Gross Margin & Gross Profit Per Share as Predictors of Stock Price Performance
Summary
Core Framework: The guest emphasizes gross profit/margin as a leading indicator of business quality and future stock performance, often outperforming net income-based metrics.
High-Valuation Tech: Palantir (PLTR) is dissected for extreme price-to-sales multiples, government/AI exposure, and high gross margins, with caution on size and growth expectations.
Platform vs. Content: Contrast between Alphabet/YouTube (GOOGL) and Spotify (SPOT) highlights how content acquisition costs and bargaining power drive gross margin durability.
Cyclical/Materials Examples: Encore Wire (WIRE) and U.S. Lime (USLM) show how capacity utilization, commodity cycles, and pricing power can swing gross margins and re-rate multiples.
Turnarounds & Risk: Carvana (CVNA) demonstrates how improving unit economics and resolving near-term liquidity stress can drive outsized rebounds despite earlier cash flow strain.
Footwear Split: Extensive comparison of Crocs (CROX), Deckers (DECK), and Nike (NKE) underscores market expectations, brand momentum, and gross margin trends behind differing valuation multiples.
Beverage Lessons: Boston Beer (SAM) shows how mix shifts (e.g., seltzer) can boost revenue but compress gross margins and stall operating profits, capping valuation.
Transcript
Welcome, welcome, welcome. How's everybody doing? Hope you are doing well. My name is Andrew with Focus Compounding on Air live with Jeff Ganon. Jeff, how's it going today? >> It's going very well, Andrew. How's it going with you? >> It's going great. We hope it's going great with everybody else as well. If this is the first time you are tuning in with us, thank you so much for joining us. Uh, be sure to go check out all of our content that we push out into the investing universe. Best way to do that is to go to focuscompounding.com, click that blog section and have the ability to type in any topic that's on your mind and get access to information going all the way back to uh the early 2000s. Um, if you want to follow me on X, which is the best place to get everything that we push out regarding the podcast, you could do that uh by following me at Focuscompound. All the information is in the description below. So today's podcast, chef, I want to talk about um gross profits, gross margin, and almost their predictive ability on future stock price movements. Um not only that, but also on analyzing the business. Talk about different scenarios where you could have companies that look like they are uh left for dead. And it's cool. you could go back and look at and be like, "Yeah, you know, things looked a little bit on on edge here and that, you know, they didn't look so good." However, if you sort of go up that income statement, you could see that the overall business was improving, right, from a gross profit uh perspective. A lot of investors focus on gross margins. Um, but, you know, that doesn't always tell a case, right? Like you could look at a company like Amazon for example and say oh you know at a certain point in their their um you know history they had low gross margins um because they're just looking at that actual number um and it may not tell the full story. So um before we do that though Jeeoff we were talking about this um off air recently. Palunteer Technologies. Have you ever seen a company trade at a 118 times price of sales? Right. So, as a general rule, you always talked about look, you can go your entire investing career and be perfectly successful never investing in a company trading 10 times sales. So, what about something that's 10 times your uh, you know, general rule? Are you really playing with fire here? I mean, what's going on? Hey, I don't even know what this company does, right? It's sort of the black box. Government contracts, AI. Supposedly, the government can't run without it. You could put the tinfoil hat on and say, "Oh, Peter Teal and blah blah blah." Right? But, I mean, goodness, 116 times, >> yes. >> Sales, 118 times price of sales. What's going on here? Have you ever seen >> Yeah. Yeah, I don't think I've ever seen a chart that even calculated how many companies were selling above 20 times sales. That's the most I've ever seen is like tracking a bubble. 10 is what I've used, but you know, they'll sometimes be charts that are like, are there any companies over 20 times sales? Um, yeah, I've never seen it in the this is a $370 billion market cap. So, I've definitely never seen it with a big cap stock that it's been at this price. I mean, because you compare by revenue to other things and uh obviously they're much much smaller. They're much much bigger companies that are normally that size or the market cap of companies that have three billion in sales are often a lot smaller. You could if you kind of comped to what those are. This is not a large company that way. But, you know, some things do grow rapidly. We talked about Celsius on this podcast, you know, years ago. And that did grow rapidly. So, it kind of grew into being more the same size as uh what you would expect from a high price to sales. Um, this one does have really high gross margins. doesn't have super fast growth right now, but I guess it's expected to have super fast growth in the future. >> Yes, definitely. Yeah. And and and on the topic today, yeah, gross margins have improved. Um but, you know, it's like you're getting into this point now at at these valuation levels where it's like, okay, like what percentage of the economy is this company, you know, going to represent or like what could it grow into? And at some point, isn't there sort of a ceiling there or is this just like an infinite ham? Well, I mean I I guess the addressable market is any, you know, um well, it could even be beyond what I think. Um you know, it could I mean, no one would have thought an addressable market. You mentioned Amazon for that, you know, involved Amazon Web Services and stuff eventually. So, you can go into other things, I guess, for the technology that, you know, you didn't know you were going to originally, but yeah, it's it's big anyway because technology used by friendly governments and stuff could be huge. So, it could be big. Yeah, it's one of the top spending areas for most uh well, not most, but for it's a large spending area for several governments. >> Yeah. Are you familiar with their CEO at all? He's a bit of a sataric guy. >> One thing that stood out to me, one thing he said, he he doesn't drive, so he doesn't have a driver's license. And they asked him why, and he said because I was too poor and then I was too rich. So, he never got his driving his driver's license. Um but yeah, obviously large language models and they do a lot of stuff with the government and uh yeah, crazy though. Look at that. 119 times 118 times price of sales. So um >> yeah, but it does revenue growth you the revenue growth like yeah it's a lot but I mean it's not like it's 100% per year. >> No, it looks like a great it looks like a great business. Yeah, it has the right margins for for having really high gross margins and they went up for uh at small size and it has really good revenue growth. Um but you know we talked about so it looks like a FICO or something but we talked about FICO at one10enth the price to sales I thought was you know a lot. So but it it has the things that you would need which are very very high gross margins and increases in revenue without necessarily having to have increases in assets and things. So it it has a business model based on the numbers alone that would make it a really great business. Uh this one that we're talking about is just size issue. So that could be true for any of the ones we talk about. We can talk about how good or bad a business it is, but then there's the issue of how big can the business get. And those are two separate things. Some businesses can get really big but don't have the economics that they're going to make a ton of money. Some look like they'll make a lot of money but you don't know how big they'll be. um this price is just on a handicapping basis it's just hard to make the stock make sense even if the business shows quantitatively really attractive things which it does. >> So before we jump into gross profits I wanted to pull up a article that you had wrote uh back in 2012 from the Ganon archives um which obviously is on our website focuscon.com and you're talking about gross profitability matters more than most investors think. You said it's not necessary for a company to have high margins and certainly not pricing power to achieve truly remarkable returns on capital and it's definitely not necessary to have high net profit margin from the business's earliest days. But you do need some basic evidence of a strong business model and you say what is a strong business model? There are countless qualitative ways of looking at a business model. Gross profits divide by receivables plus inventory plus PP&E minus payables plus acred expenses. This number should start looking good and keep looking better pretty early in a company's history. Look, Amazon is an expensive stock and it's got low margins, but it also doesn't tie up capital in the business. >> Yeah, this is a long time ago. This is not this stuff isn't true anymore. The business changed from that. Yeah. So, it might be a much less attractive business in the future, but it was that was true at the time. So, when it was growing then, it would have been able to fuel a lot of fund its growth and everything. Now these companies today the you know it's a different story. The the Amazons, the Microsofts, the Metas they are investing huge amounts of capital which they weren't doing before. So they that changed but that article is from when the business different than they are today. >> It's it's a good way spotted earlier though is what I'm saying. >> Yeah. No, agreed. But I just mean the the the business models of all them might are changing dramatically. So they may no longer, you know, have very high gross returns on on the assets they have because they have a lot higher assets. Um they shifted from being like asset light and doing work for other people to investing in their own assets. Um which is fine. A lot of companies do that later in their life and their profitability declines, but obviously they funded themselves from the part where they had really high returns on capital. So >> So you've talked about like gross profit per share before as a um interesting metric to follow. Most investors don't follow that. So can you take us through, you know, your line of thinking there and and why that's something that you think people should track and what it means to the company? >> So in the long run, return on equity and things like that are really important to stock returns. And one reason that countries like the United States have historically had higher returns is how they are funded. So they're funded through retained earnings. The companies become profitable early on in their life. they are then um don't have heavy borrowings that they have usually and then they also don't issue a lot of stock once they're public. So they go public and people get rich on IPOs usually in the United States but once the companies are public they don't except issuing some stock to insiders all the time they don't fund their operations a lot through a lot of stock issuance um and you know borrowing a lot of money and issuing a lot of stock are kind of the two things that cause a problem in some places where the country has good growth but the owners don't get it. So like you take China or something. Great amazing growth for the economy and the workers who live there and everything but not necessarily great returns for people who just own stocks there as opposed to countries that have almost no growth because of that reason. And so you know Buffett talked about um ad agencies as a gross profit royalty. So what he meant by that is that basically advertising is funded out of gross profits. is kind of like a selling expense they would have, but you need to have a profitable business on that basis before you can invest in trying to grow the scale and all those things. And there are accounting issues about why this could be misleading because if you just focus on this but didn't really understand the business, things could look better or worse on gross profit because of how it's kind of calculated. We took an extreme example. I had mentioned FICO. We just looked at a stock. The gross profit thing is kind of complicated because there's probably almost no variable cost to them. So they invest in a platform of some kind to do something and then they basically probably are using most of the same thing for one customer after another after another. The investment is really in having a capability and then they're providing that capability to the customer and it would not radically change if they have one or 100. Now their selling expenses might they might need a lot more salespeople on commission doing this or that or whatever but like the actual direct cost of providing the service is is not high. So you invest in something and then you hope to sign up enough people right to like make it justified. So those are hard to judge as opposed to the ones that are more easier for people to imagine the gross profit is like your supermarket. That's very easy for people to understand. Okay, it has a 25% gross mark gross margin. That's because it's marking up this amount and then it costs this much to run the store. You know, that kind of thing. But it helps a lot with scale because early on in the history of a company, a lot of companies people will say are not profitable. Why are investors investing all this in this company that isn't profitable? But the business model looks like it is profitable, but it hasn't scaled up enough. And in some industries they might even seek for competitive reasons especially to try to grow even when it's kind of dangerous to do that um funding wise because they want to be no I mean like we talked about big tech things they felt they had to be number one that there wasn't going to be a lot left over number two three four so they have to get big fast to do that and there's other industries where it would be similar where they're concerned about competition splitting things up um and then there's other ones where they're just people really want to get rich really fast and they think the business model works and so they open up a lot of um new locations and everything before they actually show the profits from it. Um so and companies invest a lot in that all the time doing that. Um you know Buffett's talked about like Geico, they don't make money when they first sign someone up but they have good retention over a long period of time. Anything that you look at from a Home Depot to whatever probably when they first open the store doesn't make sense. But the the point is that it's not this year's earnings that they care about. It's that for the long term it makes a lot of sense. Um and so when you can analyze that other ways besides the financial statements but if you're going to do it in the financial statements the best way is to look at gross profit. Um the other way is to understand the business model the kind of like uh you know store level economics and all that kind of stuff but there's no unbiased information about that. That's a management presentation that's you can't reliably check yourself usually. How do you think about like so when you're talking about Home Depot, is that more of like thinking about it from like a customer acquisition and Geico customer acquisition costs? What is that to the company? How can you retain them? And then how does that math work out over time? >> Right? So it's investment. So all these things involve an investment. And the best business is usually well we talked about ones that are different big technology things and stuff are different in that they invest a lot in capability that then they don't customize to each customer but a lot of other businesses invest a lot in the customer relationship and almost always that doesn't make you money in the beginning when you have that it's not worth it. So, um, and sometimes it's not captured by the financials, but like if banks want to attract commercial deposits or something, it could take them three, four, five years of calling on that um, prospect trying to get the business and then they finally get it. Uh, you don't see that in the financial statement so much, but obviously that's what, you know, that's business development type stuff we're talking about. And so, they have to do that to then make it make a lot of money for them. for stores and things like that, it's usually um investment in the area and then you have to grow awareness, but it depends. Um so take restaurants. Uh Cheesecake Factory when they open a location, they get almost everyone that they're ever going to get right away. Historically, like that wasn't their problem is awareness. They had high awareness. Um other places, a mom and pop thing that opens up, it's going to take it a little while to build awareness in the in the area. And so then it's just a question of getting up to capacity. Um there's other things that could take years to do that. So you build out a new warehouse. You know, we talked about this with like distribution companies and stuff. If um you know something decides that it needs a to be able to have more capacity, then when it first adds it, it adds it in a big chunk. There's no way for them to add 1% capacity to what they have. They have to choose to add 20% or something if they only have, you know, four or five warehouses. So then to that's not going to be profitable till it absorbs that capacity. um you know and uh and then like uh theme parks and things it would take them five or six years to get full awareness. So they're they're not going to get their money back until later on those things. Um and and the gross profit part of it is a lot of it goes to investment and selling expense. Usually it's what can justify it. If you have good gross profit, then you can justify a lot of selling expense, whether that's salespeople or spending a lot on advertising or something. If you have poor gross profit, it doesn't make a lot of sense to spend a lot on advertising. Mhm. Why do some companies then like sometimes they'll they'll have a negative gross profit and they're they're scaling that? Is that just purely like for the customer relationship and and scale advantages and they think over time that they're going to just grow out of it? I mean I've seen companies do that before and it's like I mean I think about gross profit as hey does this business work right? Is there a business model here? But I have seen situations where they have a negative gross margin and it's like, wow, you're kind of two feet, you know, deep or or in the ground and trying to claw yourself out. It's a really hard way to make money because you can't. >> So, there's two possible reasons why that