Unemployed Value Degen Stephen Farrington on small cap stocks $PTLO and $CROX | S07 E31
Summary
Investment Philosophy: Stephen Farrington focuses on small cap value stocks, emphasizing the potential for finding mispriced opportunities where fundamentals have improved but prices have not adjusted.
Insider Buying Strategy: Farrington values insider buying as a key indicator, particularly purchases by Chief Financial Officers (CFOs) and General Counsels, as they are often the most informed and cautious within a company.
Portillo's Analysis: Portillo's, a fast-food chain, is highlighted for its strong market niche in everyday value, with impressive revenue per location and a high net promoter score, suggesting strong customer loyalty and potential for growth outside Chicago.
Crocs Investment Case: Crocs is noted for its international growth, particularly in China, and its ability to maintain reasonable pricing, which helps fend off competition from knockoffs and supports strong brand loyalty.
Market Dynamics: The discussion touches on the potential for a rotation from large cap to small cap stocks, driven by factors like interest rate cuts and the impact of AI on profitability, which could benefit smaller companies more significantly.
Current Market Trends: There is a notable shift in options trading dynamics, with realized volatility exceeding implied volatility, suggesting potential opportunities for those who understand the underlying companies well.
Sector Challenges: The restaurant sector faces challenges due to consumer pressure and economic conditions, but companies like Portillo's are seen as well-positioned to weather these issues and capitalize on future growth opportunities.
Transcript
I think we're live. This is Value After Hours. I am Tobias Carlile joined as always by my co-host Jake Taylor. Our special guest today is Steven Farington. He is unemployed Value Den on Twitter and Substack. Welcome Stephen. How are you? >> Oh, I'm I'm fantastic and I'm I'm a huge fan. So, I'm going to try not to fanboy out too hard here, but uh but yeah, it's very grateful for the opportunity. You're welcome. Um, your focus is small cap value. Take us through a little bit about your philosophy and, uh, your history, how you got to this point. >> Yeah. Well, um, small caps, uh, I I feel if you're looking for value, the best thing is to go where the mispricing is the most extreme and then sometimes the mispricing lasts so long um that, uh, you know, even after the fundamentals have improved, the prices still haven't adjusted. Um, so it can be a little frustrating. I've learned over time that the a lot of things that are are cheap really turn out to be more cyclical. And so knowing what I know now, maybe I'd be the uh the the cyclical degen, but there's just a lot of things that have huge enormous cyclicality. And you know, at the bottom, people are saying, "Oh, this is obsolete. It's going away. We're not going to be doing this anymore." And then a year later, it's the price tripled or 5xed or something like that. So, um, yeah, I love the mispricing in small caps, but if I was smarter, I would, uh, for my writing, I would go up market cap a little bit because every time I write about a midcap, it gets about 10 times the attention. So, it's it's not a smart business strategy to focus on small caps. >> Yeah. You want to you want a Tesla blog or a Tesla Twitter account that way you have millions of followers. >> That would be fantastic. >> So, tell us a little bit about your philosophy. How do you identify undervalued small caps and what are you looking for? >> Oh, so it's very hard to be a generalist because every industry has their own metrics that matter. So every time you try and crack into a new industry, um you're you're really grasping in the dark. Um I I have gravitated more towards price to sales than price to earnings because there's just so many accounting tricks people can use to manipulate earnings. it's much much harder to manipulate uh sales and revenue. Um but uh um one of the first places I look and and um this ties into my background a little bit. So I I did um I was a former professor. I've I've been through all the classes for the PhD program and I've had way too much math. And uh I really love insider buying, but when you speak to people that do the multivariate regressions, they say, you know, that doesn't add anything to the model. And one of the problems with the people that use huge data sets is they always assume that more data is better. And sometimes the parsimonious model is the best one. If you take all insider behavior, you've got a lot of noise in there. you've got um you know, for one thing, just forget about the the insider sales because most of the time uh most of the time you're dealing with management who considers that part of their salary and selling is what's supposed to happen. And you have other times there was a a Scandinavian company, I remember the CEO sold half of his position and and the market was was terrified about it. He even came out with a press release. He said, "Sorry guys, I'm going through a divorce. I still believe in the company." Um, so just forget about the sales and look at the buys. Uh, because there's only one reason why, um, somebody that works at a company is going to buy stock in that company. And even then, um, I ignore the directors most of the time. Sometimes I'll check out the biographies of the directors and see if they really have, you know, good experience that industry, but I would ignore the insider buying from independent directors and even the the chief executive officer. So uh one of my PhD adviserss this was her area of research and um uh chief executive officers uh if you look at him uh there is an advantage to managing a company with a chief executive officer who is consistently wrong but he's biased optimistically. So, if you have a CEO that says, you know, next year we're gonna have full self-driving and next year we're gonna have full self-driving. >> Who are we talking about? >> Next year we're gonna have full self-driving. So, CEOs that are consistently wrong but are wrong u overshooting their estimates, their engineers produce more patents per engineer. >> So, they believe it's possible. >> Huge advantage to leadership. >> Yep. You got to make people believe. So, CEOs have to make people to believe. And in making people believe they believe. So I love to ignore CEO buying and director buying and I go straight to the most pessimistic bean counters. I want to see when is the CFO buying and even better when is the general counsel buying? Because you take the most pessimistic people in the building that have all the information to know where all the bodies are buried and know where all the risk is. And if I see a chief financial officer take $300,000 out of their checking account and buy stock in a company and I see the general counsel take $200,000 out of their checking account and buy stock in the company, then I'm engaged. I'm So maybe on average insider behavior is noise, but within that noise is a lot of signal. If you know that the parsimmonious model is sometimes more more correct. So that's insider behavior is maybe my my most favorite screen especially for being a generalist and not knowing so many so much about every industry. >> I'd be curious if you could move that to even the like treasurer or the comproller because it's like okay the cash is real. >> Yep. Exactly. And chief operating officers are pretty good too. But you just have to know the CEO he can he can be wrong. He can believe he can drink the Kool-Aid. And directors they could be doing a better job. But um but there is there is real hard kernels of data in the insider behavior and it has has worked out well for me in the past. >> I think that's a I think that's a pretty clever hack actually because as a former general counsel I can confirm that the CFO and the general counsel are the most pessimistic guys in the building. >> If they're buying I I'll just take a flyer and punt on it and buy some as well. If I see a company with both with those two at the same time buying. I think that recently happened to one of the companies I was going to talk about today. I'd have to double check. Um but yeah, no that I was going to talk about two stocks today, Crocs and Portillos. >> And Portillos, you had big inside buys by the CFO and the general counsel at the same time and large for the size of the company. >> Well, let's talk about Portillos first. We'll come back come back to Crocs since we've started along that line. >> Toby, have you ever eaten eaten at a portillos? >> I have not. No. >> Is that a Is that an East Coast thing? Are they on the West Coast? >> It's a Chicago native restaurant. >> Yeah, so a Chicago native. They even have uh they even have a special called the Leo for the new pope who's from Chicago and uh and enjoys Portillos. >> Um so Portillos is a fast food chain. Their their market niche is interesting. So they're going for everyday value. So while McDonald's was trying to sell $9 cheeseburgers, you know, Portillos was um they're they're trying to capture the everyday value market to make sure that their food is high quality and affordable. And um I it's kind of where to start, where to untangle this thing because it's such an amazing business. I remember before I had ever looked at a restaurant, I had just seen the statistic that Chick-fil-A, you know, crushes all the competition because they do 7.5 million dollars of revenue per location. And you see, well, Chipotle does, you know, five million revenue per location. McDonald's does three and a half million of volume per location. A restaurant like Crystals will do like a million dollars. Something like a uh not a Dunkin Donut. So like a BaskinRobins or a Crystals is doing like a million dollars of revenue a year per location. >> Yeah. Subway is like way down there. >> Yep. Subway is way down there too. Subway had the they have now have the problem they got bought out by private equity who now wants to sell a a $13 sandwich and the quality hasn't improved. >> $13 sandwich doesn't sound as good, does it? Well, I I was at a conference with my wife and it was on the beach and I I thought, "Oh, well, maybe this is just beach pricing." I talked to the staff there like, "No, no, all Subways are like this now." So, $13 a sandwich everywhere. I'm like, "What? What are you doing? I'm going to buy >> Thanks, Jerome. >> You can't charge more than a dollar an inch. That's that should be put in the constitution. >> I'm gonna I'm gonna leave that one alone." >> Oh. So um Portillos is going for the everyday value market and uh when the founder of the company sold it, so he sold it to a private equity firm. He didn't sell it to the highest bidder. He sold it to someone who promised we're going to maintain this culture. We're going to maintain this value. It's going to be an everyday value business. You know, it's not we're not going to jack up the prices. And I the the founder of the company sold it. They only had 50 restaurants at the time, sold it for a billion dollars to private equity, who took it public and um has been trying to grow it aggressively. So, um now where to start? So, I told you Chick-fil-A does about 7.5 million per location. A portillos in the Chicago area does about $10 million a year in revenue per location. And Chick-fil-A has an average ticket size of about $15 a person. Portillos has an average ticket size of $11 a person. So, think of Chick-fil-A on a Saturday and how busy it is. And then think that Portillos is going to have about 40% more people than that. >> And it's just enormous massive amounts of volume. >> And the menu. So, they they they do have in restaurants. The bigger the menu, the more likely you have waste or spoilage. They have an enormous menu, but they're able to keep it moving with that much volume. So, they're doing uh a Portillo's location will do $600,000 a year in salads. I think Sweet Beans is only doing about 2 million in salads. So, it's it's just this have something for everyone, right? They've got their kind of signature item is the hot Italian beef sandwich, but they have milkshakes. They have, of course, they've got Chicago hot dogs. They've got hamburgers. They've got a nice selection of salads. And they serve beer, so it's it's fast food. There's no tipping. It's adamantly no tipping. It doesn't ask you for a tip. It'll never ask you for a tip because they want to be everyday value. But the inside is decorated like an Applebee's or a Chili's. So, it's like a sit-down restaurant, but you bus yourself and there's no tipping. So, and it and they serve beer. So, for me, it has this fantastic market niche I think is very attractive. Um, and at the same time, um, uh, the the customers get absolutely hooked on it. So, um, there is a concept in marketing for brands called a net promoter score, which is how likely you are to recommend this business to a friend. and Portillo's crushes all competition on net promoter score. And I I lived this firsthand because I hadn't heard about the company was a former professor and one of my students uh his girlfriend was doing a master's degree in Chicago. And this student of mine, he texts me out of the blue. I I swap phone numbers with about four or five excellent students. If I was smarter, I would have done that with a hundred students, but I was only smart enough to swap phone numbers with about four or five excellent students that were really going somewhere and making things happen. and he texts me out of the blue and says, 'You have to try Portillos. And this is a student. So he he graduated in two years. He was the most ambitious student I've ever met in my entire life. And we had never had a conversation about anything other than business, right? There was there's no non-b businessiness. And I I asked him like, "Has your account been hacked? What is going on?" Texting me out of the blue. What do I tell? >> And um no, the net promoter score of this company crushes everyone. If you have this simple one question survey, are you going to recommend this company to a friend? The answer is yes. And in a world where Google just takes all the profits and ad revenue in a in a world where marketing is just so hard to reach people, having that word of mouth that that is real and effective, I think does matter. And it it does take some time for these restaurants to become more established. But one of the big criticisms against Portillo's and I think the the bearish take on it is this can't work outside of Chicago. And to me that's shocking because Chicago has always been one of the choicest test markets of the country because their demographics are so diverse. If it can work in Chicago, it can work everywhere because they have black, they have Hispanic, they have white, they have everything. It's always been Chicago is the test market. And now there's this weird narrative on Portillos that it can work if they don't know if it can work outside of Chicago, but um uh they did expand to Arizona. They've got four restaurants in Arizona about 10 years ago and those are doing the same volumes as Chicago, but recently they've expanded to Texas. They've had a bit of a hiccup. So they're their chief marketing officer got poached. Their chief marketing officer got poached to be the CEO of Jordano's Pizza. So, on this big roll out, they're doing this huge roll out without a chief marketing officer. And so, they've had some near-term stumbles and the market's not believing it. Um, and I think that's all short-term noise. This is the one of the most amazing companies I want to own a piece of. Um, they opened their first location in Texas in Dallas, and it was in the