everything to try to get you to avoid making those decisions and stay patient?
Yeah, I think for everybody, you need to try and find a way that you're not in a rush. You're not trying to get rich quick because that's very difficult or impossible in this way of investing. People are really about doing different ways. Some people have maybe got built up a nest egg already so they can kind of use that as a backstop or they're some of the forms of income. I think that's what you need to do if
you're going to be patient. So yeah, you either need some kind of busser or cushion if things for stocks for you're not going to be panicking and thinking, I'm not going to be able to pay my mortgage or my rent next month, then that's going to make you make bad decisions like I need to make that money back because you've just lost it. So you've got to avoid that kind of setup. Yeah. And I think it's a fundamental thing. You've kind of set up your life in a way that allows you to do that and give yourself
years and years of time to be able to figure out what you're doing and work it out that way, at least five years and be a long amount if you can. But yeah, I think people need to be careful. And I think most people do do that to in terms of the people that I follow on social media, do that. And it makes you worry about some of the crypto investors who are maybe putting a large amount of their early wealth or whatever into crypto and some will make a lot of money. Some might
lose it, get burned by that, which is very sad. But I think you have fundamental kind of structure, what you're doing, however you do it through, money you've saved up, if you're working, or some other kind of buffer that allows you to give you that time where you can just have that buffer against the volatility, because even the best investor in the world will have up and down periods and you just need to have that cushion.
So from researching your investing letters and some of your conversations, I know that you invest quite heavily in global businesses. You're not just sticking with the United States here. So I know part of the advantage of that is that it's allowed you to kind of rotate capital, say, you know, the US market gets expensive. You can rotate it to a completely different geography.
Obviously, there's there's bonuses to that because, you know, you're not, you're not restricted to staying just in one market. And if that market gets really expensive, it's not exactly, you know, the most fertile playing field of planes. Many investors such as myself, however, though, have had difficulties.
investing in areas like East Asia where I know that you guys have had some success, especially in regards, I think, to circle of competence. So I'd like to head over you, you know, tell me how you've kind of found success in these more faraway regions where, you know, maybe you're not super, super embedded into, you know, the culture or, you know, how those countries work.
Yeah, it's partly made easier by things like the internet, where you can search up a lot of information and go down rabbit holes. It's kind of amazing sometimes what you can find if you really dig down into all kinds of weird and wonderful websites. Amazing information is how they're even in different countries.
And I think it's also been recently made easier to some extent with AI and Google Translate. So it used to be difficult sometimes that you could kind of just about recognize the income statement numbers and the balance sheet, because you could see where the numbers made sense versus how you understand those things fit together. But you wouldn't be able to read the language behind it, the management discussions around it. But now that you know, the Google Translate and other translation AI tools, that's become a lot easier.
But yeah, it makes it a little bit difficult. I mean, it kind of goes against against the scuttlebutt kind of approach where people actually visiting stores to see products and see if they're selling. That's one thing that you want to be able to do and be able to get this kind of alternative information. And it does make it a little bit difficult if you're looking at a completely different place, which maybe means you have to do a bit more digging around of what's going on over there. But I think there's often a lot more similarities than people think.
in non-English speaking or in different countries outside the US. A lot of investors don't really like looking at non-English speaking countries and don't invest that much outside of the US, which then potentially creates opportunities that there are markets like Singapore, there's been some good investments over there and it has historically got some links with the West in ways that other countries maybe don't have the same kind of links.
Other countries like India are very difficult to invest in if you're on the outside, sadly, great sort of barrier there. But it's really just kind of doing the same kind of analysis. Often the businesses are doing similar kinds of things. Every country has a lot of countries that banks and different kinds of businesses. You do get similar quirks in certain countries where things work a little differently. In East Asia and Japan, I was doing a research through A to Z of Japanese stocks.
I couldn't get comfortable with most of them because they weren't doing very many buybacks or they didn't pay any dividends, they were just building up cash. There's a lot of stocks that they're fantastic businesses, but just that capital allocation is atrocious compared to somewhere like the United States where people do lots of good buybacks if they're building up too much cash.
That's starting to change and has been pushed to push companies to do that. There have been a few that popped up on a radar. Companies started to buy back some things that make more sense in terms of capital allocation. I think it's understanding the differences and the similarities. Some markets have certain similarities and some have differences.
And then it's been surprising to me over the last couple of years in Canada that people have not really been as invested in Canada as they maybe should be. And that seems to have changed the last year or so. And there have been some bargains over the years in Canada that probably shouldn't have been because it could be. It's not that different to the US in terms of a lot of things that are going on over there.
I think the one thing that has helped us is that when markets were cheap in one place they've been expensive, another place we were able to shift. There was a point a few years ago where the US got very expensive but East Asia was very cheap so it shifted, rotated over the air, and then it flipped back the other way a little bit. We've had some better ideas in the West again. Over the last couple of years, Europe has had some good pockets of good investments.