would happen. Uh, one is if you're middleman type business and you expect that you'll eventually have scale, which will give you bargaining power over others, and then you'll be able to use that. So, Movie Pass thought that that's what they were going to do. Now, it didn't happen and they went out of business and then the movie theaters who really did have the power just implemented the same plans and stuff for themselves. Um, >> good idea. >> Yeah. >> Uh, so their idea was like we'll just give we'll have pay people and then take a loss on that, you know, people will pay us less than tickets are worth. we'll buy the tickets, we'll lose money on it, but we'll grow to a big enough base where I think of really their hope was like advertising and stuff, but um we'll have this customer list and we'll be able to use this both to say to movie theaters, oh, we won't, you know, you have to give us a better price and so we can bring this down or to like advertisers and things that we have this list of people and you can, you know, use it. Um and then on the other side of that, you have um so let's give an example with like tech things for instance. So it's a bargain power thing between the two of what I mean with a middleman. It isn't lit. It doesn't just have to be like distribution or something. So a good difference on that is why is YouTube so profitable and Spotify not because Spotify has to buy content that it has to use and it isn't in a strong position to bargain for it and everything whereas YouTube doesn't. Um so YouTube can make a lot of money to the detriment you know relatively of the creators whereas the creators can't really be taken advantage of in the same way versus Spotify. you could say the creators taking advantage of them or whatever, but basically you have people who create things who then have um you know publishers, agencies, things that that are able to sell entire cataloges and things and uh so you're not going to make a lot of money in music for instance, but you will by you know these videos that we put up, you know, uh uh Alphabet can make a lot of money off of them from us because we're not in a position to get as high rates for ad time or something as as we would if we were part some group that that bargained on our behalf for that. Um so basically people will give them free content you know. Um so some idea that that will change. Then the other possible reason is uh highly volatile inputs and outputs. So that happens refiners and stuff can just completely lose money in a year. Um or like uh um bare if it's very short cycles fine. So uh eggs are the traditional example of that. That's a super short. Yeah. So, it's fine to lose money in a year to have no gross profit because it'll rationalize quickly. You know, um hens that lay eggs don't live for that long and you can produce more of them really fast. So, it's not like uh something that if it's in an imbalance where you have over capacity or um shortage that's going to last for too long. So, you know, every 18 months or something, you're going to see this violent cycle that when it's really profitable, people should start having doing things that causes the profitability to come down and vice versa. So, it's okay to have years where you just go, I'm going to lose money because it's so cyclical and so but so it's a short cycle. I'll get back out of it. Yeah. I mean, for people listening, you you could have years in um negative or you could have years that are eight figures in operating profit. Uh but then you could have years that are in the billions or or close to it in operating profit for um called the short cycle nature of it just swings all over the place. >> Yeah. And so like in their defense so you have a year there 2017 it says their gross profit was 4% margin which meant that their gross profit in dollars was $46 million. So obviously they lost a huge amount of money because it cost a lot more than $46 million to run the business. Um, in their defense on that though, it could have looked perfectly fine. I don't remember everything about 2017, but um, because you could say, well, people are always going to want to buy eggs at some price, but, you know, supermarkets going to want to give them to their customers, you know, have them available there. So, that makes sense. And they might have known that competitors were losing even more money than them, you know, like they might have had competitors who had a negative gross margin or something. So, if you knew your relative position was fine, it would be okay. Now, if you are the highest cost producer or something, then that would be a different story because yes, people will need eggs, but they don't necessarily need your eggs. But if you're the most efficient way of getting them eggs and just there's no money in eggs in one year, then that's life. And you know, uh there used to be a 100 years ago a lot more businesses like that in the United States that were in businesses where you might have to accept that you would lose money in some years because it's a pure commodity. And even if you're the lowcost producer, um, supply and demand, you're going to have boom and bust years. You're going to make a ton of money in some years with amazing gross margins, and then you're going to have some years where your gross margin is nothing. >> I want to talk about um like gross margins and and how they drive the multiples in in some stocks and businesses, right? So I guess before we jump into some examples, why do you think I mean I've read some quant studies that show the the best indicator of future momentum in a stock um is gross profit momentum, right? So growth in growth profits. Why why do you think that is? >> Well, so there's a few possible reasons. Uh one, moving up the income statement is good for getting closer to the actual business realities, right? So that's one part of it. Um, I think that the the issue with quant things that we're talking about is that obviously they wouldn't know or they seek not to know. I mean, you could see it other way. Um, things about the business that would be helpful that aren't captured in the financial statements basically. So, I mean, they might look at some other things that are in the financial statements, but basically they're looking for publicly available information that is comparable and quantifiable to everything. So, they don't have color on things. Um, so the gross profit is probably the best number for that. It would become a less good number if people paid too much attention to it because you could definitely manage it from from a management perspective. Management probably does goose sales and probably does goose uh income or or in a lot of cases ibida uh because those might be things that people are looking at but is less likely to be focused on gross profit. Um and then in terms of the things that you know it it does with what we were talking about with um the indicators that it has. If you imagine putting those aside the the biases of what management could be doing and how the number works just if if everything was prepared properly without the idea that they knew they were public company. It's really helpful because there was a book um that kind of talked about the it's one of the better books on investing stuff in terms of explaining the where value comes from which is basically that you have to be able to charge more than others for your product and you have to be able to pay less which there's all sorts of different ways that that could be. You could pay your labor less. you do whatever, but um that that gap is what makes businesses profitable. And that is captured earliest in in gross uh margin. And so an improvement in that is kind of like an improvement from the perspective that you're getting an indicator that customers value this more highly than it cost you to produce it, which is what you need to know. Um, but you know, venture capitalists and stuff maybe don't need that number and can kind of speculatively say, "Oh, I see what you're doing and this is going to be really valuable to customers when it's out there and everything and so they can do it earlier." But a quant can't do that. So, you know, that's that's the underlying truth you're trying to get to is whether you can take something that costs you a low amount and charge a lot for it. And gross profit is the first indicator and like public statements that's the case. So you could think about um couple different scenarios that could drive a multiple right in a stock. So it could be consistency, right? And we've spoken about before how Costco is probably like the purest form of that, right, of consistency. So I have it up here on the screen. So I mean gross margin obviously it's not high, right? Back to our earlier example, but it's it's incredibly consistent over time and Costco trades at an insane multiple, right? Um and then the other factor that can um drive uh you know a multiple rate or multiples higher is just of course the growth in in gross profits. And you know we could talk about like a company like US lime uh for example where you know gross margin went from call it you know low 20s to over the past handful of years um you know we're we're close to 40 on average right if you average that out. Um and the multiple rerated I mean basically more than doubled I believe which we could pull up uh key ratios and let's see um you could see price to earnings. Yeah I mean basically have doubled over the past five years um another example of that could be a company like Buckle um which is an interesting one. this company always came up on like screens like magical formula screen or or other like high quality screens. Um and you could see that you know revenue growth hasn't been anything spectacular right.5 u so less than 1% 10-year ker on revenue. Um but gross margin ha hasn't has you know held up and and only improved or or done okay over time and return on equity has done good as well. And um you know the stock price movement in buckle has been okay. So want to get your thoughts on you know sort of the difference in um you know from a consistency level right you used to write the Mer newsletter of guru focus or you're part of that and things that you screen for. Um but then actually the growth in gross profit which could drive that multiple. >> Yeah. Maybe that's where more of our our listener base is going to focus because I don't think a lot of investors that follow us are probably um going to buy like a Costco at 50 times earnings. So maybe if you're going to get that multiple expansion, it's it's more of the improvement side of things. >> Yeah. And so but we could but again with the the thing of looking at just the numbers versus knowing a little bit more about the business helps in these cases. So if you take the gross margin at Costco, you know that their strategy is they don't want the gross margin to expand. They actually want if if they could plan perfectly, they want the gross margins to to stay the same. Their goal is to take on the benefit that they would have that they could have a higher gross margin and then pass on to customers which will drive greater revenue growth which you know and then through that cycle. That's that's their model. Other companies might not do that. If you talk about buckle or something, they don't think that they could sell more and more um you know jeans or whatever fashion things they might have because there's a limit to that. Whereas Costco wants to sell everything possible in huge quantities to the people who are members. Right? So it's a different model that way. Whether you want to make sure that you keep pricing high enough, you know, your profitability high enough or whether you want to have something where you're driving as much value for the customer in terms of just like um low cost, which is their model. Um so theirs looks more like, you know, uh I mean I don't I think in recent years progressives doesn't look like that, but if you could see things that would kind of be the goal of both a Costco and a progressive or something. Their goal is not to make wider and wider margins over time. They feel that they miss if they price too high and actually had too big a margin. Um they would rather that that be be similar um over time. They feel like >> scale economy share model >> that everyone will buy one auto insurance policy and they will they could you know if they pray if they had too much profitability it meant that they could have had more market share than they do basically right so they're balancing those two things against each other whereas someone who who's you know Rolex or something is not going to think they could sell to everybody so they want to make sure that they have a certain amount of profit on everything that they sell um and are okay if that gets wider over time probably. Um that's not the case with with the ones that we just saw there. Um but in terms of like what would cause it to widen out, that's pretty easy for some companies. The question is how early you would be. So US Lime, you could predict that um it could have an explosion in gross margin if you researched the industry, the company, etc. or even just read some things the company said because it was operating at so much less after the the um financial crisis. Uh it was producing so much less output than it was capable of. Right? So when something has capacity utilization basically of like 60% or something but is making good profit well that means you know if if it goes to 95% uh it's going to be making a ton. Or the other thing is whether it's like monopolistic in the sense that um people won't necessarily uh its customers won't necessarily be able to to get um any relief in case of inflation and things like that, right? Um a good example of this I think is uh I think they still have a quick app. It's no longer a public company, but Encore Wire W is that it what it was? Yeah. So this is a good example because you can see it through 2023 knew this company knew it was a super lowcost very efficient producer deliveries on time at really low cost and it had like the model that worked the best that way. But if you can see after um the commodity boom kind of busted right around the time of the financial crisis all the way till almost COVID in that graph there uh being the best producer in the United States got you like a 10% return like uh so most assets in the industry probably weren't even justifying you know being public or or you know using owner money. this company was maybe barely doing that and it was doing it at being very efficient in terms of cost and everything. Now what that meant is that it exploded once um the price of copper went up basically and and other things but once there was and especially an expansion and it not just like it being a high level but if it was going upwards that would you know have a dramatic increase kind of like when we talked about banks or something like they're they if they're very efficient but they depend a lot on the net interest margin then it's only once the uh rates are higher for some banks and then for others the yield curve is is steep that they make money. We talked about that basically Frost in the case of higher interest rates and I think we talked about Hingham in the case of steepness of the curve. Uh if you you you're kind of a lowcost producer of money, but you just make all your money on the the other side of it of um of what you get paid. And if you don't get paid a good price, then you're not going to be making money. But you could tell in each case that if the value of the commodity as an output that they were had that they were positioned for happened, then they they'd suddenly be making a lot of money. and vice versa that if it collapsed they wouldn't be. >> I want to go over like growth versus profitability and just different um three different scenarios right and we could talk about it. It's Elite Corp. If you're a micro cap investor, I'm sure you're familiar with this company. Um, but you know, strong revenue growth over time. Um, but gross margins decline and you know, the stock underperformed, right? So, look at 2015 right here. And again, people listening that may be more familiar with the business, maybe you could say, oh, where they did this or they did that. I'm not, you know, here to debate that, but just looking at this from like a highle overview right here. Um, you know, gross margins in 2015 went from about 52% uh to 40%. Even though revenue went from 18 million in 2015 to 44 million in 2024, right? And the stock did not do well. Um, another example, we could look at Boston Beer right here. um grew revenue much faster uh but failed to grow gross profit per share and and the stock you know drastically has underperformed. That's an interesting chart we should pull up. Sam >> Boston beer is a really good example because I wrote the stock up like 13 years ago and everything that I wrote up about it turned out to not essentially not be true. It would have been true if the business and the company had stayed the same, but as an investor, you invest in a company and if they change their product mix, pivot into other industries, whatever, that's the return you get. And so, they ended up being a much faster growth, much lower profitability company because they went into things that were different from what they were in initially. when I was talking about them, they were primarily really really primarily um just like a Sam Adams like a what they call better beer type category, higher priced beers and um then you know you talk about spike and all that. I mean they had twisted tea and stuff by then and and angry or stuff but like that expanded and they became in a lot of other categories that were different and had much faster growth um in terms of volumes and stuff. they were probably selling a lot more but in terms of um gross profit you know like we talked about not so great and certain I mean you know they grew but not amazing for all those years and then gross margin obviously declined. Yeah. >> Mhm. So for people >> turn on capital declined. Yeah. >> For people listening on the podcast. So in 2015 revenue was 960 million and gross profit was 52 million 52.3% gross margin. In 2024, revenue basically doubled was just over 2 billion. Um, but gross profit was uh 894 million and it was a 44.4% uh gross margin. And even years before that, a few years before that, it was actually a lot less. So operating profit, which is interesting, even though revenue doubled from 2015 to 2024, operating profit was basically the same uh 10 years later at 152 million. >> Yeah. Yeah. And if you look at this one, and you'd only see this in the video, but um it's the really key part is the 2018, 2019, 2020, 2021 fiscal years, because what's interesting about those are the difference in the revenue growth, which looks quite strong and my memories that caused the stock to go up during that period um actually that it the multiple expanded during the 2018 to 2021 period. >> Oh yeah. >> But was that like the Seltzer