same shopping plaza as Warren Buffett's Nebraska Furniture Mart. that first location in Dallas in its first year. Keep in mind, your average Chick-fil-A that's so packed on Saturdays and has the line that outside the the that's shutting down traffic because it's leaking onto the highway. Um, that is $7.5 million of revenue a year. The first location in Dallas did $17 million in revenue its first year. And the management on the earnings call said it almost broke the store. This is is ridiculous. So, they they kind of did a a hub and spoke. They opened five more locations to try to siphon the traffic away from this location next to Nebraska Furniture Mart. And it did. It did siphon the traffic away, which it was supposed to. But now in their data, you look at the 2023 cohort and people say, "Well, why did traffic fall in the 2023 cohort?" >> Well, because it was intentional because they had to siphon some traffic off of You can't have one fast food location do $17 million of revenue a year. It just breaks the whole system. It's just it's just nuts. But there's so much I like about the company. They've got a great management team. They're iterating quickly. They're experimenting to try and figure out what works. So, they're just launching breakfast options now in Chicago. So, you're already doing $10 million of revenue a year. They could start including breakfast on top of that. I mean, that's just just absolutely amazing. Um uh so they're they're going to see does it work? Does the market like it? I think when you have a new chief marketing officer in there to handle the store launches a little bit more appropriately. Oh, and um in March of this year, they just launched a uh membership rewards program to get people to sign up and download the app. They got in the first six months of this membership program 1.9 million reward members. They only have 86 locations. They have 86 locations and they have 1.9 million rewards members. That's over 20,000 rewards members per location. Chipotle only has 5,000 rewards members per location. Like the the customer base of this company is so fanatic that you know on my write up on Substack, every paragraph I interspersed, you know, how do you how how can you tell if somebody knows uh somebody eats at Portillos? And don't worry, they'll tell you. Um, so I did uh >> going to Harvard and Portillas. >> Yeah. So, um, and then I I have to ask myself, so why is the market sleeping on this? I always want to know if the price is wrong, why is it wrong? And part of it is just this false narrative that they can't be successful outside of Chicago, which I think Arizona and Dallas has proven they can be successful outside of Chicago, but for some reason this narrative has taken hold. Uh but the other one is I think um it's it's kind of like the story of Pelaton, right? You the people that work in finance have to use the product and they haven't opened a location in Manhattan. I think if they opened a location in Manhattan, the price to earnings ratio would go from, you know, 10 to 40 because suddenly people that work in finance would try the food. >> But they're they're focusing on some belt growth. Um but uh yeah, I I think um most of the successful restaurant fast food chains that are fetching, you know, five times price to sales, seven times price to sales, they open a location in Manhattan, so people that work on the stock market can try the food. Um and I I think that makes all the difference. It works for Pelaton. It works for a lot of these, especially high-end luxury consumer brands. >> Um can you walk us through the valuation of Widmouth? >> Yeah. So um >> Steve, sorry. >> Yeah. So um right now there's another reason the stock might have sold off. So the private equity firm that bought it originally for a billion dollars, they have been slowly uh exiting. So they've been taking their limited partnership uh LLC units and selling them in the market. And when it does that, it looks like dilution. It looks like the share count is increasing because the the LLC shares that were off the market weren't considered in the float and that that sales process is almost over now. I think they only have one or two% left that when they went public they kept around 50% and then over time they sold into the market and that's >> how did that show up as like minority interest or something like that? How was that captured? Yeah, it's just um I there's another company that was like this, Finance of America companies, and I'm my memory's uh it's in the 10K, but it's not in you know your standard. >> It's in the notes, not in the >> Yeah, it's not in the Yahoo finance numbers. It's not in the Finn viz numbers. It's not whatever data sets they're pulling for this information. It it's fooling the retail investor or the any uh algorithmic investor that they're diluting, but they're they're not diluting. They're growing through mostly through cash flow and um and al a little bit through debt because they wanted to um they only had 87 locations. They're opening 12 this year. So they're trying to grow aggressively. Um so price to sales is 68 right now. I think Chipotle's price to sales is five or seven. It's just uh outrageous. Price to book is not super accurate because they have some very old locations and some of those old locations they own the land. So you've got a lot of depreciation price to book uh with older assets that can throw off. Um and price to earnings uh price to earnings can get thrown off by this huge capex. You've got 87 locations. You're opening 12 more. There's this enormous capex affecting earnings. So price to earnings right now is at 14 and a half, but again that's you're doing this enormous buildout of locations. Um, so I', for this one, I'd focus on price to sales. And if the market starts believing, um, then I think that's going to go from 68 to three pretty quick. Um, and then, uh, yes, they really just need a new chief marketing officer that's on his game to come in and take this rewards membership program and have some fun with it and, uh, and to pay a little more attention to their new new opening launches. And also, you're just in a tight time right now for restaurants. So a lot of restaurants are missing earnings and missing comps. So you have restaurants generally are having outflows and some of those are undeserved. So two of the two of the darlings in the restaurant space, Cavas and Sweet Greens, they focus their expansion on the Washington DC area. So you look at year-over-year comps for Cava and Sweet Greens, and it's just through the floor, but Trump laid off all the government contractors in Washington DC where they launched their initial expansion in the first place. So restaurants are struggling right now, right? The consumer is a little under pressure and you have um this is just across the board every earnings call you listen to, you know, the the consumer is more choiceful, the consumer is under pressure. I think that's all going to go away once we um so this is a little off topic, but um mortgages the way you know as opposed to interestonly debt, mortgages are taking money out of the system every month. Every time somebody makes a mortgage payment, you know, the money supply is shrinking, debt is decreasing, and that person individually is saving. Once mortgage rates are 5 and a half% for a 30-year mortgage, and you have home equity loans pick up, a lot of people, and Home Depot and Lowe's are big on this in earnings calls, everybody's putting off the major projects because they want a nice, attractive home equity loan rate to put in a swimming pool. Once the money is flowing through the system that you know just enough home equity loans to offset the natural behavior of mortgages pulling money out of the system then that money is going to work its way through the economy. People are going to be a lot less choiceful and everybody's going to have more money in their pocket. So is really is there's a lot of um negativity out there. You know what's what's 50 basis points of interest rate cuts going to do? And I think it could have a huge effect on home equity loans and building swimming pools and putting in a new deck and redoing your kitchen. Then all that money is going to circulate through the economy, you know, and this uh consumer choicefulness, I think, is going to go right out the window once that money starts moving again. So, I think it's a great time where restaurants are hated and the sector has outflows and you're buying this thing for the market cap right now is 495 million. So when the founder sold it to private equity for a billion dollars, it only had 40 locations. So you're buying it now for half the price with twice as many locations. So it's about a fourth of the price as when private equity first bought the thing originally. Um I'm I'm pretty locked in. Portillos is one of my bigger positions. >> Was this Was this the one that that somebody asked Buffett about this at the last meeting? Like there was a Portillos that showed up in the >> Do you know what I'm talking about, Jake? Yeah, I >> but it was something else like they they were off on it. >> Yeah, I I missed the I missed the last uh meeting. My my one I know this is the temple of Warren Buffett. My one take was I was going to talk more about on uh Crocs. If we're pivoting to Crocs, um Crocs had 30% year-over-year growth in China and American companies are just notorious at not being able to penetrate China. And I think the the recipe for why they're so successful is because uh Warren Buffett was asked about this during the the Craft Hind acquisition and he was asked about why not all these other consumer staple companies and the topic moved to aren't they just charging too much? You know, you've got for example in Nabiscoco crackers the the white label box of saltine crackers is $150 and Niscoco is charging four bucks for a box of crackers. Aren't these markups just just too much? and uh and Warren Buffett was coming down pretty hard on the side of yeah their their brand is powerful but they're pushing too hard. Crocs is the the name brand for these kind of resin injected clogs and they only charge $45. And I think if they were pushing for like $150 or $125 for the name brand clogs, they wouldn't have 30% year-over-year growth in China. When somebody's asking themselves, should I go with a knockoff or should I go with the name brand? Well, if your name brand isn't pursuing those aggressive margins, if your name brand is going for a reasonable price, there's no reason to go for the knockoff. And and Chinese people love to go for the Chinese competitor. There's this huge stickiness culturally in China, like a it's like an old by American campaign, but it's not even necessarily pushed so hard by the government. There's an old sociology political science paper that tracked after how many generations does an immigrant become indistinguishable from the native population. And for most immigrant groups, it was one generation. For most immigrant groups, if your kids grow up here and go to college, then they're indistinguishable. The way they vote, the way they behave, you can't tell the difference. For Chinese immigrants, it's more than three generations. So unless your great-grandparents were building railroads in California, the cultural stickiness of the Chinese is just so powerful and so strong. So every American company that goes to China has such enormous difficulty penetrating that market. And there's Crocs with 30% year-over-year growth. And last quarter, they just flipped to 52% international, 48% US. There's an enormous international growth story. And they're crushing it in Korea and they're crushing it in Japan. And it's a combination of, you know, they're really good at social media marketing, they get the right influencers to wear their shoes, and they don't push the price, 45 bucks for a pair of clogs. Why would you want the knockoff if the name brand is is reasonable? >> What is it about the Chinese culture that has a more stickiness? >> Oh, I mean, it's it's it's kind of central to it, you know? It's I mean, the French is a little bit similar. Uh but the Chinese take it to a whole another level. Like the whole concept of the the symbol for China is that uh the line with a little circle in the middle it stands for the middle kingdom. That's a way of saying the center of the earth. Like it's it's just inherent within. This is the center of the universe. The sun revolves around China. It is you know we are the best. And if we are the best, why would you not why would you want to change anything about yourself if you're already the best? So it's really, you know, foundational to the whole Chinese identity to be part of the Middle Kingdom to to be, you know, the the best people on earth. It's uh once upon a time I was uh my first 10 years of my career, I was a chef and a car accident sent me back to college. It was a fantastic car accident because I had a lot more to offer the world than a Bernay sauce. I I found myself working for a French chef in Honolulu and uh he would like at least twice a day he would go through the kitchen to tell everybody get everybody's attention and say this this is the best mustard. Do you know why this is the best mustard? Because it is French. And then he would just leave the room and he would do that at least twice a day with a different ingredient. And it was just that the the the sort of ethnosentrism of it all has always found it hilarious. But I think the >> Wasn't French's mustard American brand? >> No. No. He was talking about uh it was a whole grain uh stone ground djon. Yeah. Anyway, but but he would do that with a different ingredient at least, you know, three or four times a week. >> Um but Chinese take it to a whole different level. Just, you know, the middle kingdom, center of the earth. It's just so foundational to their identity and who they are that uh American brands, yeah, it's very hard to penetrate there. But but if you don't push the price too hard and you do the right social media marketing, there's Crocs with 30% year-over-year growth in China. >> Can can you work walk us through the uh the Crocs opportunity? >> Yeah. So, let me take a step back and and share a a picture uh because something kind of amazing happened in the market uh last quarter. And um so this graph is the spread between the realized move and the implied move. The normal outcome which has happened since the beginning of options trading is what happened to Nvidia last quarter. Last quarter Nvidia's implied volatility. So if you are buying the options, you're you're buying expensive options based on implied volatility, but the market expected Nvidia to move 9% on earnings. And then when the earnings call came out, Nvidia only moved 4%. So the realize was much less than the implied. That's the normal state of affairs since options were invented for all of the history of options is how it's been. And last quarter, for the first time ever, that flipped that on the average option, the realized volatility ended up being so much more than the implied. So for example, Crocs coming into last earnings, the implied volatility was 8 or 9%. And the stock sold off from $101 to 75. So the realized volatility was over 25%. And so the for the first time in the history of options, the people who buy options are on average making more money than the people who sell options. And that's never happened before. And maybe this is just a one-off. Maybe this will go back to mean reversion. or maybe this is a new structural part of our market um that you know these dips become so extreme when these sell-offs become just absolutely crazy. That that's one aspect. And then when I pull up the um pull up the