Yeah, I think in general, we kind of look at places where there's going to good governance ready, it kind of comes down to that and being careful of what the kind of political, geopolitical situation is behind that. You know, we've already done anything where there's been a really bad geopolitical issue or, you know, wars breaking out of that kind of thing, but yeah, you have to be kind of mindful of that when you look around the world as well.
So in another one of your letters, you were assessing your ability to outperform the market and you came up with kind of these four main factors. One was that you focused on overlook markets with less competition, which we just talked about here. Two was that you analyze just a lot of businesses. You know, you mentioned kind of go do it in the buffet A to Z thing. And you look for tons of different businesses that hopefully have these large discrepancies between price and value.
Three, you prioritize buying cheaply. And four, you have a process which insulates you from this external noise and different fleeting trends. So I want to focus actually on the third point here, which you kind of broke down to as price being your due diligence. I'd love for you to just kind of further elaborate on how you use that as an edge and maybe how you also triage your time to ensure that you're maximizing time spent on positions that are worth spending the time on.
Yeah, I guess we have a couple of elements to that. I mean, one's kind of as much as anybody does in terms of looking for cheap businesses that are growing. And I think it's probably the second of those that helps with that if you're looking at a lot of different stocks. It's kind of amazing what will pop up, especially if you're looking across the whole world.
There'll be things that are kind of jokingly thought about them as gulp stock, so grosser, unbelievably low price. You can find some things if you look hard enough that you're almost surprised they exist and they're that cheap. And then you'll find somebody else has also found them. So you're not the only one, but if you look across enough stocks, then you see more of those than perhaps other folks would.
But I guess the other thing we do kind of embeds the way we look at individual stocks into the portfolio and do a cross comparison of how cheap they are with a whole bunch of metrics within the portfolio and against the external market and other ideas we're looking at. So looking at the yield or how much cash or company has on its balance sheet, but just looking that across the whole portfolio and trying to balance that in this kind of good way to look at things as well, because it kind of again changes your mental model because it forces you to sell things that are becoming a little bit too expensive.
And stops you thinking about the price movement, one of the biases that, you know, it's used to get caught up with. It just fundamentally makes you realize this stock is, you know, it's now whatever it would be, you know, P of 2025. It might be still growing or it's growing okay, but it's not, you know, it's three times less cheap than it was when I bought it. So maybe I should be selling a little bit of that and buying out of the one I've just found that.
you know, had a PE of five, say it was, then yeah, it kind of helps you. And as I say, there's some metrics we use to kind of force ourselves to do that. And it kind of, it's stopped some of the biases that you have when you look at stock movements. And you see, you know, the movements on charts. So that's kind of one of the ways we look at it. That thing helps.
So you obviously spoken a lot here about just simple valuation tools that you use. And so you actually mentioned one that I actually want to discuss a little bit more is so you wrote that, you know, determining under valuation is actually really easy. You just divide the market cap by the earnings in a year or two in the future and you get a number. But you also mentioned that, you know, once you get that number, there's obviously a lot of work that needs to be done once you get to that point.
And also, you know, estimating future cash flows with high certainty can be pretty hard after just a year or two time, even with these, you know, super major businesses out there. So I'd actually like to know, you know, let's say you have two businesses, you know, ABC has a lower valuation in the next two years. And then let's say XYZ maybe has a slightly higher evaluation, but you maybe you have more certainty in the cash flows, you know, maybe from year three to five.
I know that might not be enough information for you, but between the two of those, which one would you pick? Yeah, that's probably not enough information. But just to take the general point, I guess, I think it would be the one where we can get the most certainty. So, yeah, if you can figure out the certainty that it may be it's not as cheap, but you have more certainty for whatever reason it would be. Those often, often you're biased psychologically, I think, to the cheaper one, but often the latter turns out to be the better investment because
It will carry on being certain, maybe it's in a business where the cash flows are more certain, and that will steadily grow over time. We've had examples and coloured both sides where there are some business out there that are doing extraordinary things and growing over many, many years. We rates above 30%, and you can see that continuing, because there's
There's embedded, really strong business notes that they have, and it comes down to that. Maybe the uncertain one doesn't have as much of a note. Maybe the reasons they go into that, that's causing. You might see court to volatility or something that makes you feel less certain because of the nature of the business. Some high levels of cyclicality and some businesses are just more uncertain. I'll probably go for the more certain business maggots.
So I want to shift over and talk a little bit about tech because I know you have some really interesting points on that in your shareholder letters. So there was this interesting trend that you noticed and you pointed out in your letters in around the mid 2023 mark. And this was that technology is encompassing a broader and wider area. Maybe that goes in line with your McCoy global investment.