cris? Yeah. >> People get thrown here a metric >> and it really high. >> I mean, yeah. >> Yeah. >> Yeah. Obviously that changed everything. But if you look each year they have like double digit type revenue growth, but each year they have fairly dramatic drops in in the gross margin where the gross margin is going from like 51% to 38% at the end of that. But every year gross margin is coming down. >> Yeah. people listening in 2021 it looks like price of sales was like nine times >> which is interesting because >> today >> yeah as we said the gross margin contracted from 51 to 38 so we don't have the calculation here but price but but like enterprise value or market cap to gross profit actually went up even more than price to sales because sales was justifying that kind of gross that kind of growth but gross margin wasn't um and then after that period actually they probably you know I don't have a lot of details on the company know everything about it but in the period after that it actually looks like it returned more probably towards what it had been before that part probably shrank the other part probably grew and if it hadn't been for that period in between um it if we had just had a snapshot of the company before and after that 2018 to 2021 period it might actually have looked much more the same though they ended up in a worse position obviously um you know operating profit in 2024 was the same as it was in 2015 which is not great usually unless you bought back a lot of stock or because there was a lot of inflation. So in real terms it's about 2/3 actually it's probably a little le 2/3. Yeah. So it kind of contracted by about 30 35% as a company in terms of how much money it was making in real terms probably. So as an investor, what is the the scenario that you would prefer to invest in? Sort of the lowcost producer where maybe it's more about scale, scale economy shared, customer satisfaction, and more of like a volume play versus maybe less volume, higher prices, more of your craft beer, more of your Rolex verse, you know, name your favorite cheap watch company. >> That's a great question. uh the way to make tons and tons and tons of money as we've seen recently is in the lowcost huge total addressable market. I prefer the opposite. The number of things that historically that have survived for long as on the lowcost approach is not high. Uh so you know we'll see. >> Do and just just so I ask do you do you believe though with the high price point model right you have to be much more familiar with uh you know consumer and customer tastes and and sort of the behavior there right and and feel comfortable with that and feel comfortable with it not changing verse the other side well the customer and consumer preferences is cheap prices and it's you know everyone's always going to like that that's never going to change. Uh, no. So, I disagree on that point in that I think that usually how you have very very low prices is you have an extremely fit system that will be wiped out as soon as there's a change in how something's delivered. So, the problem that you have is you develop this thing that is the absolute lowest cost way of getting things from here to there, selling them, organizing them, whatever, and then something changes where people actually have another method of getting that and your system no longer benefits you. And so, that's really dangerous. So like if you were offline and you had this extremely elaborate system for how to have the lowest cost in stores once online comes in that that can potentially change that. If you had an approach that that was based on reaching customers a certain way in terms of um advertising and selling to them and then that changes then you have a real problem. So I do think that low cost you can it depends if you have lowcost you know deposits of some mineral that's going to last you 50 years then then that's very safe but usually it's lowcost distribution systems that it really could have a problem pretty dramatically you even see that in things like um GEICO versus progressive I mean Geico had a model that was based on uh attractive customer acquisition and then um some things within that about to some extent selection and Progressive had one that was based on pricing correctly to uh risk and you saw pretty dramatically how quickly Progressive was able to not to profitably take a lot of market share from them because certain things changed in terms of technology and stuff that made that ability scalable in a way that suddenly you could take a much bigger advantage of it. Um and so that worries me. So like yes it I I know that that people feel like say uh Google or something right let's put YouTube part of it out but the Google part is very safe compared to like I said a Rolex um but AI and stuff if people get AI answers instead of typing something into a search thing if people go directly to Amazon and have an AI suggestion of what to do to as they're shopping instead of going through Google if they do different things with travel with whatever They're dependent on a lot of those things for advertising. It might not be valuable to people anymore once that happens. I mean, there was there, you know, newspapers were once a very cost-effective way of getting your news and then they no longer were. And there are not many. So, you take the most extreme examples, retail, where efficiency is what matters the most. They have an incredibly high extinction rate. Um, so there's people who've gotten rich off them, then sold them, and then put their family's money into something else. But if you just like kept your family's money in something um and that's all you owned and stuff, you you didn't create something that was wealth forever that way as opposed to brands and things which have a much much longer existence um that are more agnostic in terms of distribution. So, um, but you know, so if you're asking like like just what are your odds that you'd be able to survive forever when we're comparing, you know, this is happening in streaming things? Netflix did better than Disney. But which was more likely to survive and everything? Disney because of the content, everything. It could be agnostic about that. Eventually, there'll be some way to distribute it. Someone will pay you for it. You can create your own channel. So, it'll work out. Um, Netflix had to race to make sure they got big enough, fast enough to survive, and then they've done great since then. Um, but also everyone who tried to do another Netflix lost money. So, I mean, if if it's a home run if you're right about it. Um, but the other thing is if you are on the lowcost one, you you there have been examples where it's been reversed, but you probably want to get out pretty fast once that starts going the wrong way. Like, you wouldn't want I mean that happened with Southwest. We went over that in one podcast where he said, "Look how big the gap was and then look how it went away." If that's an insurer, if you used to be able to save people, you know, you had 10 points of advantage over other insurers or something or you had a better operating ratio on things with a uh airline because airlines a lot like insurance that way. Um you could pass it on to customers and you could do great but as soon as that gap closes, you don't really have anything to offer. Um and you know that has a tendency to happen. Um, so most of the lowcost type businesses, you know, don't last forever, I would say. Uh, they have a tough time that way. Um, and even ones that do are often single sight or something. Like even when I said retail things, the retail, honestly, if if certain department stores and stuff had never expanded to owning other stores outside of the original ones they had, some would have done okay if their location did okay. Nebraska furniture or something is different than like Walmart. It's a bit safer. >> Mhm. uh final example that we can show here uh waters right so sort of the opposite story of the first two that we spoke about uh slow revenue growth so the first two were you know high revenue growth um but solid gross profit per share growth and the stock I mean it did okay I mean not necessarily I don't know if it was market beating right now the past few years obviously the markets have been super strong but the business itself um did did pretty good pull it up against the S&P S&P crushed it but let's see over the last 10 years. Yeah. So, opposite story though. >> Ones like that. Well, one problem that you have with that I don't know that was always an expensive stock. So, I'm not sure that it was even cheaper 10 years ago. Um, but the other factor that you have there is actually just that the gross margin is very very consistent. So, you have a situation in which this is where we're going to with profitability. So the quant stuff like quality is often profitability quality are often considered the same and then growth is somewhat separate. This is a company that has strong quality um uh numbers but not growth. The the best situation is a high quality company that is high growth. Um high growth without quality is rare and dangerous. um it doesn't usually last that long unless you have some funding source that that's um uh you know that isn't your >> ownized. >> Yeah. But but any company that that grew really fast and got really like any company that's giant today usually has something in its past in the United States at least p you know businesses that were private sector and everything. Um there's something in its past where it had a really good run of making a high returns on capital otherwise it wouldn't get to be the size that it is. um the actual business, not the market cap. Right? We started this off by talking about a business that's a $300 billion market cap, but it's only a $3 billion revenue business or whatever. If you're a $300 billion revenue business, at some point in your history, you were a really good business because you somehow funded a lot of growth. Um now there is one other exception that we should bring up, which is the return on capital thing. There's a weirdy thing which is some businesses don't have moes around them necessarily, but people think they do because they have high return on capital, which could just be you're the first one in or they're shortage or something and it could last for a few years and then go away. So, it's a longer term thing of that. And then the other weird example we have is some have funding advantages which are probably not they're good to have, but they're probably not as attractive as having good gross margins in terms of what it means. So somehow you've been able to like um whether it's lease the thing or get the customer to fund you or something which is always a good thing but it isn't as strongly indicative of a good business even though it has really high returns for owners as like having gross profit. Um because gross profit basically means that you know you have some you're doing something right in terms of what value you're able to get and give on the supplier and and customer side so that there's a gap there that you know you can make money off of. >> Make money. Yeah. >> Let's talk about gross margins or gross profit and gross margin as um like an early signal, right? You've always said that you worked for a guy that uh was, you know, he would do a lot of stuff in technology and like internet of things, right? And he would always tell you that whenever if he was ever in a company and their gross margin dropped like quarter over quarter, he immediately got out. >> Yeah. So for his own investing stuff. Yeah. Because you invest new technology things invested in that and just knew from technology stuff that you only want to be in a tech company when its gross margins going up and as soon as it starts to go down you have to sell it. Yeah. >> Why is that? Explain that logic like play it on what usually happens after. >> Sure. So there's a few different things. So so one is with tech things. So we talked about like supply and demand. It's no longer in like short supply. Um, so there's enough of it to go around, which could be that other people want to, you know, could be that things are changing technology in terms of how it's being used. It could be the competitors getting better that way. It can also be companywide. You're selling less new stuff and selling more old stuff, you know. So this is the Phil Fisher type stuff. The other way of doing it from the quant side is how many of your products are you came out with this year, five years ago, whatever, you know, and Phil Fischer that depended more on getting honest answers from people in the company and around it and everything to build the same sort of thing that we're talking about. Whereas um some people's feeling is just whatever the companyy's saying doesn't matter. If it's a tech company and there's a decline in gross margin, it means that those things are happening even though they're not telling you. Yeah. it's not as hot a product anymore. You know, tech and fashion have some similarities that way. The hope with tech is that it's not a short-term thing that it keeps being the case, right? That you have this great technology, you're going to keep that edge. Um, but whether it's a same thing with like fashion merchandising edge, you know that because we think of a fashion cycle as that happening. Um, it's the same sort of idea. You know, you want that to continue. You uh it has to be the thing that people want, the fashionable thing. >> Yeah. It's like Blackberry when when the iPhone came out. You could cut prices to keep revenue coming in, but if no one wants it, margins are going to absolutely collapse. >> And that gives you a good idea of the technology thing because while that company uh was incredibly profitable and had like, you know, magic formula type stock and all that to like losing money was a very short period as opposed to most businesses. That's why I mentioned fashion. You only see that in like tech and fashion things, you know, like you have a people can't explain why some teen retailer or something went from being the most profitable to like losing money in two years and you don't understand it. Same thing happens in in um tech things too like happened with iPhone and Blackberry and everything. Yeah. Same idea. It's a huge switch. Everyone switches from one thing to the next. >> Let's talk about Carvvada. So, you know, basically looked like roadkill, but gross profits did, you know, keep improving, which is obviously what you would want to see if you're ever looking at a turnaround situation or where you're extremely worried about, uh, you know, an impairment or something like that, right? Um, saw this tweet. So, we had obviously wanting to talk about Carvana on the podcast and then I woke up and I saw this this morning and I thought it was funny. Carvanao was down 98.99% from 2021 highs. It's now up nearly 9,000% from the lows. And you said the stock market is wild. I mean, that's pretty crazy. Think about that. >> Yeah. Although that's that's flat if you owned it before and after. We have to do the math of that for people so that 9,000% it's in the same place. Yeah. >> Yeah. >> Um, yeah. So, I mean, let's look at the companywide things because I just know something about the unit economics from years ago, but which is kind of why I mentioned it um to you a while ago is that um this is one of these cases where it was interesting because the company's basic economics seemed like it wasn't impossible that this could make sense, you know. You know, so I've looked at companies like this, Chewy, some other ones where you go, I really say just uh management saying one thing, you could look at it one way. It might be possible to make money on each order, but it's it's hard to know. It's very attractive for customers if this is true. Um, and Carvana is very very good deal for for customers, good experience for customers. I mean, people should sell their their used cars to Carvana. Definitely, I would recommend it. But I would recommend Movie Pass and I took advantage of Movie Pass. that has nothing to do with whether the business is any good or will survive. I mean you could obviously it's very easy to offer people something that they would prefer um than to make it a profitable business. So um but the problem of that was was scale right was always the question of how quickly would it scale and keep getting better and that's the point that I was mentioning before where you asked like why would something have a negative gross margin or in Carbon's case I don't know if it was negative but in 2015 161 17 has a gross margin of 1 to 8%. um like the I mean car dealers might have something almost as low as 8% if it's like a fleet thing and something maybe on like actual car sales I guess. So like you know they don't make a lot of money on new cars but this is companywide. So the reason why they would sell you a lot of new new cars or something is because then they get your business for service and other things. you know, in those years, what Carvana was doing is not something other dealers would want to copy because they would just think you couldn't make any money off of it. Um, you know, that's too low on amount of uh that's too low in terms of how much profit you're trying to generate. Um, and then, you know, as you go on, you can see, let's see the gaps there. So, that till they eventually have um, uh, a big improvement into the operating to actually operating profitability in 2024. Mhm. I mean, what happened during these years? We're familiar with car prices and and in and dealerships and what happened. Maybe take our listeners through that. >> Okay. So, some of it's complicated because of accounting rules. Some of it is is somewhat misleading. Um, if we looked at cash flow things, the the economics were were worse and they were closer to bankruptcy than those numbers would suggest. Um, they're probably very very close. Um, because I mentioned this once about Tesla. there's a period where like margins expand or something people were impressed during co uh if there's lead time between when you make something and when you're selling it and there's inflation uh that margin doesn't exist. So there's a period here where there there's a gross margin that's it's just it's phony. Um there's no if you went then went and replaced the car, you know, you you sell a car and then you turn around and you have to replace the car, but you don't have enough money to cash to replace the car. Now, if you're being if you have certain credit arrangements and stuff, which you know, dealers do and stuff, then it's a little more complicated than that. You only have to replace part of the value of it because most of it's being provided by the the the dealer and by the um like floor plan financing and stuff. But um basically, if it's an allcash business, there's a period there in which you are selling inventory and you don't have enough money to buy more inventory because cars have gone up in value more than your markup on the car. So that's an initial