Crocs uh price chart, you can see that here. So this last earnings call again. There's the it was $101 and then just crashes down to 75. And this was their highest revenue quarter ever. They uh they absolutely crushed it. But there was there was enough in there for the algorithms not to like. So there was a non-cash write down. There was a goodwill write down from their Hey Dude acquisition. Three years ago. Crocs did a bad acquisition. Um and they they overpaid. I think they spent $2.5 billion dollars for a a shoe brand called Hey Dude, which is sort of a a Jimmy Buffett oriented uh and it's a traditional shoe. it's got several different kinds of fabric. Whereas Crocs, these resin injected molded shoes, they've got 60% gross margin on those things. When you switch to having four different kinds of materials that have to be stitched together, the margins go way down. And also, you know, they are experts at social media marketing, but their social media marketing um I think they thought too highly of their expertise because half of it I think is that Crocs fit the modern world much better than Hey Dude. So, um I think I wrote about it in my Substack write up that there's this sort of pajamification of society that everybody's walking around in their yoga pants and their and their clogs now. And um so yes, Crocs are masters of social media marketing, but I think they accidentally had the right product for the time. And with the Haydude acquisition, you know, they're trying their social media marketing and it's not getting the right traction. But that bad acquisition was three years ago. And right now the the the whole company together is being just aggressively punished. And part of it um those non-cash write down. So you you when you write down goodwill and generally accepted accounting principles, it shows up as negative income. And if you if you actually think that's real income, even though no cash changed hands, you'd say that right now Crocs has a price to earnings of eight, right? Even this is showing 20. But if you actually look at the operating cash flow, it's trading at a price to earnings of four and a half. I mean, this is just an incredibly cheap company that's growing aggressively. They also guided for a week next six months in the US but everybody guided for a week next six months in the US because the consumer is squeezed and there's tariff uncertainty and there's uh you know interest rate uncertainty so every consumer brand across the whole country is guiding for a week six months in the US uh but then better after that. So um yeah, I I think the sell-off was overdone and then on top of that these this um new world where the realized volatility is so extreme, I think the only strategy to make uh to overcome that is to know what you own, have a lot of small positions and when a 40% dip or a 25% dip comes on earnings and you know it's a good company and you know what you own, then you can move quickly and grab on with both hands. And that's why my my theme for the writeup was uh the one that got away because I first found Crocs a couple years ago because of the insider behavior. And I didn't understand these these stupid ugly clogs. I just didn't get it. And I was at my uh pediatric dentist taking the kids to the dentist for a cleaning and there was a elementary school kid next to me for the their family for the dental cleaning and they were wearing Crocs and they were all covered with the charms. They call them jibbits. I like what's the deal with Crocs? I said, ' Everybody in elementary school is wearing them. Absolutely everybody. So 25% of Crocs revenue is elementary school kids. What's amazing about that is their feet grow. They need to they need to have new replacements every every year, every couple of years. >> What else is >> Yeah. >> constant demand. >> So um and then another thing that's amazing about it is um you know kids get bullied in school if they're not wearing the name brand, but the name brand is 45 bucks, so what does it matter? But then uh the customers who are fanatic about Crocs and it's almost a little bit like beer where in beer I think 50% of sales is your 10% of your customers and 80% of your sales is 20% of your customers. There are Crocs fanatics and the Crocs fanatics they'll do a dyed to match approach. So they'll have a they'll have a pair of Crocs to colorcoordinate every aspect of their wardrobe. So the super users in cro I think one of the reasons why Crocs is so underappreciated is because people that work in finance have to wear real shoes at work but then when they go home their wife and their kids are all wearing Crocs and I I think there's a certain amount there's just a hatred there. Let me go ahead and share this um quickly. So um there was a famous value investor Norbert Louu of Punchcard Management and at last 13F he has 17 uh.3% of his portfolio in Crocs and um and he bought it at over 100 bucks a share. So you can buy it now cheaper than he bought it. And the the hatred, the animosity on Twitter, you waited your whole life for Crocs and PayPal question mark question mark question mark. And as you scroll down, it's just for every one thing that says, you know, Crocs is a legit company, it's just, "OMG, laughing faces, death, skulls." Um, this is the reaction when somebody sees you, you buy so much. The company's trading at a price to earnings ratio of four, and there's nothing but ridicule for people who want to buy Crocs. It's just amazing at how hated it is. Um, so I just, uh, but I'll go to my writeup. And so there's a Reddit page as r/crocs where these super crocs users will share their wardrobes and it's just um let me share one of these. Uh this lady has hold on let me click the share button make it work again. That's uh 29 pairs of Crocs at 45 bucks a pair plus decorative jibbits and things like that. And on this r/crocs Reddit, these super users will go on there and say like, "Yeah, my, you know, when I'm at the mall and I don't want to leave empty-handed, I want to buy something, I'll just buy a pair of Crocs or they'll buy some of the charms to decorate the Crocs with." So, you got 25% of their sales is to children for elementary school, but I a huge amount is to adults. This is a massive uh housewife phenomenon because, you know, they they want to be comfy. They want to have some comfy footsies and they will dye to match. They'll color cord. They get one of every color of the rainbow and then some to match any possible outfit that they can imagine. And now suddenly you have uh somebody who's spending $1,500 on resin injected clogs with a 60% gross margin. And another thing that's fantastic about it is because um a lot of companies that I've dived into, they want to make uh DTC, direct to consumer marketing work. And direct to consumer marketing is hard to make it work unless you have a razor and razor blades kind of business model. Um otherwise if you advertise Google takes 40% or the retail store takes 40%. So it's kind of you know a lot of companies have tried to do DTC direct to consumer. Half of Croc sales are DTC. Half of Croc sales they just get to keep all the money because once you know your size and say you need a olive green pair to match your wardrobe, half of their sales are just shipped through the mail and so they don't have to pay Google for advertising. They don't have to pay the retail store for a markup. Um so you have 60% gross margins. These aggressive super users that want one of every color. These elementary school kids that um you know their feet are growing all the time. And one other amazing thing they did is they they now have these charms that you plug into the holes in the crocs they call jibbits. And what's amazing about that for elementary school is I think somewhere around 20% of public schools have school uniforms and kids hate that. Another 40% of public schools have a dress code that's categorized as restrictive. That the it's not a uniform but the dress code is extremely precise. And these elementary school kids, they're they're grasping for some way to express their individuality. And it comes out by going to the mall and paying 20 bucks for a five-pack of Scooby-Doo Jibbitz to put on your Crocs. So they found a way to get 20 bucks out of people at a time when they go to the mall to decorate their shoes, which is or or they will order them online direct to consumer and not have to pay those markups. So, this is an amazing company and if you look through the non-cash write down, it's trading at a price to earnings ratio of a 4 and a half to five. So, I'm I'm with Norbert Lou of Punchcard that you can have a a pretty interesting chunk of your portfolio in Crocs. >> Yeah. Full disclosure, I I hold some Crocs uh in accounts of match four and a half times earnings. It's uh not a lot's got to happen for that to go right. >> Yeah. Oh, it's it's it's so good. So, I Yeah. And the first time I found it, it was because of insider buying and I just didn't understand it. I just thought these are stupid ugly shoes. And you know, they are stupid ugly shoes, but they're stupid ugly shoes with a very dedicated group of super users that'll just uh buy one of every color all the time. Uh so, and growing 30% year-over-year in China. Who who can do that? Who accomplishes that? It's amazing. Uh let me let me go around the horn very quickly and then JT you want to do your uh >> Yes sir. >> Vegetables. Uh Pickic for Israel. What's up Tallahassee? Lewis Delaware. Uh pronunciation is always appreciated. Toronto Palestine. Hifa Israel. Jupiter Florida. Tampa Florida. Goththingberg Sweden. Sounds good. Valareereeso. Hav. It's a hard one to say. You might have to give me the pronunciation for that one. Vienna, Austria, Breenidge, Serbeton, Raita, Spain, Gard, Wales, Philly, Belleview, Gavir, San Diego, and uh over to you JT Bergenfield, New Jersey. Last one over JT >> Austria. Well, good day, mate. >> All right. Uh so today this segment is a play on words called bacons of truth. Not beacons but uh bacons. And you'll see why in a bit. And I want to take you on a journey across centuries from the closters of medieval friars in the 13th century to courtly halls of early modern England. And our topic is this timeless question. Why do human beings struggle so much to reach some kind of capital T truth? And it's as relevant today with Twitter threads and you know investment fads as it was back in the day of scholastic uh debates and royal decrees of the ancients. And we're going to learn about two remarkable thinkers both with the last name of Bacon which is quite curious. Uh and hence the this segment is Bacons of Truth. Uh and these two men were Roger Bacon and Francis Bacon. And no they weren't related and they lived about 400 years apart. Uh but they both tried to answer the same riddle. Why do we get truth so wrong so often? So we'll start in the 1200s with Roger Bacon and he was a Franciscan frier and he lived in a world dominated by scholasticism where theology was the queen of the sciences and Aristotle was this unchallenged authority and Roger wasn't anti-Aristotle exactly he was just suspicious of kind of blind obedience to any authority and so in writings in 1267 he identified what he called four obstacles to truth and we'll walk through them real quick. Uh so first is unworthy authority. Bacon argued that people leaned too heavily on authority figures, whether that was Aristotle or Augustine or, you know, whoever was considered the great sage of that moment. And the second was long-standing custom. Bacon noticed that tradition has a kind of hypnotic power. And just because a practice or belief has been around for generations, people treat it as then therefore true. Uh, and you know, like for instance, medieval medicine clung to Galen's, you know, humoral theory, not because it worked, but because it was old. Um, so you know they're they're bleeding you out uh to save you. Uh, think of how often the answer to why is simply because that's how we've always done it. So number three was popular opinion. Bacon warned against mistaking the consensus for the truth. Uh, he said just because everyone believes something doesn't make it correct. And fourth, the concealment of ignorance with a show of wisdom. This is a kind of a direct jab at scholars of his day who who papered over their ignorance with jargon and rhetoric. uh maybe speaking in Latin where the the ley couldn't understand. >> Host a podcast. >> Yeah, host a podcast. It's hard to hide your ignorance there. Uh so but so for Roger the the way forward was clear. You you need to experiment mathematics direct observation and he was really centuries ahead of his time essentially calling for the empirical revolution that wouldn't arrive until really the scientific method took root. So now let's fast forward to the early 1600s. Francis Bacon was the Lord Chancellor of England, a political insider, philosopher and he was wrestling with similar questions. So in 1620 he introduced what he called the four idols of the mind. These were false images, phantoms or illusions that distort our thinking. That that that type of idol. The first is idols of the tribe. These are errors common to human nature itself. We see patterns where none exist. Remember our segment we had a while back on periodia? Uh we exaggerate. We remember the evidence that confirms our beliefs and ignores the rest. Second, we're idols of the cave. This is these are your personal biases shaped by your upbringing, education, temperament. Uh each of us has kind of lived in our own private cave effectively. Uh and some of us, you know, are cautious, some of us are reckless um based on our experiences. Um third was idols of the marketplace. These come from language. Words are not neutral. They're slippery, ambiguous, often misleading. you know, we argue about words instead of realities. You know, debates about maybe freedom or justice are often turn into shouting matches because we haven't really clarified what we mean. Uh, and fourth, idols of the theater. These are errors inherited from philosophical systems or or ideologues. Um, so just like actors play these scripted roles, scholars play within the scripts of kind of their intellectual traditions. um you know I think you see that whatever reigning paradigm might be uh is is used instead of investigating the world they interpret it through some kind of pre-written script. So uh Francis Bacon's remedy for all this was a systematic uh new method careful observation inductive reasoning and the patient accumulation of facts which we all now call the scientific method and he was kind of the father of that. So how do these frameworks line up? They're both very suspicious of inherited wisdom. They both want the truth to be tested, not just accepted. They both anticipated in their own way actually modern behavioral science what um you know that human error isn't random. It's systematic. And if you merge Roger's obstacles with Francis's idols, you end up with something that that looks strikingly like cognitive bias framework. Centuries before Conorman and Tverki, the Bacans were sketching the same terrain, the way our minds systematically fail us. So, um, I'm going to skip some of this because it's already running long. Um, but besides the the the historical curiosity of two guys, both named Bacon, putting forth four frameworks, like four item frameworks that map onto psychological biases. Why does any of this really matter? Um, it's because I think the the pursuit of truth is isn't just about collecting facts. It's about disciplining the mind against its natural tendencies to error. Uh, you know, the the truth was was slippery in the 1200s. It was slippery in the 1620s, and it's slippery