Now, you know, this makes it easier for a business that maybe in the past would not be associated with technology and now can consider itself a technology business today. So my question for you is, you know, are there businesses that are maybe taking advantage of this just to specifically, you know, chase a premium multiple and increase the price of their stock price? Or do you think that this is like an accurate signal and there's businesses that are truly creating value based on technology?
Yeah, I think that people chasing technology was true years ago, maybe 20 years ago for .coms, and there's probably still an element of that, I guess, now with AI, not companies claiming to be doing a lot with more with AI than they really are. But I think there is also a trend, a real trend as well, that I started to notice it as we do have portfolio reports and you bucket things for investors into different categories. So this is industrials.
Consumer discretionary, this is technology. Now technology, Buffett buckets start to keep going up. And it was because some of the things we're investing with, kind of clear technology companies, software companies. But then some of them, you kind of dug into the business, like, well, this probably wouldn't have been called a technology company 20 years ago, wouldn't have had that element to what it's doing. Maybe it would have been called publishing or something else like that.
So it just kind of made me think that it gets the point where McCoy, who you say is probably a good example of that has such a large technology component to what they're doing. It's not just what they're doing. They'll save a lot of hardware manufacturing as well, but you can maybe say that they're 30% technology or 50% and then that kind of bumps it up and eventually gets the point where what is technology is kind of a lot of different things that color covers almost everything in it to some extent rather.
Yeah, I think that's a real trend. I think the other thing that kind of made me think about that was buffet himself who of all we did technology, whatever that meant, over the years, they was investing, and then he started investing things like Apple and realized actually that's a really good investment that totally fits.
Inside is a circle of competency and lots of other things probably would have done through the way and maybe his bias against technology kind of delayed him doing that. Yeah, and it kind of made me think it should be biased against technology that it can be uncertain and there are cases where some businesses are uncertain that technology aspect and high level of competition can be a factor, but there are a lot of businesses out there that are much more stable and much more certain than there would have been if there were technology companies 30 years ago.
So you also had a really good point about how technology focused businesses today spend money on research and development to build things like you said, pools of data, you know, networks of servers or lines of code. And an interesting thing to do with that is that, you know, traditional accounting standards doesn't really value these, but it's very clear as you just said that, you know, these areas can add a very, very significant amount of value to a business. And this point actually kind of makes me think of Adam Cecil's excellent book, where the money is where
His basic premise of his book was that he kind of needed to understand how tech businesses worked because it was financially dangerous. Not too. I really like how he worded that. And his point is that legacy accounting methods are kind of outdated now because it doesn't incorporate the value that's added in this R&D to the tech businesses today. So, you know, give me some more information on how you kind of incorporate that into your investing.
Yeah, that's a really good point. I think a lot of people have more and more people have started to realize this. 50 years ago, a company is building a widget or build a factory to create the widget to build the widget. Yeah, and that factory would have an asset value to show up on the balance sheet.
Nowadays, you have software companies developing all kinds of very valuable tech assets effectively that don't really get valued correctly and the expenses that go into creating them, always just fall off the balance sheets and get subtracted against the income statement in to aggressive away. Some companies make adjustments for that.
the accounting and we think of as the right way. But yeah, I think that's on lags a lot behind where these companies should be valued. So you get a lot of much more asset-like businesses than you would have done in previous decades. And it's only going that in that same direction. Maybe with the event of AI, you'll have more data centers, but still the AI technology itself still won't necessarily get valued in the right way.
So, yeah, one thing we do is, and again, it's more and other signs, it's difficult, but try and work out what components of the R&D, for example, expenses should be taken out and are really actually true income. And I think that comes down to a lot of things in the income statement.
It's easy to think of the income statements are very certain set of line items, but there's a huge amount of art, right, and sites in terms of the numbers that take you from revenue to internet profit. And I think this is what example of that where we should really just be accruing those expenses over a much longer life, much time. And for a fast growing business, that can have a huge impact in terms of the amount of expenses being recognised now for growth that's going to come five years down the line and create much more income.
And a similar thing is, well, I'm not necessarily directly related to technology, but it can be, but often with software is the sales and marketing lines as well, that sales are produced now, dick in the SaaS businesses, and that approach can be generating income for a long period of time as well for those kinds of businesses. That could be a big effect as well. So taking those expenses out is often far too aggressive. So we make adjustments for that to try and normalize earnings.
Often it's quite shocking the result that comes out that you find that something that looks fairly valued or a little bit too expensive, it tends out to be incredibly cheap. And then it's interesting because then as you follow that through the years, you see that actually starts paying out that the income goes up and those expenses are starting to come through as having generated that growth that you see. So Andrew, thank you so much for coming onto the show today and sharing your excellent insights with me and the audience. So I'd love to give you a handoff. Where can the audience learn more about you? Read your shareholder letters.
Yeah, well, yeah, to come to our website, I guess, fairlightcapital.com. We put information out on X as well, starting to use other social media platforms a little bit as well. So yeah, under fairlight cap. So yeah, just really continue to read our letters.
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