period there in COVID that's happening that uh let's try looking at the cash flow thing to get an idea of what I mean on a cash basis the business wouldn't have really been generating at that point. Um and so because you can see yeah so um yeah cash from operations is significantly negative in fact the most negative ever right from 2019 to 2021. Yeah, the story went from oh, we're improving and then in 2021 2022 it went boom like just completely. >> Yeah. Let's see. But we have net income. So we can compare to some extent I mean net income is not the best measure for this but you can compare to some extent the what I meant about the cash in relationship to the income and everything in that it's significantly worsening because before all that let's say take 2017 as a clean measure um you know your net income was negative 160 million and your cash from operations was a use of 200 okay a few years later your net income is not that different you know it's like report -3654 -287 but you've now tripled or or worse your cash flow from operations in terms of um the the burden that's happening there. So the the quality of the earnings has deteriorated during that period. um you know and that's a weird thing to say because they're reporting losses but it's even worse than the losses they're reporting at that time the reality of the business and then later it changes and then you have positive cash flow from operations in uh the last couple years two years basically >> and significant cash flow yeah >> and the stock is up 9,000% off the bottom >> but back to >> yeah well it yeah we talked about quant things if you quan could come up with a way to predict when the market will think something's about to go bankrupt and yet there's a high probability it will not even probability there's some decent possibility it won't go bankrupt that's the best thing in the that's the best inside information you can have in the market you know people always talk about like oh there's going to be a choir or something the best thing you could have is like you know ahead of time that someone's going to restructure a loan or something and everyone else thinks they're about to file for bankruptcy on Friday or whatever um which is what happened here yeah if if you could tell the difference between things that are going to be bankrupt and uh you Chapter 11 and and those that are going to recover in some way, even if they never get remotely back to where they were, that's going to make you a lot of money. >> Let's talk about uh you know, to close this out. Um I mean, don't want to bring it too much back to fashion because I know that that's harder to judge, but um Crocs, this is a company that's talked about a lot recently. Um gross margins obviously very good, have improved over time. Uh trading like a home builder. So, you know, what's what's going on here? Is this a fad or or is it a trend? What is it? >> Yeah, I think that's a good way of putting it. And I think that's the same sort of thing that you see with home builder. Same idea. So, I mean, you wouldn't you'd say, oh, um, what does Crocs have to do with a home builder? But, it's kind of the the theme of what we've been talking about today is that what does technology have to do with fashion or something? The issue is how do people differentiate between this is a trend? So all these things when you have good margins and expanding gross margins there's a trend and that's kind we talk about the quant things momentum wise the business momentum is great let's not even worry about the stock price momentum we're all agreed on this the question is are you too late is it about to turn those sorts of things is it sustainable the best thing would be if you have you know business momentum that's expected to be sustained for a period of years or something um because even if you're not going to own the stock for years they'll just be good news the whole time that you do own it and then sell it you know um but here you see the multiple is low Right. And so people have downs. Um it has, you know, good revenue things. There's been years where gross margins higher, but it has very high gross margin variability. So I wouldn't worry that much about that. Um there's no trend towards worse gross margins in the last few years going into this. Now there might be now we could look at quarterly and stuff. Um but that would be the obvious thing would be people's concerns about that, you know. Um yeah. So, I mean, yeah, quarter to quarter there's declines, but seasonally there isn't really. Um, so yeah, you basically I mean I won't tell you whether you should buy the stock or not, but I think you can tell in the case of Crocs. I think you can tell in the case of homebuilders um that there's an expectation that the future is going to be worse from a supply demand case. So, in other words, like this is kind of a there's maybe a uh they don't expect crocs to become an even bigger trend, let's put it that way, than this right now. And they don't expect uh home building in terms of inventory and stuff probably to be a better situation than it is um been recently. I mean, because otherwise they would put those multiples much higher if you just look at what the results are. Mhm. Mhm. And then Deckers, another popular uh company, hookah brand name. That's what I wear. Uh got a pair of hookas. >> Kind of could see in your just everyday life how much that brand has taken off, right? Seems like everybody wears those. Um >> but uh another example of, you know, so revenue growth has just been incredible. Um but also growth margins and gross profit growth has been incredible. And you could see right how much that has scaled uh from like an operating margin perspective. So probably SGNA is a percentage of revenue uh has gone down right and that's what you want to see when you see companies growing a lot. >> Yeah. And you can see there the multiple is much higher. So presumably people are more optimistic about that one. Yeah. We could we have like first Nike or one of those because those are the ones that are the losers to you know um Nike in particular I think. uh has been the loser to some of the trends that you were talking about about that people are probably more concerned about um some of the more recent ones in the running shoes type space. I don't know if people are really running with them but you know that look >> yeah we got Nike pulled up right here um you could see you know revenue growth 10-year keer 4.2% but gross margin has been falling 46% in 2016 to 42.7% in 2025. Yeah, I don't know the business. This is always one that amazes me in terms of the price that it has and versus what its results have been recently. Obviously, it's it's famous as a amazing business long term. Um, yeah, because you're looking at something that's I mean, you know, let's see. Um, well, okay. Yeah. No, no, no, that's right. So, the the Okay, so the peak profitability was the last few years, not not this most recent year. So if you price off of that, it's more like 20 sometimes like record earnings probably 20 times or something. So the P isn't as bad as it looks that way. Um you know, so it could bounce back to where it was just a few years ago. But what's the market cap on it? The EV, if you could just >> EV 112 million. >> Yeah. So I mean even if you look at peak, it's probably it's certainly over 15 times uh and more like 20 times pre-tax uh what it kind of peaked at in terms of profitability. So, even it got back to where it was just a year or two ago. Um, you know, that uh it's not a cheap stock. I mean, it's it's it looks kind of expensive for a stock that's only grown sales by 4% for 10 years and and hasn't grown EPS at all, although it did until this most recent year, I guess. So, >> I mean, Deckers versus Crocs, I mean, what's the difference here? Why does Decker trade at a higher multiple basically double what Crocs trades at? >> That was my point. My my feeling on that is the same which is why I mentioned homebuilders and stuff is that value investors look at these things and go >> oh Crocs is so much better than Deckers or oh this particular home builder is so much better than the other one. Where you want to be careful is we could say it's clear that something's priced into the differences in terms of people who think they know something about fashion, let's say, or think they know something about particular home building markets or whatever that there's concern and that could clear up. They could be thinking, "Oh, things are about to be really lousy and and uh you know, they're not." I mean, like four months ago, no, maybe like five months ago or something, you saw things in the stock market that indicated things around travel, uh yeah, anywhere from three or five months ago, uh travel, tourism, um spending by certain things like that were all like there was concern about it. And then the kind of as the year went on the it seems like the market's not concerned about that kind of consumer spending. So the same thing can happen with any prediction here. They're probably concerned about one things um fashion versus another. And I'm sure that that's why we mentioned the home building thing. It's the same thing. People there's certain markets where people are concerned about what they see in terms of inventory or something. Mhm. I mean, it's hard to, you know, I mean, you look at like Crocs and you see that they're selling like charms for for their shoes and be like, "Huh, that's kind of interesting." Um yeah, that's a really big part of it of the whole um thing I think over time for them that's helped them is creating that kind of uh like um like Pandora the jewelry company and stuff, you know, building up a whole thing around what it is for the um uh for people to buy more of them and to be more loyal customers and to be a certain kind of uh buyer versus some of the other things that we're looking at. So I always find that hard to to analyze. Yeah. >> I I just wonder if they look like do or do investors look at Crocs and say, "Oh, it's sort of, you know, single thing." And then maybe they look at Hookah and say, "Oh, they're trying to become more of like a platform company, right? You got UGG, which is obviously super popular." Um, shut up. Um, and I will say this, um, honestly, >> there will be a strong tendency for investors to overvalue something like those shoes that you're seeing there, uh, the running shoes and stuff company and undervalue a Crocs. Uh, this is something I've noticed across my whole time investing and it's definitely very pervasive. If you have something like AI or something, investors don't understand it, don't whatever, you know, but they can or it could be biotechnology, it could be all sorts of things. If they don't understand it, but it's not something that's just not to their taste or fashion or whatever, then uh they may give it a high multiple. If it is something that's very appealing to a group of people they are not, uh it it tends to have a low multiple. So that's one thing that you just notice. Um that's almost universal. If investors tend to be from urban areas and things and this is a rural thing, the rural thing will be undervalued relative to the urban. If they're male and uh it's almost exclusively bought female, then it'll be that way. I mean, there's just one thing after another where I've seen that generationally there's all sorts of things. So, um yeah, and that's what I mean about fashion type things. So, when it gets into things like this, there's an idea of like uh this makes sense to me that people buy this product. it doesn't make sense that they would buy that product. And that's fine, but the one thing you want to ask is like, well, does that reflect your tastes, right? Because that's the important thing uh there is to make sure that, you know, um it isn't affected by that. You know, >> maybe these two should just get a room and merge together, solve everyone's problem. >> Well, yeah. The interesting thing about it, and this gets the gross profit thing, is um does that solve it? So, there's companies that have done this. You put together lots of apparel things or you put together lots of um shoes or whatever, right? Uh what was the one the uh the best example that was? Um well, actually, there's a couple examples in in apparel. Um but I was going to say like um which is North Face and all those things. And then um uh you know and so the point is as you get each of these brands um they often you're often buying it happens a little in restaurants too. You're buying a brand that's supposed to be faster growing have better more attractive things at the time you buy it and then over time as they mature in what you own they don't look like that anymore. Um you know what I mean? So like a mature brand isn't as profitable in terms of being able to charge a lot for and stuff as a hot brand. And so you have a tendency to put together things that are hot brands at the time that you bought it. And uh but over their whole life cycle they end up looking like the brands you already had, you know. >> Very interesting. Very interesting. So I guess what I mean this scenario right here, right? I mean, Crocs because of the price you think would be more interesting to you or is this more of a bad? >> Uh, no. I I would think that anything that I think I would have these sorts of quantitative numbers that look good and then I think I have some edge that's not quantitative in would be something that would be attractive. And then in the vice versa cases where I think other people who are buying the stock know more than I do about it. Um, yeah, but I wouldn't just be contrarian to be contrarian on something like that. But I did mean that seriously because like when you were talking about the charm things and stuff. Yeah. For people who have the the shoes, they know all about that and that's a big part of it is being able to do that as an expression of things that they're into and stuff to put that all in the in there which other shoes don't have and don't seek to have. So it does differentiate it in a important way. Um it doesn't mean that it's not a fad, but I just mean it's different. It's a highly differentiated product certainly. Yeah. It's kind of like Keely's, right? Yep. which was a fad, but a highly differentiated product. Yeah, water beds. Highly differentiated product that no one uses. I mean, >> bring them back. Bring it back. Water beds. My grandparents had one. >> Awesome. >> You know, so >> I think my grandma developed back problems because my grandpa was heavier, so it shouldn't be down. It should be like up in the air, you know? >> But whatever. Mattresses are a really good example that way because we've cycled through so many different ones where we have to come out with a new technology, new way to market it, >> new business model on it, >> negative gross margins. >> Yeah. And so whether it's purple or tempropedic or sleep number or um you know where we talk about going back to water beds and things like that, it does allow you as a technology slashfad to have high margins at the time that you're selling them then. And then once it becomes mature and it's just like everybody else has a knockoff of this, those margins go away. And so we have to kind of reinvent that, you know, sort of thing. It's like if it's kind of like if you had a drug and it was a under patent and stuff and then it's a uh generic now you got to go find the next that's not a generic to, you know, fix up the portfolio. >> Would it worry you to be like we have a new way of distribution, a new way of marketing this product that's been around for a long time and has just like always never worked from like an investor standpoint? Yeah. Yeah. So I mean this is where we talked about. So so you know I don't >> like Carvana was not that Carvana. Okay. Like dealerships have worked and are very profitable can be very profitable and this was a different way for that. >> Yeah. >> Verse mattresses. >> I mentioned venture capital things before. Don't do any venture capital investing. Don't know anything about it and stuff. But if I had no numbers to go off of overwhelmingly it would be is this a product that sells itself and doesn't have good distribution now versus is this something that has good distribution. I'd be much more interested in something that the product is seems to have a good sales proposition but has really bad distribution. And the question is just can we get it in certain doors? Can we get an affordable way to sell this thing to people and bring it to them but when they see it they'll like it. But if you're talking about oh everything's great but in a focus group they really don't like this product. Um then that would be the one that I would avoid. I would much rather uh you know it it just has really good um uh well like we were talking about uh movie things before, right? So Princess Bride got one of the highest ever scores with exit audiences and it didn't do that well in theaters, right? But it had a long life on on a distribution after that and stuff. That's the kind of thing that someone in the industry would be like, "Oh, I'll buy this from you." Like even though it it opened poorly and stuff because we know that it had one of the best ratings by people who actually saw it. So the problem was just marketing. Um, marketing is really important, but if you have a product that that people really like, but just doesn't have good marketing or we talked about Celsius just wasn't in a lot of places. And so, it's just a question of getting to more places, will it sell more? You know, you've already had it proven. That's the Peter Lynch kind of thing of like I feel like these companies don't um go private at such an early st go public at such an early stage when he saw them, but oh, it's in a town, it's got eight locations, they're doing great. It wants to raise money so it can then go to the next town in the next state and uh you know whether that's a linto or a fast food thing or whatever the that's yeah that's the best it's got proven um numbers on the really basic numbers >> unit the business model. Yeah the unit economics. Yeah >> and yet it's not showing up yet in the the statements. Yeah. So what we talked about here it's showing up in the statements but it's showing up at a much higher part of it. So maybe you're early compared to someone who's looking at the bottom line by looking closer to the top line. >> Cool. Good job out of you, Jeffrey. Well, I want to thank everybody so much for tuning in with the both of us on the Focus Compound podcast. Make sure you hit the subscribe button wherever you are listening or watching us to be notified every time that we upload a podcast every Friday from here on out. Uh be sure to follow me on Twitter or X, formerly known as Twitter at Focuscompound. And of course, if you're interested in learning about our money management services, you can reach out to me at andrew focuscompound.com. I thank everybody so much for all the support and we will see you in the next podcast. Take care.