in your Twitter feed today. Uh, the Bacons remind us that human error is not an accident. It's a feature of how we think. And the question is whether we let those idols and obstacles rule us or whether we choose the harder path, which is testing, questioning, and humbling ourselves before reality. >> Good stuff. JT, did you uh did you land that one with the investment investment thesis? Uh what do you mean? >> Just just just generally be be uh be careful about the way you think. >> Oh yeah. >> Be careful behavior errors. >> Good stuff. >> Yeah. I mean I I had um I mapped a bunch of those the idols and stuff onto current day behavioral bias errors, but we were already running long, so I just decided to trash that. >> No worries. It was good stuff. Um do you guys know enough about the craft? what's happening with Craft Hinds to talk about it >> a little bit. >> What do you want to What's What's happening with We've We've had a few questions. Uh it seems like Berkshire has a grand strategy playing out in real time with Craft Hinds. >> Well, um we're in something like a spin-off wave, which I I think is welcome because uh you typically people know about economies of scale. You want to be bigger to have scale, but there's what's often overlooked is disconomies of scope. The more different kind of stuff you do, the worse you get at it. And there tends to be a pretty big conglomerate discount that companies that try to do too much, they get punished in their in their valuations, their multiples. So, Craft Hind wants to split itself into two pieces. And you saw um General Electric spit itself into three pe pieces and it's was welcomed by the market in those three pieces and now have much higher multiples than the parent company and are much more profitable. Uh Honeywell is in the process of splitting itself up into three pieces. XPO Logistics in the process of splitting it up into seven pieces. I think this is very welcome because we've had this massive wave I think pushed by zero interest rates to acquire all your competitors and the number of publicly traded companies from 20 years ago went from 9,000 to I think four and a half thousand. It's even it's hard to make a Wilshire 5,000 now because you can't find 5,000 companies. So, I think the spin-off wave is is welcome and timely. And I think it it is just even more evidence that the zero interest rate policy that they gave Bernaki a a Nobel Prize for was completely insane, had enormous unintended consequences. I think it deserves more more jail time than a peace prize. But, um, the Craft Hind they're splitting the company into two pieces. Um, and it's it's not that they're splitting craft and hinds. It's that they're splitting the grocery store kind of business with the the I think the more commercial kind of business, the more industrial scale business. And so like there's there's there's some craft on each side of the spin-off and there's some hinds on each. So it's a it's a strange splitting. I don't know if that splitting is a you know I know spin-offs in theory are welcome by the market. I don't know if the specific mechanics of that spin-off are are good or bad. And then I think um uh Warren Buffett uh had written that uh you know it because they didn't bring the vote to shareholders if they did it. They just started enacting it. And as a large shareholder I think he felt uh pretty uh abused by not having a say in the matter. Uh so that's that's all I can say about the Craftine spin-off. >> I have to recuse myself of this one because my wife works for one of the subsidiaries of Craftine. So, I I know I know too much. >> Well, that's good. I I don't have anything to add to that really, but that was a that was a good summary. Uh Buffett was Yeah, I Buffett seemed to me to be um upset about it, but ultimately >> disappointed was the word. >> Disappointed. Yeah. >> Yeah. >> Yeah. I don't know the details of the specific spin because I'm not a shareholder and I haven't dug into it. So, I I don't know if it's because he felt that company shouldn't split or that the way they're doing it is wrong or just that they should have asked him first. But I know he he was uh not happy about it. >> What happened to the private equity firm that uh has sort of engineered all of this stuff? Are they they still around? Are they still I mean I I imagine they're still around. Are they still putting stuff together like this? >> Well, I think 3G's been digesting a fair number >> previous acquisitions between the the Tim Hortons, um Burger King, uh yeah, the Craft Times. I mean they did a lot of stuff in kind of a relatively short period of time. So >> one of the big problems in private equity right now is is getting their exits. And you even see so private equity they usually have in their rules you're supposed to try and exit in five years and if you really need to push it you can exit in seven. And with this massive discrepancy between large cap valuations and small cap valuations. one of their exit strategies would be to IPO, but who wants to IPO when your industry is trading at four times earnings. So, um if we are on this new uh there have been these tiny little hints that we might be uh might be some sort of a rotation going on to to small cap value. And if that occurs, you'll see this enormous wave of IPOs as these pent-up private equity firms are able to exit. right now they're playing games and they're they're kind of some private equity firms are selling their stake back to the company and the company's paying for it with a convertible bond issued by the companion private credit fund. So right now they're just playing checkers with themselves. Um but if there's ever an opportunity when small cap valuation because and Tobias has been all over this uh for years and on social media historically small cap companies trade at a premium to large cap because you know just mathematically if you're small you can grow more and what's been happening is with particularly intellectual property sometimes economies of scale and also network goods. So these these large cap tech companies a network good has just fundamentally different characteristics and also the um you know uh market cap weighted ETFs and the the just the the um the indexed buying the large cap growth companies have become so much more valuable than small cap value. But if there is any rotation of small cap value you'll see this massive wave of of pentup private equity exits waiting to happen. And um uh >> kind of interesting though because they've you know a lot of the big pools of capital have redeemed the small and midcap managers who would have been the ones primarily who would have bought some of these IPOs. So when everybody's just an index you know mega cap indexer who's going to be buying uh you know random PE company XYZ that they want to take public >> it's not unprecedented in the data. There's something that I looked at uh cuz I posted there's a Yard Denny chart that shows the S&P 100 which is the largest 100 out of the 500. And we all think about the 500 as being super massive companies because we're small cap value guys for the most part. But even within the 500 there are clearly there's the same phenomenon continues to occur when you get closer to the 100 or the nifty50 in the 70s or the magnificent 7 now they're just getting peakier and peakier and you can track the performance of so I that the chart only goes back so far as to include the 2000 peak of the 100 over the 500 and the current peak of the 100 over the 500. So I went back to uh the French Ken French data and used the size uh series there and that's broken into deciles and so the largest decile is 178 companies which is bigger than 100 but it serves the same purpose and then if you take the top three deciles that's 535 companies so it's like it's equivalent to the 500 >> park >> and you can run that back to I think at least 1926 and it might be earlier than But there are very distinct peaks and every single one of these peaks is around a famous stock market peak. So there's 1929 is the first one in the data and then there's a 66 peak and uh there's there may be another one in there somewhere, but there's definitely a 2000 peak and then there's a 2020 peak which is now a foothill relative to the 25 peak which exceeds all of the others except for except for 2000. It >> exceeds 1929 as well. So >> 20 200 was still bigger the 100 versus 500. Wow. >> It was but you also have to remember there's this drift because small typically outperforms large. So there has been this drift since 1926 to the tune of8% compound a year for being in the 500 over the 100. It's just these when these peaks come up it destroys >> that sequence a little bit. And this peak started in 2014. It started breaking the >> the small cap >> the downtrend >> premium. >> Yeah. So it's 10 years in this peak which is the longest one that we have. They've none of them have had this like really slow build to this kind of peak. But if we look at 2000 it's currently it's equivalent to it being it's like October 1998 and the peak was uh something like May 1999 in this data. I know that doesn't map exactly to the to the stock market but this is the size. This is one thing I've noticed in the Schiller PE data too that the the the peak in terms of the Schiller PE doesn't match up to the peak in terms of the market. I think it starts rolling over before >> the market peaks. >> But the equivalent would be I think I I worked out that if this is 2000, if today is 20 thou, you know, an equivalent sort of peak, we're in like um we're like 6 to 8 months shy of the very highest peak. And so it would need to at the moment it's like 50 on this on this little chart. It's like it's a 50 and it needs to get to 52 >> to be equivalent to the 2,000 p. So it's close. It's not quite >> party on for a little longer. Is that what I'm hearing? >> 7 months room to run. >> Go bananas. That's who knows. >> It could be two quarters away from looking really smart for spending so much time in small caps. >> That's right. There's no there's no guarantees of course and it could be it could be years. So there's there's no reason why it has to match up, but it's just an interesting thing. I just >> it's uh Have you ever seen data on Japan on this one? Like in '89, was that big cap, too? >> I I haven't, but I assume so. I mean, it's it the current market over there is is a big cap market. It just I because I was I was searching for like what's the inverse strategy of what I've been doing, which is small cap value. And so I've been thinking >> it's called it's called winning, Toby. >> Yeah. Well, I don't know. I don't know how to do that. But I've been thinking like you want momentum, you want high profit growth, you want profitability. None of that works. >> Quality, all these other things. >> None of that works because what you need is market capitalization waiting >> and you just put more money into the biggest ones and you do better. And so like for quite a lot of the per of the time in the market, you look smarter just buying bigger stuff. So there's there's a good argument for just making a hyperconentrated nifty50 the nifty50 style, you know, strategy, but then ultimately you're wrong. Like you lose more money than you're going to be down. You don't you don't make money, but you go for long periods of time looking like you're not doing >> run an arc or something like that. >> Almost a whole career. >> Yeah. Could be. >> With any luck, we get to run the other way. What do you think, Steve? you got a any views on on that phenomenon? >> When does the pain stop? >> Yeah, that's all I want to know. >> It it it feels like it's so overdue and um I mean one possib So there's so much money in these passive ETFs if if the money's in the MAG 7 ETF then even if so right now it feels like and I could be easily wrong but it feels like Nvidia on its last earnings call they they hit all of their targets, right? But they they didn't surprise to the upside. And once a growth trap stops surprising to the upside, then look out below. And also uh there was the announcement between OpenAI and Broadcom to make AI chips. So now Nvidia's losing a monopoly veneer and they stopped surprising to the upside. And at at a $4 trillion market cap, you know, a 25% selloff is a trillion dollars. But I don't know if that money is going to rotate into the other aspects of the MAG7. Maybe Tesla starts looking shiny and new at the same time to absorb some of those inflows or does that money get recycled into the S&P 500. So I I don't know what it's going to take for that money to find small caps. And is absolutely right is somebody has to be buying it and even the active uh even the active managers a lot of I think more than 60% of active money is algorithmic. So the small caps have to do something that looks good to the math equations. And one aspect of that is going to be interest rate cuts. So large caps have a lot of fixed debt. Small caps have a lot of floating rate debt. And that floating rate debt, you know, obviously it won't change eB, but it'll change net income. So uh you take a company like um Sleep Number, the mattress company. I I have a write up on my Substack about one of their competitors, Purple. Somebody posted online, what stock do you own that you're the most ashamed of? And I put my write up for Purple the the mattress company because it it has a lot of fundamental things for it that's really interesting. But Sleep Number their floating rate debt that right now their profitability is so thin that just the one percentage point of interest rate cuts would double their profits and doubling profits is something that algorithms would get excited about. >> So you could see a lot of that just coming from interest rate cuts. Um there is also the smaller cap companies in this world of new tariffs. um a lot of them from earnings calls they've said well we can change supply chains we do have room to increase manufacturing capacity here so you're going to see you know some of the larger competitors um they can't really divorce themselves from doing manufacturing in Vietnam and China and some of the small caps they can get around the tariffs by manufacturing here so I there is a really good chance um and this uh so uh there is also the artificial intelligence about who's going to become the ultimate artificial intelligence beneficiary. And if you take uh a I have a write up on United Natural Foods, UNFI, who is the uh you know, a distributor of natural foods. So they're they're the um they're the wholesalers. This is massive thin margin business. They $30 billion of revenue, 1% profit margins. But if they can get some efficiencies from artificial intelligence, it's much much easier for them to go from a 1% profit margin to a 3% profit margin than it is for a lot of large companies to, you know, take a company like um like Apple. How can they triple their profits? Well, not as easily as United Natural Foods could implement some AI tools and triple their profits. So, there is there is a world where artificial intelligence ultimately benefits uh small and midcap companies. And then once it gets momentum, all the momentum strategies are going to keep on pushing what's working. One of the problems is small caps haven't been working. So momentum keeps it not working. And once that elastic gets pushed so far down, you know, if you start having a trillion dollars come off of Nvidia and earnings in small caps are growing because of implementing AI tools and because their sofur plus debt is now cheaper. Um there's there's a world where we all look really smart in nine months. >> It's a good narrative. >> I love it. We'll have you back. take a victory lap. >> Uh Steve Farington, um unemployed value DGEN on Twitter and Substack. Thanks so much for joining us today. Folks want to get in contact with you or uh follow along with what you're doing. What's the best way to do that? >> Yeah, so uh Substack is is my main thing. I I have a newsletter. I give away a lot of free samples. I I believe in free samples, but I put some paywalled content and I charge uh $7 a month, $70 a year. I'm trying to, you know, trying to focus on growth and just like Portillos and Crocs, I believe in that everyday value. Um, so I'm I'm I'm I'm smoking my own brand. Um, yeah, and I I'm I'm I'm active on Twitter just as uh for chatting, but I everything I post I post on Substack. >> That's awesome. Uh JT, any final words? >> Nope. Good to go. >> Thanks, folks. Uh we'll be back same time next