Gross Margin & Gross Profit Per Share as Predictors of Stock Price Performance
Summary
Transcript
Welcome, welcome, welcome. How's everybody doing? Hope you are doing well. My name is Andrew with Focus Compounding on Air live with Jeff Ganon. Jeff, how's it going today? >> It's going very well, Andrew. How's it going with you? >> It's going great. We hope it's going great with everybody else as well. If this is the first time you are tuning in with us, thank you so much for joining us. Uh, be sure to go check out all of our content that we push out into the investing universe. Best way to do that is to go to focuscompounding.com, click that blog section and have the ability to type in any topic that's on your mind and get access to information going all the way back to uh the early 2000s. Um, if you want to follow me on X, which is the best place to get everything that we push out regarding the podcast, you could do that uh by following me at Focuscompound. All the information is in the description below. So today's podcast, chef, I want to talk about um gross profits, gross margin, and almost their predictive ability on future stock price movements. Um not only that, but also on analyzing the business. Talk about different scenarios where you could have companies that look like they are uh left for dead. And it's cool. you could go back and look at and be like, "Yeah, you know, things looked a little bit on on edge here and that, you know, they didn't look so good." However, if you sort of go up that income statement, you could see that the overall business was improving, right, from a gross profit uh perspective. A lot of investors focus on gross margins. Um, but, you know, that doesn't always tell a case, right? Like you could look at a company like Amazon for example and say oh you know at a certain point in their their um you know history they had low gross margins um because they're just looking at that actual number um and it may not tell the full story. So um before we do that though Jeeoff we were talking about this um off air recently. Palunteer Technologies. Have you ever seen a company trade at a 118 times price of sales? Right. So, as a general rule, you always talked about look, you can go your entire investing career and be perfectly successful never investing in a company trading 10 times sales. So, what about something that's 10 times your uh, you know, general rule? Are you really playing with fire here? I mean, what's going on? Hey, I don't even know what this company does, right? It's sort of the black box. Government contracts, AI. Supposedly, the government can't run without it. You could put the tinfoil hat on and say, "Oh, Peter Teal and blah blah blah." Right? But, I mean, goodness, 116 times, >> yes. >> Sales, 118 times price of sales. What's going on here? Have you ever seen >> Yeah. Yeah, I don't think I've ever seen a chart that even calculated how many companies were selling above 20 times sales. That's the most I've ever seen is like tracking a bubble. 10 is what I've used, but you know, they'll sometimes be charts that are like, are there any companies over 20 times sales? Um, yeah, I've never seen it in the this is a $370 billion market cap. So, I've definitely never seen it with a big cap stock that it's been at this price. I mean, because you compare by revenue to other things and uh obviously they're much much smaller. They're much much bigger companies that are normally that size or the market cap of companies that have three billion in sales are often a lot smaller. You could if you kind of comped to what those are. This is not a large company that way. But, you know, some things do grow rapidly. We talked about Celsius on this podcast, you know, years ago. And that did grow rapidly. So, it kind of grew into being more the same size as uh what you would expect from a high price to sales. Um, this one does have really high gross margins. doesn't have super fast growth right now, but I guess it's expected to have super fast growth in the future. >> Yes, definitely. Yeah. And and and on the topic today, yeah, gross margins have improved. Um but, you know, it's like you're getting into this point now at at these valuation levels where it's like, okay, like what percentage of the economy is this company, you know, going to represent or like what could it grow into? And at some point, isn't there sort of a ceiling there or is this just like an infinite ham? Well, I mean I I guess the addressable market is any, you know, um well, it could even be beyond what I think. Um you know, it could I mean, no one would have thought an addressable market. You mentioned Amazon for that, you know, involved Amazon Web Services and stuff eventually. So, you can go into other things, I guess, for the technology that, you know, you didn't know you were going to originally, but yeah, it's it's big anyway because technology used by friendly governments and stuff could be huge. So, it could be big. Yeah, it's one of the top spending areas for most uh well, not most, but for it's a large spending area for several governments. >> Yeah. Are you familiar with their CEO at all? He's a bit of a sataric guy. >> One thing that stood out to me, one thing he said, he he doesn't drive, so he doesn't have a driver's license. And they asked him why, and he said because I was too poor and then I was too rich. So, he never got his driving his driver's license. Um but yeah, obviously large language models and they do a lot of stuff with the government and uh yeah, crazy though. Look at that. 119 times 118 times price of sales. So um >> yeah, but it does revenue growth you the revenue growth like yeah it's a lot but I mean it's not like it's 100% per year. >> No, it looks like a great it looks like a great business. Yeah, it has the right margins for for having really high gross margins and they went up for uh at small size and it has really good revenue growth. Um but you know we talked about so it looks like a FICO or something but we talked about FICO at one10enth the price to sales I thought was you know a lot. So but it it has the things that you would need which are very very high gross margins and increases in revenue without necessarily having to have increases in assets and things. So it it has a business model based on the numbers alone that would make it a really great business. Uh this one that we're talking about is just size issue. So that could be true for any of the ones we talk about. We can talk about how good or bad a business it is, but then there's the issue of how big can the business get. And those are two separate things. Some businesses can get really big but don't have the economics that they're going to make a ton of money. Some look like they'll make a lot of money but you don't know how big they'll be. um this price is just on a handicapping basis it's just hard to make the stock make sense even if the business shows quantitatively really attractive things which it does. >> So before we jump into gross profits I wanted to pull up a article that you had wrote uh back in 2012 from the Ganon archives um which obviously is on our website focuscon.com and you're talking about gross profitability matters more than most investors think. You said it's not necessary for a company to have high margins and certainly not pricing power to achieve truly remarkable returns on capital and it's definitely not necessary to have high net profit margin from the business's earliest days. But you do need some basic evidence of a strong business model and you say what is a strong business model? There are countless qualitative ways of looking at a business model. Gross profits divide by receivables plus inventory plus PP&E minus payables plus acred expenses. This number should start looking good and keep looking better pretty early in a company's history. Look, Amazon is an expensive stock and it's got low margins, but it also doesn't tie up capital in the business. >> Yeah, this is a long time ago. This is not this stuff isn't true anymore. The business changed from that. Yeah. So, it might be a much less attractive business in the future, but it was that was true at the time. So, when it was growing then, it would have been able to fuel a lot of fund its growth and everything. Now these companies today the you know it's a different story. The the Amazons, the Microsofts, the Metas they are investing huge amounts of capital which they weren't doing before. So they that changed but that article is from when the business different than they are today. >> It's it's a good way spotted earlier though is what I'm saying. >> Yeah. No, agreed. But I just mean the the the business models of all them might are changing dramatically. So they may no longer, you know, have very high gross returns on on the assets they have because they have a lot higher assets. Um they shifted from being like asset light and doing work for other people to investing in their own assets. Um which is fine. A lot of companies do that later in their life and their profitability declines, but obviously they funded themselves from the part where they had really high returns on capital. So >> So you've talked about like gross profit per share before as a um interesting metric to follow. Most investors don't follow that. So can you take us through, you know, your line of thinking there and and why that's something that you think people should track and what it means to the company? >> So in the long run, return on equity and things like that are really important to stock returns. And one reason that countries like the United States have historically had higher returns is how they are funded. So they're funded through retained earnings. The companies become profitable early on in their life. they are then um don't have heavy borrowings that they have usually and then they also don't issue a lot of stock once they're public. So they go public and people get rich on IPOs usually in the United States but once the companies are public they don't except issuing some stock to insiders all the time they don't fund their operations a lot through a lot of stock issuance um and you know borrowing a lot of money and issuing a lot of stock are kind of the two things that cause a problem in some places where the country has good growth but the owners don't get it. So like you take China or something. Great amazing growth for the economy and the workers who live there and everything but not necessarily great returns for people who just own stocks there as opposed to countries that have almost no growth because of that reason. And so you know Buffett talked about um ad agencies as a gross profit royalty. So what he meant by that is that basically advertising is funded out of gross profits. is kind of like a selling expense they would have, but you need to have a profitable business on that basis before you can invest in trying to grow the scale and all those things. And there are accounting issues about why this could be misleading because if you just focus on this but didn't really understand the business, things could look better or worse on gross profit because of how it's kind of calculated. We took an extreme example. I had mentioned FICO. We just looked at a stock. The gross profit thing is kind of complicated because there's probably almost no variable cost to them. So they invest in a platform of some kind to do something and then they basically probably are using most of the same thing for one customer after another after another. The investment is really in having a capability and then they're providing that capability to the customer and it would not radically change if they have one or 100. Now their selling expenses might they might need a lot more salespeople on commission doing this or that or whatever but like the actual direct cost of providing the service is is not high. So you invest in something and then you hope to sign up enough people right to like make it justified. So those are hard to judge as opposed to the ones that are more easier for people to imagine the gross profit is like your supermarket. That's very easy for people to understand. Okay, it has a 25% gross mark gross margin. That's because it's marking up this amount and then it costs this much to run the store. You know, that kind of thing. But it helps a lot with scale because early on in the history of a company, a lot of companies people will say are not profitable. Why are investors investing all this in this company that isn't profitable? But the business model looks like it is profitable, but it hasn't scaled up enough. And in some industries they might even seek for competitive reasons especially to try to grow even when it's kind of dangerous to do that um funding wise because they want to be no I mean like we talked about big tech things they felt they had to be number one that there wasn't going to be a lot left over number two three four so they have to get big fast to do that and there's other industries where it would be similar where they're concerned about competition splitting things up um and then there's other ones where they're just people really want to get rich really fast and they think the business model works and so they open up a lot of um new locations and everything before they actually show the profits from it. Um so and companies invest a lot in that all the time doing that. Um you know Buffett's talked about like Geico, they don't make money when they first sign someone up but they have good retention over a long period of time. Anything that you look at from a Home Depot to whatever probably when they first open the store doesn't make sense. But the the point is that it's not this year's earnings that they care about. It's that for the long term it makes a lot of sense. Um and so when you can analyze that other ways besides the financial statements but if you're going to do it in the financial statements the best way is to look at gross profit. Um the other way is to understand the business model the kind of like uh you know store level economics and all that kind of stuff but there's no unbiased information about that. That's a management presentation that's you can't reliably check yourself usually. How do you think about like so when you're talking about Home Depot, is that more of like thinking about it from like a customer acquisition and Geico customer acquisition costs? What is that to the company? How can you retain them? And then how does that math work out over time? >> Right? So it's investment. So all these things involve an investment. And the best business is usually well we talked about ones that are different big technology things and stuff are different in that they invest a lot in capability that then they don't customize to each customer but a lot of other businesses invest a lot in the customer relationship and almost always that doesn't make you money in the beginning when you have that it's not worth it. So, um, and sometimes it's not captured by the financials, but like if banks want to attract commercial deposits or something, it could take them three, four, five years of calling on that um, prospect trying to get the business and then they finally get it. Uh, you don't see that in the financial statement so much, but obviously that's what, you know, that's business development type stuff we're talking about. And so, they have to do that to then make it make a lot of money for them. for stores and things like that, it's usually um investment in the area and then you have to grow awareness, but it depends. Um so take restaurants. Uh Cheesecake Factory when they open a location, they get almost everyone that they're ever going to get right away. Historically, like that wasn't their problem is awareness. They had high awareness. Um other places, a mom and pop thing that opens up, it's going to take it a little while to build awareness in the in the area. And so then it's just a question of getting up to capacity. Um there's other things that could take years to do that. So you build out a new warehouse. You know, we talked about this with like distribution companies and stuff. If um you know something decides that it needs a to be able to have more capacity, then when it first adds it, it adds it in a big chunk. There's no way for them to add 1% capacity to what they have. They have to choose to add 20% or something if they only have, you know, four or five warehouses. So then to that's not going to be profitable till it absorbs that capacity. um you know and uh and then like uh theme parks and things it would take them five or six years to get full awareness. So they're they're not going to get their money back until later on those things. Um and and the gross profit part of it is a lot of it goes to investment and selling expense. Usually it's what can justify it. If you have good gross profit, then you can justify a lot of selling expense, whether that's salespeople or spending a lot on advertising or something. If you have poor gross profit, it doesn't make a lot of sense to spend a lot on advertising. Mhm. Why do some companies then like sometimes they'll they'll have a negative gross profit and they're they're scaling that? Is that just purely like for the customer relationship and and scale advantages and they think over time that they're going to just grow out of it? I mean I've seen companies do that before and it's like I mean I think about gross profit as hey does this business work right? Is there a business model here? But I have seen situations where they have a negative gross margin and it's like, wow, you're kind of two feet, you know, deep or or in the ground and trying to claw yourself out. It's a really hard way to make money because you can't. >> So, there's two possible reasons why that would happen. Uh, one is if you're middleman type business and you expect that you'll eventually have scale, which will give you bargaining power over others, and then you'll be able to use that. So, Movie Pass thought that that's what they were going to do. Now, it didn't happen and they went out of business and then the movie theaters who really did have the power just implemented the same plans and stuff for themselves. Um, >> good idea. >> Yeah. >> Uh, so their idea was like we'll just give we'll have pay people and then take a loss on that, you know, people will pay us less than tickets are worth. we'll buy the tickets, we'll lose money on it, but we'll grow to a big enough base where I think of really their hope was like advertising and stuff, but um we'll have this customer list and we'll be able to use this both to say to movie theaters, oh, we won't, you know, you have to give us a better price and so we can bring this down or to like advertisers and things that we have this list of people and you can, you know, use it. Um and then on the other side of that, you have um so let's give an example with like tech things for instance. So it's a bargain power thing between the two of what I mean with a middleman. It isn't lit. It doesn't just have to be like distribution or something. So a good difference on that is why is YouTube so profitable and Spotify not because Spotify has to buy content that it has to use and it isn't in a strong position to bargain for it and everything whereas YouTube doesn't. Um so YouTube can make a lot of money to the detriment you know relatively of the creators whereas the creators can't really be taken advantage of in the same way versus Spotify. you could say the creators taking advantage of them or whatever, but basically you have people who create things who then have um you know publishers, agencies, things that that are able to sell entire cataloges and things and uh so you're not going to make a lot of money in music for instance, but you will by you know these videos that we put up, you know, uh uh Alphabet can make a lot of money off of them from us because we're not in a position to get as high rates for ad time or something as as we would if we were part some group that that bargained on our behalf for that. Um so basically people will give them free content you know. Um so some idea that that will change. Then the other possible reason is uh highly volatile inputs and outputs. So that happens refiners and stuff can just completely lose money in a year. Um or like uh um bare if it's very short cycles fine. So uh eggs are the traditional example of that. That's a super short. Yeah. So, it's fine to lose money in a year to have no gross profit because it'll rationalize quickly. You know, um hens that lay eggs don't live for that long and you can produce more of them really fast. So, it's not like uh something that if it's in an imbalance where you have over capacity or um shortage that's going to last for too long. So, you know, every 18 months or something, you're going to see this violent cycle that when it's really profitable, people should start having doing things that causes the profitability to come down and vice versa. So, it's okay to have years where you just go, I'm going to lose money because it's so cyclical and so but so it's a short cycle. I'll get back out of it. Yeah. I mean, for people listening, you you could have years in um negative or you could have years that are eight figures in operating profit. Uh but then you could have years that are in the billions or or close to it in operating profit for um called the short cycle nature of it just swings all over the place. >> Yeah. And so like in their defense so you have a year there 2017 it says their gross profit was 4% margin which meant that their gross profit in dollars was $46 million. So obviously they lost a huge amount of money because it cost a lot more than $46 million to run the business. Um, in their defense on that though, it could have looked perfectly fine. I don't remember everything about 2017, but um, because you could say, well, people are always going to want to buy eggs at some price, but, you know, supermarkets going to want to give them to their customers, you know, have them available there. So, that makes sense. And they might have known that competitors were losing even more money than them, you know, like they might have had competitors who had a negative gross margin or something. So, if you knew your relative position was fine, it would be okay. Now, if you are the highest cost producer or something, then that would be a different story because yes, people will need eggs, but they don't necessarily need your eggs. But if you're the most efficient way of getting them eggs and just there's no money in eggs in one year, then that's life. And you know, uh there used to be a 100 years ago a lot more businesses like that in the United States that were in businesses where you might have to accept that you would lose money in some years because it's a pure commodity. And even if you're the lowcost producer, um, supply and demand, you're going to have boom and bust years. You're going to make a ton of money in some years with amazing gross margins, and then you're going to have some years where your gross margin is nothing. >> I want to talk about um like gross margins and and how they drive the multiples in in some stocks and businesses, right? So I guess before we jump into some examples, why do you think I mean I've read some quant studies that show the the best indicator of future momentum in a stock um is gross profit momentum, right? So growth in growth profits. Why why do you think that is? >> Well, so there's a few possible reasons. Uh one, moving up the income statement is good for getting closer to the actual business realities, right? So that's one part of it. Um, I think that the the issue with quant things that we're talking about is that obviously they wouldn't know or they seek not to know. I mean, you could see it other way. Um, things about the business that would be helpful that aren't captured in the financial statements basically. So, I mean, they might look at some other things that are in the financial statements, but basically they're looking for publicly available information that is comparable and quantifiable to everything. So, they don't have color on things. Um, so the gross profit is probably the best number for that. It would become a less good number if people paid too much attention to it because you could definitely manage it from from a management perspective. Management probably does goose sales and probably does goose uh income or or in a lot of cases ibida uh because those might be things that people are looking at but is less likely to be focused on gross profit. Um and then in terms of the things that you know it it does with what we were talking about with um the indicators that it has. If you imagine putting those aside the the biases of what management could be doing and how the number works just if if everything was prepared properly without the idea that they knew they were public company. It's really helpful because there was a book um that kind of talked about the it's one of the better books on investing stuff in terms of explaining the where value comes from which is basically that you have to be able to charge more than others for your product and you have to be able to pay less which there's all sorts of different ways that that could be. You could pay your labor less. you do whatever, but um that that gap is what makes businesses profitable. And that is captured earliest in in gross uh margin. And so an improvement in that is kind of like an improvement from the perspective that you're getting an indicator that customers value this more highly than it cost you to produce it, which is what you need to know. Um, but you know, venture capitalists and stuff maybe don't need that number and can kind of speculatively say, "Oh, I see what you're doing and this is going to be really valuable to customers when it's out there and everything and so they can do it earlier." But a quant can't do that. So, you know, that's that's the underlying truth you're trying to get to is whether you can take something that costs you a low amount and charge a lot for it. And gross profit is the first indicator and like public statements that's the case. So you could think about um couple different scenarios that could drive a multiple right in a stock. So it could be consistency, right? And we've spoken about before how Costco is probably like the purest form of that, right, of consistency. So I have it up here on the screen. So I mean gross margin obviously it's not high, right? Back to our earlier example, but it's it's incredibly consistent over time and Costco trades at an insane multiple, right? Um and then the other factor that can um drive uh you know a multiple rate or multiples higher is just of course the growth in in gross profits. And you know we could talk about like a company like US lime uh for example where you know gross margin went from call it you know low 20s to over the past handful of years um you know we're we're close to 40 on average right if you average that out. Um and the multiple rerated I mean basically more than doubled I believe which we could pull up uh key ratios and let's see um you could see price to earnings. Yeah I mean basically have doubled over the past five years um another example of that could be a company like Buckle um which is an interesting one. this company always came up on like screens like magical formula screen or or other like high quality screens. Um and you could see that you know revenue growth hasn't been anything spectacular right.5 u so less than 1% 10-year ker on revenue. Um but gross margin ha hasn't has you know held up and and only improved or or done okay over time and return on equity has done good as well. And um you know the stock price movement in buckle has been okay. So want to get your thoughts on you know sort of the difference in um you know from a consistency level right you used to write the Mer newsletter of guru focus or you're part of that and things that you screen for. Um but then actually the growth in gross profit which could drive that multiple. >> Yeah. Maybe that's where more of our our listener base is going to focus because I don't think a lot of investors that follow us are probably um going to buy like a Costco at 50 times earnings. So maybe if you're going to get that multiple expansion, it's it's more of the improvement side of things. >> Yeah. And so but we could but again with the the thing of looking at just the numbers versus knowing a little bit more about the business helps in these cases. So if you take the gross margin at Costco, you know that their strategy is they don't want the gross margin to expand. They actually want if if they could plan perfectly, they want the gross margins to to stay the same. Their goal is to take on the benefit that they would have that they could have a higher gross margin and then pass on to customers which will drive greater revenue growth which you know and then through that cycle. That's that's their model. Other companies might not do that. If you talk about buckle or something, they don't think that they could sell more and more um you know jeans or whatever fashion things they might have because there's a limit to that. Whereas Costco wants to sell everything possible in huge quantities to the people who are members. Right? So it's a different model that way. Whether you want to make sure that you keep pricing high enough, you know, your profitability high enough or whether you want to have something where you're driving as much value for the customer in terms of just like um low cost, which is their model. Um so theirs looks more like, you know, uh I mean I don't I think in recent years progressives doesn't look like that, but if you could see things that would kind of be the goal of both a Costco and a progressive or something. Their goal is not to make wider and wider margins over time. They feel that they miss if they price too high and actually had too big a margin. Um they would rather that that be be similar um over time. They feel like >> scale economy share model >> that everyone will buy one auto insurance policy and they will they could you know if they pray if they had too much profitability it meant that they could have had more market share than they do basically right so they're balancing those two things against each other whereas someone who who's you know Rolex or something is not going to think they could sell to everybody so they want to make sure that they have a certain amount of profit on everything that they sell um and are okay if that gets wider over time probably. Um that's not the case with with the ones that we just saw there. Um but in terms of like what would cause it to widen out, that's pretty easy for some companies. The question is how early you would be. So US Lime, you could predict that um it could have an explosion in gross margin if you researched the industry, the company, etc. or even just read some things the company said because it was operating at so much less after the the um financial crisis. Uh it was producing so much less output than it was capable of. Right? So when something has capacity utilization basically of like 60% or something but is making good profit well that means you know if if it goes to 95% uh it's going to be making a ton. Or the other thing is whether it's like monopolistic in the sense that um people won't necessarily uh its customers won't necessarily be able to to get um any relief in case of inflation and things like that, right? Um a good example of this I think is uh I think they still have a quick app. It's no longer a public company, but Encore Wire W is that it what it was? Yeah. So this is a good example because you can see it through 2023 knew this company knew it was a super lowcost very efficient producer deliveries on time at really low cost and it had like the model that worked the best that way. But if you can see after um the commodity boom kind of busted right around the time of the financial crisis all the way till almost COVID in that graph there uh being the best producer in the United States got you like a 10% return like uh so most assets in the industry probably weren't even justifying you know being public or or you know using owner money. this company was maybe barely doing that and it was doing it at being very efficient in terms of cost and everything. Now what that meant is that it exploded once um the price of copper went up basically and and other things but once there was and especially an expansion and it not just like it being a high level but if it was going upwards that would you know have a dramatic increase kind of like when we talked about banks or something like they're they if they're very efficient but they depend a lot on the net interest margin then it's only once the uh rates are higher for some banks and then for others the yield curve is is steep that they make money. We talked about that basically Frost in the case of higher interest rates and I think we talked about Hingham in the case of steepness of the curve. Uh if you you you're kind of a lowcost producer of money, but you just make all your money on the the other side of it of um of what you get paid. And if you don't get paid a good price, then you're not going to be making money. But you could tell in each case that if the value of the commodity as an output that they were had that they were positioned for happened, then they they'd suddenly be making a lot of money. and vice versa that if it collapsed they wouldn't be. >> I want to go over like growth versus profitability and just different um three different scenarios right and we could talk about it. It's Elite Corp. If you're a micro cap investor, I'm sure you're familiar with this company. Um, but you know, strong revenue growth over time. Um, but gross margins decline and you know, the stock underperformed, right? So, look at 2015 right here. And again, people listening that may be more familiar with the business, maybe you could say, oh, where they did this or they did that. I'm not, you know, here to debate that, but just looking at this from like a highle overview right here. Um, you know, gross margins in 2015 went from about 52% uh to 40%. Even though revenue went from 18 million in 2015 to 44 million in 2024, right? And the stock did not do well. Um, another example, we could look at Boston Beer right here. um grew revenue much faster uh but failed to grow gross profit per share and and the stock you know drastically has underperformed. That's an interesting chart we should pull up. Sam >> Boston beer is a really good example because I wrote the stock up like 13 years ago and everything that I wrote up about it turned out to not essentially not be true. It would have been true if the business and the company had stayed the same, but as an investor, you invest in a company and if they change their product mix, pivot into other industries, whatever, that's the return you get. And so, they ended up being a much faster growth, much lower profitability company because they went into things that were different from what they were in initially. when I was talking about them, they were primarily really really primarily um just like a Sam Adams like a what they call better beer type category, higher priced beers and um then you know you talk about spike and all that. I mean they had twisted tea and stuff by then and and angry or stuff but like that expanded and they became in a lot of other categories that were different and had much faster growth um in terms of volumes and stuff. they were probably selling a lot more but in terms of um gross profit you know like we talked about not so great and certain I mean you know they grew but not amazing for all those years and then gross margin obviously declined. Yeah. >> Mhm. So for people >> turn on capital declined. Yeah. >> For people listening on the podcast. So in 2015 revenue was 960 million and gross profit was 52 million 52.3% gross margin. In 2024, revenue basically doubled was just over 2 billion. Um, but gross profit was uh 894 million and it was a 44.4% uh gross margin. And even years before that, a few years before that, it was actually a lot less. So operating profit, which is interesting, even though revenue doubled from 2015 to 2024, operating profit was basically the same uh 10 years later at 152 million. >> Yeah. Yeah. And if you look at this one, and you'd only see this in the video, but um it's the really key part is the 2018, 2019, 2020, 2021 fiscal years, because what's interesting about those are the difference in the revenue growth, which looks quite strong and my memories that caused the stock to go up during that period um actually that it the multiple expanded during the 2018 to 2021 period. >> Oh yeah. >> But was that like the Seltzer cris? Yeah. >> People get thrown here a metric >> and it really high. >> I mean, yeah. >> Yeah. >> Yeah. Obviously that changed everything. But if you look each year they have like double digit type revenue growth, but each year they have fairly dramatic drops in in the gross margin where the gross margin is going from like 51% to 38% at the end of that. But every year gross margin is coming down. >> Yeah. people listening in 2021 it looks like price of sales was like nine times >> which is interesting because >> today >> yeah as we said the gross margin contracted from 51 to 38 so we don't have the calculation here but price but