Unemployed Value Degen Stephen Farrington on small cap stocks $PTLO and $CROX | S07 E31
Summary
Transcript
I think we're live. This is Value After Hours. I am Tobias Carlile joined as always by my co-host Jake Taylor. Our special guest today is Steven Farington. He is unemployed Value Den on Twitter and Substack. Welcome Stephen. How are you? >> Oh, I'm I'm fantastic and I'm I'm a huge fan. So, I'm going to try not to fanboy out too hard here, but uh but yeah, it's very grateful for the opportunity. You're welcome. Um, your focus is small cap value. Take us through a little bit about your philosophy and, uh, your history, how you got to this point. >> Yeah. Well, um, small caps, uh, I I feel if you're looking for value, the best thing is to go where the mispricing is the most extreme and then sometimes the mispricing lasts so long um that, uh, you know, even after the fundamentals have improved, the prices still haven't adjusted. Um, so it can be a little frustrating. I've learned over time that the a lot of things that are are cheap really turn out to be more cyclical. And so knowing what I know now, maybe I'd be the uh the the cyclical degen, but there's just a lot of things that have huge enormous cyclicality. And you know, at the bottom, people are saying, "Oh, this is obsolete. It's going away. We're not going to be doing this anymore." And then a year later, it's the price tripled or 5xed or something like that. So, um, yeah, I love the mispricing in small caps, but if I was smarter, I would, uh, for my writing, I would go up market cap a little bit because every time I write about a midcap, it gets about 10 times the attention. So, it's it's not a smart business strategy to focus on small caps. >> Yeah. You want to you want a Tesla blog or a Tesla Twitter account that way you have millions of followers. >> That would be fantastic. >> So, tell us a little bit about your philosophy. How do you identify undervalued small caps and what are you looking for? >> Oh, so it's very hard to be a generalist because every industry has their own metrics that matter. So every time you try and crack into a new industry, um you're you're really grasping in the dark. Um I I have gravitated more towards price to sales than price to earnings because there's just so many accounting tricks people can use to manipulate earnings. it's much much harder to manipulate uh sales and revenue. Um but uh um one of the first places I look and and um this ties into my background a little bit. So I I did um I was a former professor. I've I've been through all the classes for the PhD program and I've had way too much math. And uh I really love insider buying, but when you speak to people that do the multivariate regressions, they say, you know, that doesn't add anything to the model. And one of the problems with the people that use huge data sets is they always assume that more data is better. And sometimes the parsimonious model is the best one. If you take all insider behavior, you've got a lot of noise in there. you've got um you know, for one thing, just forget about the the insider sales because most of the time uh most of the time you're dealing with management who considers that part of their salary and selling is what's supposed to happen. And you have other times there was a a Scandinavian company, I remember the CEO sold half of his position and and the market was was terrified about it. He even came out with a press release. He said, "Sorry guys, I'm going through a divorce. I still believe in the company." Um, so just forget about the sales and look at the buys. Uh, because there's only one reason why, um, somebody that works at a company is going to buy stock in that company. And even then, um, I ignore the directors most of the time. Sometimes I'll check out the biographies of the directors and see if they really have, you know, good experience that industry, but I would ignore the insider buying from independent directors and even the the chief executive officer. So uh one of my PhD adviserss this was her area of research and um uh chief executive officers uh if you look at him uh there is an advantage to managing a company with a chief executive officer who is consistently wrong but he's biased optimistically. So, if you have a CEO that says, you know, next year we're gonna have full self-driving and next year we're gonna have full self-driving. >> Who are we talking about? >> Next year we're gonna have full self-driving. So, CEOs that are consistently wrong but are wrong u overshooting their estimates, their engineers produce more patents per engineer. >> So, they believe it's possible. >> Huge advantage to leadership. >> Yep. You got to make people believe. So, CEOs have to make people to believe. And in making people believe they believe. So I love to ignore CEO buying and director buying and I go straight to the most pessimistic bean counters. I want to see when is the CFO buying and even better when is the general counsel buying? Because you take the most pessimistic people in the building that have all the information to know where all the bodies are buried and know where all the risk is. And if I see a chief financial officer take $300,000 out of their checking account and buy stock in a company and I see the general counsel take $200,000 out of their checking account and buy stock in the company, then I'm engaged. I'm So maybe on average insider behavior is noise, but within that noise is a lot of signal. If you know that the parsimmonious model is sometimes more more correct. So that's insider behavior is maybe my my most favorite screen especially for being a generalist and not knowing so many so much about every industry. >> I'd be curious if you could move that to even the like treasurer or the comproller because it's like okay the cash is real. >> Yep. Exactly. And chief operating officers are pretty good too. But you just have to know the CEO he can he can be wrong. He can believe he can drink the Kool-Aid. And directors they could be doing a better job. But um but there is there is real hard kernels of data in the insider behavior and it has has worked out well for me in the past. >> I think that's a I think that's a pretty clever hack actually because as a former general counsel I can confirm that the CFO and the general counsel are the most pessimistic guys in the building. >> If they're buying I I'll just take a flyer and punt on it and buy some as well. If I see a company with both with those two at the same time buying. I think that recently happened to one of the companies I was going to talk about today. I'd have to double check. Um but yeah, no that I was going to talk about two stocks today, Crocs and Portillos. >> And Portillos, you had big inside buys by the CFO and the general counsel at the same time and large for the size of the company. >> Well, let's talk about Portillos first. We'll come back come back to Crocs since we've started along that line. >> Toby, have you ever eaten eaten at a portillos? >> I have not. No. >> Is that a Is that an East Coast thing? Are they on the West Coast? >> It's a Chicago native restaurant. >> Yeah, so a Chicago native. They even have uh they even have a special called the Leo for the new pope who's from Chicago and uh and enjoys Portillos. >> Um so Portillos is a fast food chain. Their their market niche is interesting. So they're going for everyday value. So while McDonald's was trying to sell $9 cheeseburgers, you know, Portillos was um they're they're trying to capture the everyday value market to make sure that their food is high quality and affordable. And um I it's kind of where to start, where to untangle this thing because it's such an amazing business. I remember before I had ever looked at a restaurant, I had just seen the statistic that Chick-fil-A, you know, crushes all the competition because they do 7.5 million dollars of revenue per location. And you see, well, Chipotle does, you know, five million revenue per location. McDonald's does three and a half million of volume per location. A restaurant like Crystals will do like a million dollars. Something like a uh not a Dunkin Donut. So like a BaskinRobins or a Crystals is doing like a million dollars of revenue a year per location. >> Yeah. Subway is like way down there. >> Yep. Subway is way down there too. Subway had the they have now have the problem they got bought out by private equity who now wants to sell a a $13 sandwich and the quality hasn't improved. >> $13 sandwich doesn't sound as good, does it? Well, I I was at a conference with my wife and it was on the beach and I I thought, "Oh, well, maybe this is just beach pricing." I talked to the staff there like, "No, no, all Subways are like this now." So, $13 a sandwich everywhere. I'm like, "What? What are you doing? I'm going to buy >> Thanks, Jerome. >> You can't charge more than a dollar an inch. That's that should be put in the constitution. >> I'm gonna I'm gonna leave that one alone." >> Oh. So um Portillos is going for the everyday value market and uh when the founder of the company sold it, so he sold it to a private equity firm. He didn't sell it to the highest bidder. He sold it to someone who promised we're going to maintain this culture. We're going to maintain this value. It's going to be an everyday value business. You know, it's not we're not going to jack up the prices. And I the the founder of the company sold it. They only had 50 restaurants at the time, sold it for a billion dollars to private equity, who took it public and um has been trying to grow it aggressively. So, um now where to start? So, I told you Chick-fil-A does about 7.5 million per location. A portillos in the Chicago area does about $10 million a year in revenue per location. And Chick-fil-A has an average ticket size of about $15 a person. Portillos has an average ticket size of $11 a person. So, think of Chick-fil-A on a Saturday and how busy it is. And then think that Portillos is going to have about 40% more people than that. >> And it's just enormous massive amounts of volume. >> And the menu. So, they they they do have in restaurants. The bigger the menu, the more likely you have waste or spoilage. They have an enormous menu, but they're able to keep it moving with that much volume. So, they're doing uh a Portillo's location will do $600,000 a year in salads. I think Sweet Beans is only doing about 2 million in salads. So, it's it's just this have something for everyone, right? They've got their kind of signature item is the hot Italian beef sandwich, but they have milkshakes. They have, of course, they've got Chicago hot dogs. They've got hamburgers. They've got a nice selection of salads. And they serve beer, so it's it's fast food. There's no tipping. It's adamantly no tipping. It doesn't ask you for a tip. It'll never ask you for a tip because they want to be everyday value. But the inside is decorated like an Applebee's or a Chili's. So, it's like a sit-down restaurant, but you bus yourself and there's no tipping. So, and it and they serve beer. So, for me, it has this fantastic market niche I think is very attractive. Um, and at the same time, um, uh, the the customers get absolutely hooked on it. So, um, there is a concept in marketing for brands called a net promoter score, which is how likely you are to recommend this business to a friend. and Portillo's crushes all competition on net promoter score. And I I lived this firsthand because I hadn't heard about the company was a former professor and one of my students uh his girlfriend was doing a master's degree in Chicago. And this student of mine, he texts me out of the blue. I I swap phone numbers with about four or five excellent students. If I was smarter, I would have done that with a hundred students, but I was only smart enough to swap phone numbers with about four or five excellent students that were really going somewhere and making things happen. and he texts me out of the blue and says, 'You have to try Portillos. And this is a student. So he he graduated in two years. He was the most ambitious student I've ever met in my entire life. And we had never had a conversation about anything other than business, right? There was there's no non-b businessiness. And I I asked him like, "Has your account been hacked? What is going on?" Texting me out of the blue. What do I tell? >> And um no, the net promoter score of this company crushes everyone. If you have this simple one question survey, are you going to recommend this company to a friend? The answer is yes. And in a world where Google just takes all the profits and ad revenue in a in a world where marketing is just so hard to reach people, having that word of mouth that that is real and effective, I think does matter. And it it does take some time for these restaurants to become more established. But one of the big criticisms against Portillo's and I think the the bearish take on it is this can't work outside of Chicago. And to me that's shocking because Chicago has always been one of the choicest test markets of the country because their demographics are so diverse. If it can work in Chicago, it can work everywhere because they have black, they have Hispanic, they have white, they have everything. It's always been Chicago is the test market. And now there's this weird narrative on Portillos that it can work if they don't know if it can work outside of Chicago, but um uh they did expand to Arizona. They've got four restaurants in Arizona about 10 years ago and those are doing the same volumes as Chicago, but recently they've expanded to Texas. They've had a bit of a hiccup. So they're their chief marketing officer got poached. Their chief marketing officer got poached to be the CEO of Jordano's Pizza. So, on this big roll out, they're doing this huge roll out without a chief marketing officer. And so, they've had some near-term stumbles and the market's not believing it. Um, and I think that's all short-term noise. This is the one of the most amazing companies I want to own a piece of. Um, they opened their first location in Texas in Dallas, and it was in the same shopping plaza as Warren Buffett's Nebraska Furniture Mart. that first location in Dallas in its first year. Keep in mind, your average Chick-fil-A that's so packed on Saturdays and has the line that outside the the that's shutting down traffic because it's leaking onto the highway. Um, that is $7.5 million of revenue a year. The first location in Dallas did $17 million in revenue its first year. And the management on the earnings call said it almost broke the store. This is is ridiculous. So, they they kind of did a a hub and spoke. They opened five more locations to try to siphon the traffic away from this location next to Nebraska Furniture Mart. And it did. It did siphon the traffic away, which it was supposed to. But now in their data, you look at the 2023 cohort and people say, "Well, why did traffic fall in the 2023 cohort?" >> Well, because it was intentional because they had to siphon some traffic off of You can't have one fast food location do $17 million of revenue a year. It just breaks the whole system. It's just it's just nuts. But there's so much I like about the company. They've got a great management team. They're iterating quickly. They're experimenting to try and figure out what works. So, they're just launching breakfast options now in Chicago. So, you're already doing $10 million of revenue a year. They could start including breakfast on top of that. I mean, that's just just absolutely amazing. Um uh so they're they're going to see does it work? Does the market like it? I think when you have a new chief marketing officer in there to handle the store launches a little bit more appropriately. Oh, and um in March of this year, they just launched a uh membership rewards program to get people to sign up and download the app. They got in the first six months of this membership program 1.9 million reward members. They only have 86 locations. They have 86 locations and they have 1.9 million rewards members. That's over 20,000 rewards members per location. Chipotle only has 5,000 rewards members per location. Like the the customer base of this company is so fanatic that you know on my write up on Substack, every paragraph I interspersed, you know, how do you how how can you tell if somebody knows uh somebody eats at Portillos? And don't worry, they'll tell you. Um, so I did uh >> going to Harvard and Portillas. >> Yeah. So, um, and then I I have to ask myself, so why is the market sleeping on this? I always want to know if the price is wrong, why is it wrong? And part of it is just this false narrative that they can't be successful outside of Chicago, which I think Arizona and Dallas has proven they can be successful outside of Chicago, but for some reason this narrative has taken hold. Uh but the other one is I think um it's it's kind of like the story of Pelaton, right? You the people that work in finance have to use the product and they haven't opened a location in Manhattan. I think if they opened a location in Manhattan, the price to earnings ratio would go from, you know, 10 to 40 because suddenly people that work in finance would try the food. >> But they're they're focusing on some belt growth. Um but uh yeah, I I think um most of the successful restaurant fast food chains that are fetching, you know, five times price to sales, seven times price to sales, they open a location in Manhattan, so people that work on the stock market can try the food. Um and I I think that makes all the difference. It works for Pelaton. It works for a lot of these, especially high-end luxury consumer brands. >> Um can you walk us through the valuation of Widmouth? >> Yeah. So um >> Steve, sorry. >> Yeah. So um right now there's another reason the stock might have sold off. So the private equity firm that bought it originally for a billion dollars, they have been slowly uh exiting. So they've been taking their limited partnership uh LLC units and selling them in the market. And when it does that, it looks like dilution. It looks like the share count is increasing because the the LLC shares that were off the market weren't considered in the float and that that sales process is almost over now. I think they only have one or two% left that when they went public they kept around 50% and then over time they sold into the market and that's >> how did that show up as like minority interest or something like that? How was that captured? Yeah, it's just um I there's another company that was like this, Finance of America companies, and I'm my memory's uh it's in the 10K, but it's not in you know your standard. >> It's in the notes, not in the >> Yeah, it's not in the Yahoo finance numbers. It's not in the Finn viz numbers. It's not whatever data sets they're pulling for this information. It it's fooling the retail investor or the any uh algorithmic investor that they're diluting, but they're they're not diluting. They're growing through mostly through cash flow and um and al a little bit through debt because they wanted to um they only had 87 locations. They're opening 12 this year. So they're trying to grow aggressively. Um so price to sales is 68 right now. I think Chipotle's price to sales is five or seven. It's just uh outrageous. Price to book is not super accurate because they have some very old locations and some of those old locations they own the land. So you've got a lot of depreciation price to book uh with older assets that can throw off. Um and price to earnings uh price to earnings can get thrown off by this huge capex. You've got 87 locations. You're opening 12 more. There's this enormous capex affecting earnings. So price to earnings right now is at 14 and a half, but again that's you're doing this enormous buildout of locations. Um, so I', for this one, I'd focus on price to sales. And if the market starts believing, um, then I think that's going to go from 68 to three pretty quick. Um, and then, uh, yes, they really just need a new chief marketing officer that's on his game to come in and take this rewards membership program and have some fun with it and, uh, and to pay a little more attention to their new new opening launches. And also, you're just in a tight time right now for restaurants. So a lot of restaurants are missing earnings and missing comps. So you have restaurants generally are having outflows and some of those are undeserved. So two of the two of the darlings in the restaurant space, Cavas and Sweet Greens, they focus their expansion on the Washington DC area. So you look at year-over-year comps for Cava and Sweet Greens, and it's just through the floor, but Trump laid off all the government contractors in Washington DC where they launched their initial expansion in the first place. So restaurants are struggling right now, right? The consumer is a little under pressure and you have um this is just across the board every earnings call you listen to, you know, the the consumer is more choiceful, the consumer is under pressure. I think that's all going to go away once we um so this is a little off topic, but um mortgages the way you know as opposed to interestonly debt, mortgages are taking money out of the system every month. Every time somebody makes a mortgage payment, you know, the money supply is shrinking, debt is decreasing, and that person individually is saving. Once mortgage rates are 5 and a half% for a 30-year mortgage, and you have home equity loans pick up, a lot of people, and Home Depot and Lowe's are big on this in earnings calls, everybody's putting off the major projects because they want a nice, attractive home equity loan rate to put in a swimming pool. Once the money is flowing through the system that you know just enough home equity loans to offset the natural behavior of mortgages pulling money out of the system then that money is going to work its way through the economy. People are going to be a lot less choiceful and everybody's going to have more money in their pocket. So is really is there's a lot of um negativity out there. You know what's what's 50 basis points of interest rate cuts going to do? And I think it could have a huge effect on home equity loans and building swimming pools and putting in a new deck and redoing your kitchen. Then all that money is going to circulate through the economy, you know, and this uh consumer choicefulness, I think, is going to go right out the window once that money starts moving again. So, I think it's a great time where restaurants are hated and the sector has outflows and you're buying this thing for the market cap right now is 495 million. So when the founder sold it to private equity for a billion dollars, it only had 40 locations. So you're buying it now for half the price with twice as many locations. So it's about a fourth of the price as when private equity first bought the thing originally. Um I'm I'm pretty locked in. Portillos is one of my bigger positions. >> Was this Was this the one that that somebody asked Buffett about this at the last meeting? Like there was a Portillos that showed up in the >> Do you know what I'm talking about, Jake? Yeah, I >> but it was something else like they they were off on it. >> Yeah, I I missed the I missed the last uh meeting. My my one I know this is the temple of Warren Buffett. My one take was I was going to talk more about on uh Crocs. If we're pivoting to Crocs, um Crocs had 30% year-over-year growth in China and American companies are just notorious at not being able to penetrate China. And I think the the recipe for why they're so successful is because uh Warren Buffett was asked about this during the the Craft Hind acquisition and he was asked about why not all these other consumer staple companies and the topic moved to aren't they just charging too much? You know, you've got for example in Nabiscoco crackers the the white label box of saltine crackers is $150 and Niscoco is charging four bucks for a box of crackers. Aren't these markups just just too much? and uh and Warren Buffett was coming down pretty hard on the side of yeah their their brand is powerful but they're pushing too hard. Crocs is the the name brand for these kind of resin injected clogs and they only charge $45. And I think if they were pushing for like $150 or $125 for the name brand clogs, they wouldn't have 30% year-over-year growth in China. When somebody's asking themselves, should I go with a knockoff or should I go with the name brand? Well, if your name brand isn't pursuing those aggressive margins, if your name brand is going for a reasonable price, there's no reason to go for the knockoff. And and Chinese people love to go for the Chinese competitor. There's this huge stickiness culturally in China, like a it's like an old by American campaign, but it's not even necessarily pushed so hard by the government. There's an old sociology political science paper that tracked after how many generations does an immigrant become indistinguishable from the native population. And for most immigrant groups, it was one generation. For most immigrant groups, if your kids grow up here and go to college, then they're indistinguishable. The way they vote, the way they behave, you can't tell the difference. For Chinese immigrants, it's more than three generations. So unless your great-grandparents were building railroads in California, the cultural stickiness of the Chinese is just so powerful and so strong. So every American company that goes to China has such enormous difficulty penetrating that market. And there's Crocs with 30% year-over-year growth. And last quarter, they just flipped to 52% international, 48% US. There's an enormous international growth story. And they're crushing it in Korea and they're crushing it in Japan. And it's a combination of, you know, they're really good at social media marketing, they get the right influencers to wear their shoes, and they don't push the price, 45 bucks for a pair of clogs. Why would you want the knockoff if the name brand is is reasonable? >> What is it about the Chinese culture that has a more stickiness? >> Oh, I mean, it's it's it's kind of central to it, you know? It's I mean, the French is a little bit similar. Uh but the Chinese take it to a whole another level. Like the whole concept of the the symbol for China is that uh the line with a little circle in the middle it stands for the middle kingdom. That's a way of saying the center of the earth. Like it's it's just inherent within. This is the center of the universe. The sun revolves around China. It is you know we are the best. And if we are the best, why would you not why would you want to change anything about yourself if you're already the best? So it's really, you know, foundational to the whole Chinese identity to be part of the Middle Kingdom to to be, you know, the the best people on earth. It's uh once upon a time I was uh my first 10 years of my career, I was a chef and a car accident sent me back to college. It was a fantastic car accident because I had a lot more to offer the world than a Bernay sauce. I I found myself working for a French chef in Honolulu and uh he would like at least twice a day he would go through the kitchen to tell everybody get everybody's attention and say this this is the best mustard. Do you know why this is the best mustard? Because it is French. And then he would just leave the room and he would do that at least twice a day with a different ingredient. And it was just that the the the sort of ethnosentrism of it all has always found it hilarious. But I think the >> Wasn't French's mustard American brand? >> No. No. He was talking about uh it was a whole grain uh stone ground djon. Yeah. Anyway, but but he would do that with a different ingredient at least, you know, three or four times a week. >> Um but Chinese take it to a whole different level. Just, you know, the middle kingdom, center of the earth. It's just so foundational to their identity and who they are that uh American brands, yeah, it's very hard to penetrate there. But but if you don't push the price too hard and you do the right social media marketing, there's Crocs with 30% year-over-year growth in China. >> Can can you work walk us through the uh the Crocs opportunity? >> Yeah. So, let me take a step back and and share a a picture uh because something kind of amazing happened in the market uh last quarter. And um so this graph is the spread between the realized move and the implied move. The normal outcome which has happened since the beginning of options trading is what happened to Nvidia last quarter. Last quarter Nvidia's implied volatility. So if you are buying the options, you're you're buying expensive options based on implied volatility, but the market expected Nvidia to move 9% on earnings. And then when the earnings call came out, Nvidia only moved 4%. So the realize was much less than the implied. That's the normal state of affairs since options were invented for all of the history of options is how it's been. And last quarter, for the first time ever, that flipped that on the average option, the realized volatility ended up being so much more than the implied. So for example, Crocs coming into last earnings, the implied volatility was 8 or 9%. And the stock sold off from $101 to 75. So the realized volatility was over 25%. And so the for the first time in the history of options, the people who buy options are on average making more money than the people who sell options. And that's never happened before. And maybe this is just a one-off. Maybe this will go back to mean reversion. or maybe this is a new structural part of our market um that you know these dips become so extreme when these sell-offs become just absolutely crazy. That that's one aspect. And then when I pull up the um pull up the Crocs uh price chart, you can see that here. So this last earnings call again. There's the it was $101 and then just crashes down to 75. And this was their highest revenue quarter ever. They uh they absolutely crushed it. But there was there was enough in there for the algorithms not to like. So there was a non-cash write down. There was a goodwill write down from their Hey Dude acquisition. Three years ago. Crocs did a bad acquisition. Um and they they overpaid. I think they spent $2.5 billion dollars for a a shoe brand called Hey Dude, which is sort of a a Jimmy Buffett oriented uh and it's a traditional shoe. it's got several different kinds of fabric. Whereas Crocs, these resin injected molded shoes, they've got 60% gross margin on those things. When you switch to having four different kinds