but like enterprise value or market cap to gross profit actually went up even more than price to sales because sales was justifying that kind of gross that kind of growth but gross margin wasn't um and then after that period actually they probably you know I don't have a lot of details on the company know everything about it but in the period after that it actually looks like it returned more probably towards what it had been before that part probably shrank the other part probably grew and if it hadn't been for that period in between um it if we had just had a snapshot of the company before and after that 2018 to 2021 period it might actually have looked much more the same though they ended up in a worse position obviously um you know operating profit in 2024 was the same as it was in 2015 which is not great usually unless you bought back a lot of stock or because there was a lot of inflation. So in real terms it's about 2/3 actually it's probably a little le 2/3. Yeah. So it kind of contracted by about 30 35% as a company in terms of how much money it was making in real terms probably. So as an investor, what is the the scenario that you would prefer to invest in? Sort of the lowcost producer where maybe it's more about scale, scale economy shared, customer satisfaction, and more of like a volume play versus maybe less volume, higher prices, more of your craft beer, more of your Rolex verse, you know, name your favorite cheap watch company. >> That's a great question. uh the way to make tons and tons and tons of money as we've seen recently is in the lowcost huge total addressable market. I prefer the opposite. The number of things that historically that have survived for long as on the lowcost approach is not high. Uh so you know we'll see. >> Do and just just so I ask do you do you believe though with the high price point model right you have to be much more familiar with uh you know consumer and customer tastes and and sort of the behavior there right and and feel comfortable with that and feel comfortable with it not changing verse the other side well the customer and consumer preferences is cheap prices and it's you know everyone's always going to like that that's never going to change. Uh, no. So, I disagree on that point in that I think that usually how you have very very low prices is you have an extremely fit system that will be wiped out as soon as there's a change in how something's delivered. So, the problem that you have is you develop this thing that is the absolute lowest cost way of getting things from here to there, selling them, organizing them, whatever, and then something changes where people actually have another method of getting that and your system no longer benefits you. And so, that's really dangerous. So like if you were offline and you had this extremely elaborate system for how to have the lowest cost in stores once online comes in that that can potentially change that. If you had an approach that that was based on reaching customers a certain way in terms of um advertising and selling to them and then that changes then you have a real problem. So I do think that low cost you can it depends if you have lowcost you know deposits of some mineral that's going to last you 50 years then then that's very safe but usually it's lowcost distribution systems that it really could have a problem pretty dramatically you even see that in things like um GEICO versus progressive I mean Geico had a model that was based on uh attractive customer acquisition and then um some things within that about to some extent selection and Progressive had one that was based on pricing correctly to uh risk and you saw pretty dramatically how quickly Progressive was able to not to profitably take a lot of market share from them because certain things changed in terms of technology and stuff that made that ability scalable in a way that suddenly you could take a much bigger advantage of it. Um and so that worries me. So like yes it I I know that that people feel like say uh Google or something right let's put YouTube part of it out but the Google part is very safe compared to like I said a Rolex um but AI and stuff if people get AI answers instead of typing something into a search thing if people go directly to Amazon and have an AI suggestion of what to do to as they're shopping instead of going through Google if they do different things with travel with whatever They're dependent on a lot of those things for advertising. It might not be valuable to people anymore once that happens. I mean, there was there, you know, newspapers were once a very cost-effective way of getting your news and then they no longer were. And there are not many. So, you take the most extreme examples, retail, where efficiency is what matters the most. They have an incredibly high extinction rate. Um, so there's people who've gotten rich off them, then sold them, and then put their family's money into something else. But if you just like kept your family's money in something um and that's all you owned and stuff, you you didn't create something that was wealth forever that way as opposed to brands and things which have a much much longer existence um that are more agnostic in terms of distribution. So, um, but you know, so if you're asking like like just what are your odds that you'd be able to survive forever when we're comparing, you know, this is happening in streaming things? Netflix did better than Disney. But which was more likely to survive and everything? Disney because of the content, everything. It could be agnostic about that. Eventually, there'll be some way to distribute it. Someone will pay you for it. You can create your own channel. So, it'll work out. Um, Netflix had to race to make sure they got big enough, fast enough to survive, and then they've done great since then. Um, but also everyone who tried to do another Netflix lost money. So, I mean, if if it's a home run if you're right about it. Um, but the other thing is if you are on the lowcost one, you you there have been examples where it's been reversed, but you probably want to get out pretty fast once that starts going the wrong way. Like, you wouldn't want I mean that happened with Southwest. We went over that in one podcast where he said, "Look how big the gap was and then look how it went away." If that's an insurer, if you used to be able to save people, you know, you had 10 points of advantage over other insurers or something or you had a better operating ratio on things with a uh airline because airlines a lot like insurance that way. Um you could pass it on to customers and you could do great but as soon as that gap closes, you don't really have anything to offer. Um and you know that has a tendency to happen. Um, so most of the lowcost type businesses, you know, don't last forever, I would say. Uh, they have a tough time that way. Um, and even ones that do are often single sight or something. Like even when I said retail things, the retail, honestly, if if certain department stores and stuff had never expanded to owning other stores outside of the original ones they had, some would have done okay if their location did okay. Nebraska furniture or something is different than like Walmart. It's a bit safer. >> Mhm. uh final example that we can show here uh waters right so sort of the opposite story of the first two that we spoke about uh slow revenue growth so the first two were you know high revenue growth um but solid gross profit per share growth and the stock I mean it did okay I mean not necessarily I don't know if it was market beating right now the past few years obviously the markets have been super strong but the business itself um did did pretty good pull it up against the S&P S&P crushed it but let's see over the last 10 years. Yeah. So, opposite story though. >> Ones like that. Well, one problem that you have with that I don't know that was always an expensive stock. So, I'm not sure that it was even cheaper 10 years ago. Um, but the other factor that you have there is actually just that the gross margin is very very consistent. So, you have a situation in which this is where we're going to with profitability. So the quant stuff like quality is often profitability quality are often considered the same and then growth is somewhat separate. This is a company that has strong quality um uh numbers but not growth. The the best situation is a high quality company that is high growth. Um high growth without quality is rare and dangerous. um it doesn't usually last that long unless you have some funding source that that's um uh you know that isn't your >> ownized. >> Yeah. But but any company that that grew really fast and got really like any company that's giant today usually has something in its past in the United States at least p you know businesses that were private sector and everything. Um there's something in its past where it had a really good run of making a high returns on capital otherwise it wouldn't get to be the size that it is. um the actual business, not the market cap. Right? We started this off by talking about a business that's a $300 billion market cap, but it's only a $3 billion revenue business or whatever. If you're a $300 billion revenue business, at some point in your history, you were a really good business because you somehow funded a lot of growth. Um now there is one other exception that we should bring up, which is the return on capital thing. There's a weirdy thing which is some businesses don't have moes around them necessarily, but people think they do because they have high return on capital, which could just be you're the first one in or they're shortage or something and it could last for a few years and then go away. So, it's a longer term thing of that. And then the other weird example we have is some have funding advantages which are probably not they're good to have, but they're probably not as attractive as having good gross margins in terms of what it means. So somehow you've been able to like um whether it's lease the thing or get the customer to fund you or something which is always a good thing but it isn't as strongly indicative of a good business even though it has really high returns for owners as like having gross profit. Um because gross profit basically means that you know you have some you're doing something right in terms of what value you're able to get and give on the supplier and and customer side so that there's a gap there that you know you can make money off of. >> Make money. Yeah. >> Let's talk about gross margins or gross profit and gross margin as um like an early signal, right? You've always said that you worked for a guy that uh was, you know, he would do a lot of stuff in technology and like internet of things, right? And he would always tell you that whenever if he was ever in a company and their gross margin dropped like quarter over quarter, he immediately got out. >> Yeah. So for his own investing stuff. Yeah. Because you invest new technology things invested in that and just knew from technology stuff that you only want to be in a tech company when its gross margins going up and as soon as it starts to go down you have to sell it. Yeah. >> Why is that? Explain that logic like play it on what usually happens after. >> Sure. So there's a few different things. So so one is with tech things. So we talked about like supply and demand. It's no longer in like short supply. Um, so there's enough of it to go around, which could be that other people want to, you know, could be that things are changing technology in terms of how it's being used. It could be the competitors getting better that way. It can also be companywide. You're selling less new stuff and selling more old stuff, you know. So this is the Phil Fisher type stuff. The other way of doing it from the quant side is how many of your products are you came out with this year, five years ago, whatever, you know, and Phil Fischer that depended more on getting honest answers from people in the company and around it and everything to build the same sort of thing that we're talking about. Whereas um some people's feeling is just whatever the companyy's saying doesn't matter. If it's a tech company and there's a decline in gross margin, it means that those things are happening even though they're not telling you. Yeah. it's not as hot a product anymore. You know, tech and fashion have some similarities that way. The hope with tech is that it's not a short-term thing that it keeps being the case, right? That you have this great technology, you're going to keep that edge. Um, but whether it's a same thing with like fashion merchandising edge, you know that because we think of a fashion cycle as that happening. Um, it's the same sort of idea. You know, you want that to continue. You uh it has to be the thing that people want, the fashionable thing. >> Yeah. It's like Blackberry when when the iPhone came out. You could cut prices to keep revenue coming in, but if no one wants it, margins are going to absolutely collapse. >> And that gives you a good idea of the technology thing because while that company uh was incredibly profitable and had like, you know, magic formula type stock and all that to like losing money was a very short period as opposed to most businesses. That's why I mentioned fashion. You only see that in like tech and fashion things, you know, like you have a people can't explain why some teen retailer or something went from being the most profitable to like losing money in two years and you don't understand it. Same thing happens in in um tech things too like happened with iPhone and Blackberry and everything. Yeah. Same idea. It's a huge switch. Everyone switches from one thing to the next. >> Let's talk about Carvvada. So, you know, basically looked like roadkill, but gross profits did, you know, keep improving, which is obviously what you would want to see if you're ever looking at a turnaround situation or where you're extremely worried about, uh, you know, an impairment or something like that, right? Um, saw this tweet. So, we had obviously wanting to talk about Carvana on the podcast and then I woke up and I saw this this morning and I thought it was funny. Carvanao was down 98.99% from 2021 highs. It's now up nearly 9,000% from the lows. And you said the stock market is wild. I mean, that's pretty crazy. Think about that. >> Yeah. Although that's that's flat if you owned it before and after. We have to do the math of that for people so that 9,000% it's in the same place. Yeah. >> Yeah. >> Um, yeah. So, I mean, let's look at the companywide things because I just know something about the unit economics from years ago, but which is kind of why I mentioned it um to you a while ago is that um this is one of these cases where it was interesting because the company's basic economics seemed like it wasn't impossible that this could make sense, you know. You know, so I've looked at companies like this, Chewy, some other ones where you go, I really say just uh management saying one thing, you could look at it one way. It might be possible to make money on each order, but it's it's hard to know. It's very attractive for customers if this is true. Um, and Carvana is very very good deal for for customers, good experience for customers. I mean, people should sell their their used cars to Carvana. Definitely, I would recommend it. But I would recommend Movie Pass and I took advantage of Movie Pass. that has nothing to do with whether the business is any good or will survive. I mean you could obviously it's very easy to offer people something that they would prefer um than to make it a profitable business. So um but the problem of that was was scale right was always the question of how quickly would it scale and keep getting better and that's the point that I was mentioning before where you asked like why would something have a negative gross margin or in Carbon's case I don't know if it was negative but in 2015 161 17 has a gross margin of 1 to 8%. um like the I mean car dealers might have something almost as low as 8% if it's like a fleet thing and something maybe on like actual car sales I guess. So like you know they don't make a lot of money on new cars but this is companywide. So the reason why they would sell you a lot of new new cars or something is because then they get your business for service and other things. you know, in those years, what Carvana was doing is not something other dealers would want to copy because they would just think you couldn't make any money off of it. Um, you know, that's too low on amount of uh that's too low in terms of how much profit you're trying to generate. Um, and then, you know, as you go on, you can see, let's see the gaps there. So, that till they eventually have um, uh, a big improvement into the operating to actually operating profitability in 2024. Mhm. I mean, what happened during these years? We're familiar with car prices and and in and dealerships and what happened. Maybe take our listeners through that. >> Okay. So, some of it's complicated because of accounting rules. Some of it is is somewhat misleading. Um, if we looked at cash flow things, the the economics were were worse and they were closer to bankruptcy than those numbers would suggest. Um, they're probably very very close. Um, because I mentioned this once about Tesla. there's a period where like margins expand or something people were impressed during co uh if there's lead time between when you make something and when you're selling it and there's inflation uh that margin doesn't exist. So there's a period here where there there's a gross margin that's it's just it's phony. Um there's no if you went then went and replaced the car, you know, you you sell a car and then you turn around and you have to replace the car, but you don't have enough money to cash to replace the car. Now, if you're being if you have certain credit arrangements and stuff, which you know, dealers do and stuff, then it's a little more complicated than that. You only have to replace part of the value of it because most of it's being provided by the the the dealer and by the um like floor plan financing and stuff. But um basically, if it's an allcash business, there's a period there in which you are selling inventory and you don't have enough money to buy more inventory because cars have gone up in value more than your markup on the car. So that's an initial period there in COVID that's happening that uh let's try looking at the cash flow thing to get an idea of what I mean on a cash basis the business wouldn't have really been generating at that point. Um and so because you can see yeah so um yeah cash from operations is significantly negative in fact the most