of materials that have to be stitched together, the margins go way down. And also, you know, they are experts at social media marketing, but their social media marketing um I think they thought too highly of their expertise because half of it I think is that Crocs fit the modern world much better than Hey Dude. So, um I think I wrote about it in my Substack write up that there's this sort of pajamification of society that everybody's walking around in their yoga pants and their and their clogs now. And um so yes, Crocs are masters of social media marketing, but I think they accidentally had the right product for the time. And with the Haydude acquisition, you know, they're trying their social media marketing and it's not getting the right traction. But that bad acquisition was three years ago. And right now the the the whole company together is being just aggressively punished. And part of it um those non-cash write down. So you you when you write down goodwill and generally accepted accounting principles, it shows up as negative income. And if you if you actually think that's real income, even though no cash changed hands, you'd say that right now Crocs has a price to earnings of eight, right? Even this is showing 20. But if you actually look at the operating cash flow, it's trading at a price to earnings of four and a half. I mean, this is just an incredibly cheap company that's growing aggressively. They also guided for a week next six months in the US but everybody guided for a week next six months in the US because the consumer is squeezed and there's tariff uncertainty and there's uh you know interest rate uncertainty so every consumer brand across the whole country is guiding for a week six months in the US uh but then better after that. So um yeah, I I think the sell-off was overdone and then on top of that these this um new world where the realized volatility is so extreme, I think the only strategy to make uh to overcome that is to know what you own, have a lot of small positions and when a 40% dip or a 25% dip comes on earnings and you know it's a good company and you know what you own, then you can move quickly and grab on with both hands. And that's why my my theme for the writeup was uh the one that got away because I first found Crocs a couple years ago because of the insider behavior. And I didn't understand these these stupid ugly clogs. I just didn't get it. And I was at my uh pediatric dentist taking the kids to the dentist for a cleaning and there was a elementary school kid next to me for the their family for the dental cleaning and they were wearing Crocs and they were all covered with the charms. They call them jibbits. I like what's the deal with Crocs? I said, ' Everybody in elementary school is wearing them. Absolutely everybody. So 25% of Crocs revenue is elementary school kids. What's amazing about that is their feet grow. They need to they need to have new replacements every every year, every couple of years. >> What else is >> Yeah. >> constant demand. >> So um and then another thing that's amazing about it is um you know kids get bullied in school if they're not wearing the name brand, but the name brand is 45 bucks, so what does it matter? But then uh the customers who are fanatic about Crocs and it's almost a little bit like beer where in beer I think 50% of sales is your 10% of your customers and 80% of your sales is 20% of your customers. There are Crocs fanatics and the Crocs fanatics they'll do a dyed to match approach. So they'll have a they'll have a pair of Crocs to colorcoordinate every aspect of their wardrobe. So the super users in cro I think one of the reasons why Crocs is so underappreciated is because people that work in finance have to wear real shoes at work but then when they go home their wife and their kids are all wearing Crocs and I I think there's a certain amount there's just a hatred there. Let me go ahead and share this um quickly. So um there was a famous value investor Norbert Louu of Punchcard Management and at last 13F he has 17 uh.3% of his portfolio in Crocs and um and he bought it at over 100 bucks a share. So you can buy it now cheaper than he bought it. And the the hatred, the animosity on Twitter, you waited your whole life for Crocs and PayPal question mark question mark question mark. And as you scroll down, it's just for every one thing that says, you know, Crocs is a legit company, it's just, "OMG, laughing faces, death, skulls." Um, this is the reaction when somebody sees you, you buy so much. The company's trading at a price to earnings ratio of four, and there's nothing but ridicule for people who want to buy Crocs. It's just amazing at how hated it is. Um, so I just, uh, but I'll go to my writeup. And so there's a Reddit page as r/crocs where these super crocs users will share their wardrobes and it's just um let me share one of these. Uh this lady has hold on let me click the share button make it work again. That's uh 29 pairs of Crocs at 45 bucks a pair plus decorative jibbits and things like that. And on this r/crocs Reddit, these super users will go on there and say like, "Yeah, my, you know, when I'm at the mall and I don't want to leave empty-handed, I want to buy something, I'll just buy a pair of Crocs or they'll buy some of the charms to decorate the Crocs with." So, you got 25% of their sales is to children for elementary school, but I a huge amount is to adults. This is a massive uh housewife phenomenon because, you know, they they want to be comfy. They want to have some comfy footsies and they will dye to match. They'll color cord. They get one of every color of the rainbow and then some to match any possible outfit that they can imagine. And now suddenly you have uh somebody who's spending $1,500 on resin injected clogs with a 60% gross margin. And another thing that's fantastic about it is because um a lot of companies that I've dived into, they want to make uh DTC, direct to consumer marketing work. And direct to consumer marketing is hard to make it work unless you have a razor and razor blades kind of business model. Um otherwise if you advertise Google takes 40% or the retail store takes 40%. So it's kind of you know a lot of companies have tried to do DTC direct to consumer. Half of Croc sales are DTC. Half of Croc sales they just get to keep all the money because once you know your size and say you need a olive green pair to match your wardrobe, half of their sales are just shipped through the mail and so they don't have to pay Google for advertising. They don't have to pay the retail store for a markup. Um so you have 60% gross margins. These aggressive super users that want one of every color. These elementary school kids that um you know their feet are growing all the time. And one other amazing thing they did is they they now have these charms that you plug into the holes in the crocs they call jibbits. And what's amazing about that for elementary school is I think somewhere around 20% of public schools have school uniforms and kids hate that. Another 40% of public schools have a dress code that's categorized as restrictive. That the it's not a uniform but the dress code is extremely precise. And these elementary school kids, they're they're grasping for some way to express their individuality. And it comes out by going to the mall and paying 20 bucks for a five-pack of Scooby-Doo Jibbitz to put on your Crocs. So they found a way to get 20 bucks out of people at a time when they go to the mall to decorate their shoes, which is or or they will order them online direct to consumer and not have to pay those markups. So, this is an amazing company and if you look through the non-cash write down, it's trading at a price to earnings ratio of a 4 and a half to five. So, I'm I'm with Norbert Lou of Punchcard that you can have a a pretty interesting chunk of your portfolio in Crocs. >> Yeah. Full disclosure, I I hold some Crocs uh in accounts of match four and a half times earnings. It's uh not a lot's got to happen for that to go right. >> Yeah. Oh, it's it's it's so good. So, I Yeah. And the first time I found it, it was because of insider buying and I just didn't understand it. I just thought these are stupid ugly shoes. And you know, they are stupid ugly shoes, but they're stupid ugly shoes with a very dedicated group of super users that'll just uh buy one of every color all the time. Uh so, and growing 30% year-over-year in China. Who who can do that? Who accomplishes that? It's amazing. Uh let me let me go around the horn very quickly and then JT you want to do your uh >> Yes sir. >> Vegetables. Uh Pickic for Israel. What's up Tallahassee? Lewis Delaware. Uh pronunciation is always appreciated. Toronto Palestine. Hifa Israel. Jupiter Florida. Tampa Florida. Goththingberg Sweden. Sounds good. Valareereeso. Hav. It's a hard one to say. You might have to give me the pronunciation for that one. Vienna, Austria, Breenidge, Serbeton, Raita, Spain, Gard, Wales, Philly, Belleview, Gavir, San Diego, and uh over to you JT Bergenfield, New Jersey. Last one over JT >> Austria. Well, good day, mate. >> All right. Uh so today this segment is a play on words called bacons of truth. Not beacons but uh bacons. And you'll see why in a bit. And I want to take you on a journey across centuries from the closters of medieval friars in the 13th century to courtly halls of early modern England. And our topic is this timeless question. Why do human beings struggle so much to reach some kind of capital T truth? And it's as relevant today with Twitter threads and you know investment fads as it was back in the day of scholastic uh debates and royal decrees of the ancients. And we're going to learn about two remarkable thinkers both with the last name of Bacon which is quite curious. Uh and hence the this segment is Bacons of Truth. Uh and these two men were Roger Bacon and Francis Bacon. And no they weren't related and they lived about 400 years apart. Uh but they both tried to answer the same riddle. Why do we get truth so wrong so often? So we'll start in the 1200s with Roger Bacon and he was a Franciscan frier and he lived in a world dominated by scholasticism where theology was the queen of the sciences and Aristotle was this unchallenged authority and Roger wasn't anti-Aristotle exactly he was just suspicious of kind of blind obedience to any authority and so in writings in 1267 he identified what he called four obstacles to truth and we'll walk through them real quick. Uh so first is unworthy authority. Bacon argued that people leaned too heavily on authority figures, whether that was Aristotle or Augustine or, you know, whoever was considered the great sage of that moment. And the second was long-standing custom. Bacon noticed that tradition has a kind of hypnotic power. And just because a practice or belief has been around for generations, people treat it as then therefore true. Uh, and you know, like for instance, medieval medicine clung to Galen's, you know, humoral theory, not because it worked, but because it was old. Um, so you know they're they're bleeding you out uh to save you. Uh, think of how often the answer to why is simply because that's how we've always done it. So number three was popular opinion. Bacon warned against mistaking the consensus for the truth. Uh, he said just because everyone believes something doesn't make it correct. And fourth, the concealment of ignorance with a show of wisdom. This is a kind of a direct jab at scholars of his day who who papered over their ignorance with jargon and rhetoric. uh maybe speaking in Latin where the the ley couldn't understand. >> Host a podcast. >> Yeah, host a podcast. It's hard to hide your ignorance there. Uh so but so for Roger the the way forward was clear. You you need to experiment mathematics direct observation and he was really centuries ahead of his time essentially calling for the empirical revolution that wouldn't arrive until really the scientific method took root. So now let's fast forward to the early 1600s. Francis Bacon was the Lord Chancellor of England, a political insider, philosopher and he was wrestling with similar questions. So in 1620 he introduced what he called the four idols of the mind. These were false images, phantoms or illusions that distort our thinking. That that that type of idol. The first is idols of the tribe. These are errors common to human nature itself. We see patterns where none exist. Remember our segment we had a while back on periodia? Uh we exaggerate. We remember the evidence that confirms our beliefs and ignores the rest. Second, we're idols of the cave. This is these are your personal biases shaped by your upbringing, education, temperament. Uh each of us has kind of lived in our own private cave effectively. Uh and some of us, you know, are cautious, some of us are reckless um based on our experiences. Um third was idols of the marketplace. These come from language. Words are not neutral. They're slippery, ambiguous, often misleading. you know, we argue about words instead of realities. You know, debates about maybe freedom or justice are often turn into shouting matches because we haven't really clarified what we mean. Uh, and fourth, idols of the theater. These are errors inherited from philosophical systems or or ideologues. Um, so just like actors play these scripted roles, scholars play within the scripts of kind of their intellectual traditions. um you know I think you see that whatever reigning paradigm might be uh is is used instead of investigating the world they interpret it through some kind of pre-written script. So uh Francis Bacon's remedy for all this was a systematic uh new method careful observation inductive reasoning and the patient accumulation of facts which we all now call the scientific method and he was kind of the father of that. So how do these frameworks line up? They're both very suspicious of inherited wisdom. They both want the truth to be tested, not just accepted. They both anticipated in their own way actually modern behavioral science what um you know that human error isn't random. It's systematic. And if you merge Roger's obstacles with Francis's idols, you end up with something that that looks strikingly like cognitive bias framework. Centuries before Conorman and Tverki, the Bacans were sketching the same terrain, the way our minds systematically fail us. So, um, I'm going to skip some of this because it's already running long. Um, but besides the the the historical curiosity of two guys, both named Bacon, putting forth four frameworks, like four item frameworks that map onto psychological biases. Why does any of this really matter? Um, it's because I think the the pursuit of truth is isn't just about collecting facts. It's about disciplining the mind against its natural tendencies to error. Uh, you know, the the truth was was slippery in the 1200s. It was slippery in the 1620s, and it's slippery in your Twitter feed today. Uh, the Bacons remind us that human error is not an accident. It's a feature of how we think. And the question is whether we let those idols and obstacles rule us or whether we choose the harder path, which is testing, questioning, and humbling ourselves before reality. >> Good stuff. JT, did you uh did you land that one with the investment investment thesis? Uh what do you mean? >> Just just just generally be be uh be careful about the way you think. >> Oh yeah. >> Be careful behavior errors. >> Good stuff. >> Yeah. I mean I I had um I mapped a bunch of those the idols and stuff onto current day behavioral bias errors, but we were already running long, so I just decided to trash that. >> No worries. It was good stuff. Um do you guys know enough about the craft? what's