negative ever right from 2019 to 2021. Yeah, the story went from oh, we're improving and then in 2021 2022 it went boom like just completely. >> Yeah. Let's see. But we have net income. So we can compare to some extent I mean net income is not the best measure for this but you can compare to some extent the what I meant about the cash in relationship to the income and everything in that it's significantly worsening because before all that let's say take 2017 as a clean measure um you know your net income was negative 160 million and your cash from operations was a use of 200 okay a few years later your net income is not that different you know it's like report -3654 -287 but you've now tripled or or worse your cash flow from operations in terms of um the the burden that's happening there. So the the quality of the earnings has deteriorated during that period. um you know and that's a weird thing to say because they're reporting losses but it's even worse than the losses they're reporting at that time the reality of the business and then later it changes and then you have positive cash flow from operations in uh the last couple years two years basically >> and significant cash flow yeah >> and the stock is up 9,000% off the bottom >> but back to >> yeah well it yeah we talked about quant things if you quan could come up with a way to predict when the market will think something's about to go bankrupt and yet there's a high probability it will not even probability there's some decent possibility it won't go bankrupt that's the best thing in the that's the best inside information you can have in the market you know people always talk about like oh there's going to be a choir or something the best thing you could have is like you know ahead of time that someone's going to restructure a loan or something and everyone else thinks they're about to file for bankruptcy on Friday or whatever um which is what happened here yeah if if you could tell the difference between things that are going to be bankrupt and uh you Chapter 11 and and those that are going to recover in some way, even if they never get remotely back to where they were, that's going to make you a lot of money. >> Let's talk about uh you know, to close this out. Um I mean, don't want to bring it too much back to fashion because I know that that's harder to judge, but um Crocs, this is a company that's talked about a lot recently. Um gross margins obviously very good, have improved over time. Uh trading like a home builder. So, you know, what's what's going on here? Is this a fad or or is it a trend? What is it? >> Yeah, I think that's a good way of putting it. And I think that's the same sort of thing that you see with home builder. Same idea. So, I mean, you wouldn't you'd say, oh, um, what does Crocs have to do with a home builder? But, it's kind of the the theme of what we've been talking about today is that what does technology have to do with fashion or something? The issue is how do people differentiate between this is a trend? So all these things when you have good margins and expanding gross margins there's a trend and that's kind we talk about the quant things momentum wise the business momentum is great let's not even worry about the stock price momentum we're all agreed on this the question is are you too late is it about to turn those sorts of things is it sustainable the best thing would be if you have you know business momentum that's expected to be sustained for a period of years or something um because even if you're not going to own the stock for years they'll just be good news the whole time that you do own it and then sell it you know um but here you see the multiple is low Right. And so people have downs. Um it has, you know, good revenue things. There's been years where gross margins higher, but it has very high gross margin variability. So I wouldn't worry that much about that. Um there's no trend towards worse gross margins in the last few years going into this. Now there might be now we could look at quarterly and stuff. Um but that would be the obvious thing would be people's concerns about that, you know. Um yeah. So, I mean, yeah, quarter to quarter there's declines, but seasonally there isn't really. Um, so yeah, you basically I mean I won't tell you whether you should buy the stock or not, but I think you can tell in the case of Crocs. I think you can tell in the case of homebuilders um that there's an expectation that the future is going to be worse from a supply demand case. So, in other words, like this is kind of a there's maybe a uh they don't expect crocs to become an even bigger trend, let's put it that way, than this right now. And they don't expect uh home building in terms of inventory and stuff probably to be a better situation than it is um been recently. I mean, because otherwise they would put those multiples much higher if you just look at what the results are. Mhm. Mhm. And then Deckers, another popular uh company, hookah brand name. That's what I wear. Uh got a pair of hookas. >> Kind of could see in your just everyday life how much that brand has taken off, right? Seems like everybody wears those. Um >> but uh another example of, you know, so revenue growth has just been incredible. Um but also growth margins and gross profit growth has been incredible. And you could see right how much that has scaled uh from like an operating margin perspective. So probably SGNA is a percentage of revenue uh has gone down right and that's what you want to see when you see companies growing a lot. >> Yeah. And you can see there the multiple is much higher. So presumably people are more optimistic about that one. Yeah. We could we have like first Nike or one of those because those are the ones that are the losers to you know um Nike in particular I think. uh has been the loser to some of the trends that you were talking about about that people are probably more concerned about um some of the more recent ones in the running shoes type space. I don't know if people are really running with them but you know that look >> yeah we got Nike pulled up right here um you could see you know revenue growth 10-year keer 4.2% but gross margin has been falling 46% in 2016 to 42.7% in 2025. Yeah, I don't know the business. This is always one that amazes me in terms of the price that it has and versus what its results have been recently. Obviously, it's it's famous as a amazing business long term. Um, yeah, because you're looking at something that's I mean, you know, let's see. Um, well, okay. Yeah. No, no, no, that's right. So, the the Okay, so the peak profitability was the last few years, not not this most recent year. So if you price off of that, it's more like 20 sometimes like record earnings probably 20 times or something. So the P isn't as bad as it looks that way. Um you know, so it could bounce back to where it was just a few years ago. But what's the market cap on it? The EV, if you could just >> EV 112 million. >> Yeah. So I mean even if you look at peak, it's probably it's certainly over 15 times uh and more like 20 times pre-tax uh what it kind of peaked at in terms of profitability. So, even it got back to where it was just a year or two ago. Um, you know, that uh it's not a cheap stock. I mean, it's it's it looks kind of expensive for a stock that's only grown sales by 4% for 10 years and and hasn't grown EPS at all, although it did until this most recent year, I guess. So, >> I mean, Deckers versus Crocs, I mean, what's the difference here? Why does Decker trade at a higher multiple basically double what Crocs trades at? >> That was my point. My my feeling on that is the same which is why I mentioned homebuilders and stuff is that value investors look at these things and go >> oh Crocs is so much better than Deckers or oh this particular home builder is so much better than the other one. Where you want to be careful is we could say it's clear that something's priced into the differences in terms of people who think they know something about fashion, let's say, or think they know something about particular home building markets or whatever that there's concern and that could clear up. They could be thinking, "Oh, things are about to be really lousy and and uh you know, they're not." I mean, like four months ago, no, maybe like five months ago or something, you saw things in the stock market that indicated things around travel, uh yeah, anywhere from three or five months ago, uh travel, tourism, um spending by certain things like that were all like there was concern about it. And then the kind of as the year went on the it seems like the market's not concerned about that kind of consumer spending. So the same thing can happen with any prediction here. They're probably concerned about one things um fashion versus another. And I'm sure that that's why we mentioned the home building thing. It's the same thing. People there's certain markets where people are concerned about what they see in terms of inventory or something. Mhm. I mean, it's hard to, you know, I mean, you look at like Crocs and you see that they're selling like charms for for their shoes and be like, "Huh, that's kind of interesting." Um yeah, that's a really big part of it of the whole um thing I think over time for them that's helped them is creating that kind of uh like um like Pandora the jewelry company and stuff, you know, building up a whole thing around what it is for the um uh for people to buy more of them and to be more loyal customers and to be a certain kind of uh buyer versus some of the other things that we're looking at. So I always find that hard to to analyze. Yeah. >> I I just wonder if they look like do or do investors look at Crocs and say, "Oh, it's sort of, you know, single thing." And then maybe they look at Hookah and say, "Oh, they're trying to become more of like a platform company, right? You got UGG, which is obviously super popular." Um, shut up. Um, and I will say this, um, honestly, >> there will be a strong tendency for investors to overvalue something like those shoes that you're seeing there, uh, the running shoes and stuff company and undervalue a Crocs. Uh, this is something I've noticed across my whole time investing and it's definitely very pervasive. If you have something like AI or something, investors don't understand it, don't whatever, you know, but they can or it could be biotechnology, it could be all sorts of things. If they don't understand it, but it's not something that's just not to their taste or fashion or whatever, then uh they may give it a high multiple. If it is something that's very appealing to a group of people they are not, uh it it tends to have a low multiple. So that's one thing that you just notice. Um that's almost universal. If investors tend to be from urban areas and things and this is a rural thing, the rural thing will be undervalued relative to the urban. If they're male and uh it's almost exclusively bought female, then it'll be that way. I mean, there's just one thing after another where I've seen that generationally there's all sorts of things. So, um yeah, and that's what I mean about fashion type things. So, when it gets into things like this, there's an idea of like uh this makes sense to me that people buy this product. it doesn't make sense that they would buy that product. And that's fine, but the one thing you want to ask is like, well, does that reflect your tastes, right? Because that's the important thing uh there is to make sure that, you know, um it isn't affected by that. You know, >> maybe these two should just get a room and merge together, solve everyone's problem. >> Well, yeah. The interesting thing about it, and this gets the gross profit thing, is um does that solve it? So, there's companies that have done this. You put together lots of apparel things or you put together lots of um shoes or whatever, right? Uh what was the one the uh the best example that was? Um well, actually, there's a couple examples in in apparel. Um but I was going to say like um which is North Face and all those things. And then um uh you know and so the point is as you get each of these brands um they often you're often buying it happens a little in restaurants too. You're buying a brand that's supposed to be faster growing have better more attractive things at the time you buy it and then over time as they mature in what you own they don't look like that anymore. Um you know what I mean? So like a mature brand isn't as profitable in terms of being able to charge a lot for and stuff as a hot brand. And so you have a tendency to put together things that are hot brands at the time that you bought it. And uh but over their whole life cycle they end up looking like the brands you already had, you know. >> Very interesting. Very interesting. So I guess what I mean this scenario right here, right? I mean, Crocs because of the price you think would be more interesting to you or is this more of a bad? >> Uh, no. I I would think that anything that I think I would have these sorts of quantitative numbers that look good and then I think I have some edge that's not quantitative in would be something that would be attractive. And then in the vice versa cases where I think other people who are buying the stock know more than I do about it. Um, yeah, but I wouldn't just be contrarian to be contrarian on something like that. But I did mean that seriously because like when you were talking about the charm things and stuff. Yeah. For people who have the the shoes, they know all about that and that's a big part of it is being able to do that as an expression of things that they're into and stuff to put that all in the in there which other shoes don't have and don't seek to have. So it does differentiate it in a important way. Um it doesn't mean that it's not a fad, but I just mean it's different. It's a highly differentiated product certainly. Yeah. It's kind of like Keely's, right? Yep. which was a fad, but a highly differentiated product. Yeah, water beds. Highly differentiated product that no one uses. I mean, >> bring them back. Bring it back. Water beds. My grandparents had one. >> Awesome. >> You know, so >> I think my grandma developed back problems because my grandpa was heavier, so it shouldn't be down. It should be like up in the air, you know? >> But whatever. Mattresses are a really good example that way because we've cycled through so many different ones where we have to come out with a new technology, new way to market it, >> new business model on it, >> negative gross margins. >> Yeah. And so whether it's purple or tempropedic or sleep number or um you know where we talk about going back to water beds and things like that, it does allow you as a technology slashfad to have high margins at the time that you're selling them then. And then once it becomes mature and it's just like everybody else has a knockoff of this, those margins go away. And so we have to kind of reinvent that, you know, sort of thing. It's like if it's kind of like if you had a drug and it was a under patent and stuff and then it's a uh generic now you got to go find the next that's not a generic to, you know, fix up the portfolio. >> Would it worry you to be like we have a new way of distribution, a new way of marketing this product that's been around for a long time and has just like always never worked from like an investor standpoint? Yeah. Yeah. So I mean this is where we talked about. So so you know I don't >> like Carvana was not that Carvana. Okay. Like dealerships have worked and are very profitable can be very profitable and this was a different way for that. >> Yeah. >> Verse mattresses. >> I mentioned venture capital things before. Don't do any venture capital investing. Don't know anything about it and stuff. But if I had no numbers to go off of overwhelmingly it would be is this a product that sells itself and doesn't have good distribution now versus is this something that has good distribution. I'd be much more interested in something that the product is seems to have a good sales proposition but has really bad distribution. And the question is just can we get it in certain doors? Can we get an affordable way to sell this thing to people and bring it to them but when they see it they'll like it. But if you're talking about oh everything's great but in a focus group they really don't like this product. Um then that would be the one that I would avoid. I would much rather uh you know it it just has really good um uh well like we were talking about uh movie things before, right? So Princess Bride got one of the highest ever scores with exit audiences and it didn't do that well in theaters, right? But it had a long life on on a distribution after that and stuff. That's the kind of thing that someone in the industry would be like, "Oh, I'll buy this from you." Like even though it it opened poorly and stuff because we know that it had one of the best ratings by people who actually saw it. So the problem was just marketing. Um, marketing is really important, but if you have a product that that people really like, but just doesn't have good marketing or we talked about Celsius just wasn't in a lot of places. And so, it's just a question of getting to more places, will it sell more? You know, you've already had it proven. That's the Peter Lynch kind of thing of like I feel like these companies don't um go private at such an early st go public at such an early stage when he saw them, but oh, it's in a town, it's got eight locations, they're doing great. It wants to raise money so it can then go to the next town in the next state and uh you know whether that's a linto or a fast food thing or whatever the that's yeah that's the best it's got proven um numbers on the really basic numbers >> unit the business model. Yeah the unit economics. Yeah >> and yet it's not showing up yet in the the statements. Yeah. So what we talked about here it's showing up in the statements but it's showing up at a much higher part of it. So maybe you're early compared to someone who's looking at the bottom line by looking closer to the top line. >> Cool. Good job out of you, Jeffrey. Well, I want to thank everybody so much for tuning in with the both of us on the Focus Compound podcast. Make sure you hit the subscribe button wherever you are listening or watching us to be notified every time that we upload a podcast every Friday from here on out. Uh be sure to follow me on Twitter or X, formerly known as Twitter at Focuscompound. And of course, if you're interested in learning about our money management services, you can reach out to me at andrew focuscompound.com. I thank everybody so much for all the support and we will see you in the next podcast. Take care.