happening with Craft Hinds to talk about it >> a little bit. >> What do you want to What's What's happening with We've We've had a few questions. Uh it seems like Berkshire has a grand strategy playing out in real time with Craft Hinds. >> Well, um we're in something like a spin-off wave, which I I think is welcome because uh you typically people know about economies of scale. You want to be bigger to have scale, but there's what's often overlooked is disconomies of scope. The more different kind of stuff you do, the worse you get at it. And there tends to be a pretty big conglomerate discount that companies that try to do too much, they get punished in their in their valuations, their multiples. So, Craft Hind wants to split itself into two pieces. And you saw um General Electric spit itself into three pe pieces and it's was welcomed by the market in those three pieces and now have much higher multiples than the parent company and are much more profitable. Uh Honeywell is in the process of splitting itself up into three pieces. XPO Logistics in the process of splitting it up into seven pieces. I think this is very welcome because we've had this massive wave I think pushed by zero interest rates to acquire all your competitors and the number of publicly traded companies from 20 years ago went from 9,000 to I think four and a half thousand. It's even it's hard to make a Wilshire 5,000 now because you can't find 5,000 companies. So, I think the spin-off wave is is welcome and timely. And I think it it is just even more evidence that the zero interest rate policy that they gave Bernaki a a Nobel Prize for was completely insane, had enormous unintended consequences. I think it deserves more more jail time than a peace prize. But, um, the Craft Hind they're splitting the company into two pieces. Um, and it's it's not that they're splitting craft and hinds. It's that they're splitting the grocery store kind of business with the the I think the more commercial kind of business, the more industrial scale business. And so like there's there's there's some craft on each side of the spin-off and there's some hinds on each. So it's a it's a strange splitting. I don't know if that splitting is a you know I know spin-offs in theory are welcome by the market. I don't know if the specific mechanics of that spin-off are are good or bad. And then I think um uh Warren Buffett uh had written that uh you know it because they didn't bring the vote to shareholders if they did it. They just started enacting it. And as a large shareholder I think he felt uh pretty uh abused by not having a say in the matter. Uh so that's that's all I can say about the Craftine spin-off. >> I have to recuse myself of this one because my wife works for one of the subsidiaries of Craftine. So, I I know I know too much. >> Well, that's good. I I don't have anything to add to that really, but that was a that was a good summary. Uh Buffett was Yeah, I Buffett seemed to me to be um upset about it, but ultimately >> disappointed was the word. >> Disappointed. Yeah. >> Yeah. >> Yeah. I don't know the details of the specific spin because I'm not a shareholder and I haven't dug into it. So, I I don't know if it's because he felt that company shouldn't split or that the way they're doing it is wrong or just that they should have asked him first. But I know he he was uh not happy about it. >> What happened to the private equity firm that uh has sort of engineered all of this stuff? Are they they still around? Are they still I mean I I imagine they're still around. Are they still putting stuff together like this? >> Well, I think 3G's been digesting a fair number >> previous acquisitions between the the Tim Hortons, um Burger King, uh yeah, the Craft Times. I mean they did a lot of stuff in kind of a relatively short period of time. So >> one of the big problems in private equity right now is is getting their exits. And you even see so private equity they usually have in their rules you're supposed to try and exit in five years and if you really need to push it you can exit in seven. And with this massive discrepancy between large cap valuations and small cap valuations. one of their exit strategies would be to IPO, but who wants to IPO when your industry is trading at four times earnings. So, um if we are on this new uh there have been these tiny little hints that we might be uh might be some sort of a rotation going on to to small cap value. And if that occurs, you'll see this enormous wave of IPOs as these pent-up private equity firms are able to exit. right now they're playing games and they're they're kind of some private equity firms are selling their stake back to the company and the company's paying for it with a convertible bond issued by the companion private credit fund. So right now they're just playing checkers with themselves. Um but if there's ever an opportunity when small cap valuation because and Tobias has been all over this uh for years and on social media historically small cap companies trade at a premium to large cap because you know just mathematically if you're small you can grow more and what's been happening is with particularly intellectual property sometimes economies of scale and also network goods. So these these large cap tech companies a network good has just fundamentally different characteristics and also the um you know uh market cap weighted ETFs and the the just the the um the indexed buying the large cap growth companies have become so much more valuable than small cap value. But if there is any rotation of small cap value you'll see this massive wave of of pentup private equity exits waiting to happen. And um uh >> kind of interesting though because they've you know a lot of the big pools of capital have redeemed the small and midcap managers who would have been the ones primarily who would have bought some of these IPOs. So when everybody's just an index you know mega cap indexer who's going to be buying uh you know random PE company XYZ that they want to take public >> it's not unprecedented in the data. There's something that I looked at uh cuz I posted there's a Yard Denny chart that shows the S&P 100 which is the largest 100 out of the 500. And we all think about the 500 as being super massive companies because we're small cap value guys for the most part. But even within the 500 there are clearly there's the same phenomenon continues to occur when you get closer to the 100 or the nifty50 in the 70s or the magnificent 7 now they're just getting peakier and peakier and you can track the performance of so I that the chart only goes back so far as to include the 2000 peak of the 100 over the 500 and the current peak of the 100 over the 500. So I went back to uh the French Ken French data and used the size uh series there and that's broken into deciles and so the largest decile is 178 companies which is bigger than 100 but it serves the same purpose and then if you take the top three deciles that's 535 companies so it's like it's equivalent to the 500 >> park >> and you can run that back to I think at least 1926 and it might be earlier than But there are very distinct peaks and every single one of these peaks is around a famous stock market peak. So there's 1929 is the first one in the data and then there's a 66 peak and uh there's there may be another one in there somewhere, but there's definitely a 2000 peak and then there's a 2020 peak which is now a foothill relative to the 25 peak which exceeds all of the others except for except for 2000. It >> exceeds 1929 as well. So >> 20 200 was still bigger the 100 versus 500. Wow. >> It was but you also have to remember there's this drift because small typically outperforms large. So there has been this drift since 1926 to the tune of8% compound a year for being in the 500 over the 100. It's just these when these peaks come up it destroys >> that sequence a little bit. And this peak started in 2014. It started breaking the >> the small cap >> the downtrend >> premium. >> Yeah. So it's 10 years in this peak which is the longest one that we have. They've none of them have had this like really slow build to this kind of peak. But if we look at 2000 it's currently it's equivalent to it being it's like October 1998 and the peak was uh something like May 1999 in this data. I know that doesn't map exactly to the to the stock market but this is the size. This is one thing I've noticed in the Schiller PE data too that the the the peak in terms of the Schiller PE doesn't match up to the peak in terms of the market. I think it starts rolling over before >> the market peaks. >> But the equivalent would be I think I I worked out that if this is 2000, if today is 20 thou, you know, an equivalent sort of peak, we're in like um we're like 6 to 8 months shy of the very highest peak. And so it would need to at the moment it's like 50 on this on this little chart. It's like it's a 50 and it needs to get to 52 >> to be equivalent to the 2,000 p. So it's close. It's not quite >> party on for a little longer. Is that what I'm hearing? >> 7 months room to run. >> Go bananas. That's who knows. >> It could be two quarters away from looking really smart for spending so much time in small caps. >> That's right. There's no there's no guarantees of course and it could be it could be years. So there's there's no reason why it has to match up, but it's just an interesting thing. I just >> it's uh Have you ever seen data on Japan on this one? Like in '89, was that big cap, too? >> I I haven't, but I assume so. I mean, it's it the current market over there is is a big cap market. It just I because I was I was searching for like what's the inverse strategy of what I've been doing, which is small cap value. And so I've been thinking >> it's called it's called winning, Toby. >> Yeah. Well, I don't know. I don't know how to do that. But I've been thinking like you want momentum, you want high profit growth, you want profitability. None of that works. >> Quality, all these other things. >> None of that works because what you need is market capitalization waiting >> and you just put more money into the biggest ones and you do better. And so like for quite a lot of the per of the time in the market, you look smarter just buying bigger stuff. So there's there's a good argument for just making a hyperconentrated nifty50 the nifty50 style, you know, strategy, but then ultimately you're wrong. Like you lose more money than you're going to be down. You don't you don't make money, but you go for long periods of time looking like you're not doing >> run an arc or something like that. >> Almost a whole career. >> Yeah. Could be. >> With any luck, we get to run the other way. What do you think, Steve? you got a any views on on that phenomenon? >> When does the pain stop? >> Yeah, that's all I want to know. >> It it it feels like it's so overdue and um I mean one possib So there's so much money in these passive ETFs if if the money's in the MAG 7 ETF then even if so right now it feels like and I could be easily wrong but it feels like Nvidia on its last earnings call they they hit all of their targets, right? But they they didn't surprise to the upside. And once a growth trap stops surprising to the upside, then look out below. And also uh there was the announcement between OpenAI and Broadcom to make AI chips. So now Nvidia's losing a monopoly veneer and they stopped surprising to the upside. And at at a $4 trillion market cap, you know, a 25% selloff is a trillion dollars. But I don't know if that money is going to rotate into the other aspects of the MAG7. Maybe Tesla starts looking shiny and new at the same time to absorb some of those inflows or does that money get recycled into the S&P 500. So I I don't know what it's going to take for that money to find small caps. And is absolutely right is somebody has to be buying it and even the active uh even the active managers a lot of I think more than 60% of active money is algorithmic. So the small caps have to do something that looks good to the math equations. And one aspect of that is going to be interest rate cuts. So large caps have a lot of fixed debt. Small caps have a lot of floating rate debt. And that floating rate debt, you know, obviously it won't change eB, but it'll change net income. So uh you take a company like um Sleep Number, the mattress company. I I have a write up on my Substack about one of their competitors, Purple. Somebody posted online, what stock do you own that you're the most ashamed of? And I put my write up for Purple the the mattress company because it it has a lot of fundamental things for it that's really interesting. But Sleep Number their floating rate debt that right now their profitability is so thin that just the one percentage point of interest rate cuts would double their profits and doubling profits is something that algorithms would get excited about. >> So you could see a lot of that just coming from interest rate cuts. Um there is also the smaller cap companies in this world of new tariffs. um a lot of them from earnings calls they've said well we can change supply chains we do have room to increase manufacturing capacity here so you're going to see you know some of the larger competitors um they can't really divorce themselves from doing manufacturing in Vietnam and China and some of the small caps they can get around the tariffs by manufacturing here so I there is a really good chance um and this uh so uh there is also the artificial intelligence about who's going to become the ultimate artificial intelligence beneficiary. And if you take uh a I have a write up on United Natural Foods, UNFI, who is the uh you know, a distributor of natural foods. So they're they're the um they're the wholesalers. This is massive thin margin business. They $30 billion of revenue, 1% profit margins. But if they can get some efficiencies from artificial intelligence, it's much much easier for them to go from a 1% profit margin to a 3% profit margin than it is for a lot of large companies to, you know, take a company like um like Apple. How can they triple their profits? Well, not as easily as United Natural Foods could implement some AI tools and triple their profits. So, there is there is a world where artificial intelligence ultimately benefits uh small and midcap companies. And then once it gets momentum, all the momentum strategies are going to keep on pushing what's working. One of the problems is small caps haven't been working. So momentum keeps it not working. And once that elastic gets pushed so far down, you know, if you start having a trillion dollars come off of Nvidia and earnings in small caps are growing because of implementing AI tools and because their sofur plus debt is now cheaper. Um there's there's a world where we all look really smart in nine months. >> It's a good narrative. >> I love it. We'll have you back. take a victory lap. >> Uh Steve Farington, um unemployed value DGEN on Twitter and Substack. Thanks so much for joining us today. Folks want to get in contact with you or uh follow along with what you're doing. What's the best way to do that? >> Yeah, so uh Substack is is my main thing. I I have a newsletter. I give away a lot of free samples. I I believe in free samples, but I put some paywalled content and I charge uh $7 a month, $70 a year. I'm trying to, you know, trying to focus on growth and just like Portillos and Crocs, I believe in that everyday value. Um, so I'm I'm I'm I'm smoking my own brand. Um, yeah, and I I'm I'm I'm active on Twitter just as uh for chatting, but I everything I post I post on Substack. >> That's awesome. Uh JT, any final words? >> Nope. Good to go. >> Thanks, folks. Uh we'll be back same time next