Current Market Conditions & Investment Opportunities w/ Derek Pilecki (TIP758)

Summary

• Investment Strategy: Derek Pilecki emphasizes a flexible investment strategy that includes both shorting and going long on stocks, as demonstrated with Robin Hood, where he successfully shorted the stock before buying it at a low price.
• Market Outlook: Pilecki expresses concern about the overall market appearing expensive, particularly large-cap stocks like JP Morgan, Progressive, and Visa, while seeing potential in small and mid-cap stocks with single-digit P/E ratios.
• Banking Sector: He highlights opportunities in small and mid-cap banks, especially after the failures of Silicon Valley and First Republic, and notes the potential for increased profitability with a steeper yield curve and deregulation.
• Value Investing: Pilecki discusses the evolution of value investing, stressing the importance of combining value with momentum and being patient for stocks to form a base before buying.
• Interest Rates and Economy: He argues that current interest rates are restrictive and suggests that rate cuts could benefit interest rate-sensitive sectors like housing and autos, while criticizing the Fed's focus on inflation.
• European Banks: Pilecki has started investing in European banks, noting their undervaluation compared to tangible book value, with French banks like BNP Paribas and Société Générale showing promise.
• Operating Leverage: He highlights the potential of operating leverage in companies like Robin Hood and Anywhere Real Estate, where profitability can significantly increase as revenue grows.
• Financial Sector Focus: Pilecki's fund is concentrated on the financial sector, finding opportunities in fintech, European banks, and regional banks, while being cautious about the long-term trajectory of banking returns.

Transcript

(00:00) So, I feel that only a true master of  their craft can make money shorting a stock   and then turn around not too long after and  go long before it becomes a multibagger. So,   that's exactly what you did with  Robin Hood. There were two, you know,   environmental reasons why they missed the  quarter and I just thought they were temporary   and it it traded down to the $8 where I bought  it and they still had that $8 a share in cash.  (00:23) also like technically it had built a big  base like it you know had covered in March of 22   and from March of 22 to November of 23 the stock  kind of was flattish and it had built that long   base. So it you know I got fortunate that it took  off soon after I bought it and that was just good   timing, good luck. [Music] Before we dive into  the video, if you've been enjoying the show,   be sure to click the subscribe button  below so you never miss an episode.  (00:56) It's a free and easy way to support  us and we'd really appreciate it. Thank you   so much. Welcome to the Investors Podcast. I'm  your host, Clayfink, and today I am happy to   welcome back Derek Pleki. Derek, welcome back to  the show. Hey Clay, good to see you. Thanks for   having me back. So, I've really been looking  forward to this conversation as I definitely   enjoyed our last discussion about a year ago  where you shared your humble beginnings of   launching a fund all the way back in 2008, just  weeks before the collapse of Lehman Brothers.  (01:26) And since we last spoke, you rounded  out 2024 with a 41% return net of fees. And   through July of this year, you were up  another 21%. And so it's looking like   you're well positioned to have three years in a  row of really strong performance. And you know   that can even tend to be bad news for all of  us because usually after a few good years, you   tend to see a down year across the entire market. (01:52) So before we dive into my set of questions   here, I'd like to give you a chance just to  comment on your recent performance and some   of the things that you're seeing in the markets  today. Yeah, man. I think the story over the last   three years is really I navigated Silicon Valley  and First Republic's failures pretty well in 2023.  (02:06) You know, I was underweight regional  banks and after they failed, I drastically   increased my p my waitings and regional banks.  You just doing a lot of work on were the deposit   franchises intact across the country and the  valuations got extremely cheap. So that was one   big driver of returns over the last three years. (02:26) I worry about the same things that you do   like three years of strong returns that you know  is it over or you know do we have some reversion   to the mean and when I look at the overall market  I mean it looks expensive to me like generally   just as an observer and even within the financial  sector I look at the the very large cap stocks JP   Morgan Progressive Visa they look expensive  to me but then when I look at a lot of small   midcap names they're singledigit PE still and  so how does that resolve itself like can these   small stocks do well when the big stocks (02:57) underperform to get reversion of   the mean or will everything go down and the big  cap stocks will just go down more than the small   stocks. I don't really have a a good answer. I  don't know how this seems like we're getting the   effect of so many passive flows into the SPY and  all that money is going into the S&P 500 stocks.  (03:15) You have, you know, the Russell's  lagged for years. All these midcap stocks   are kind of like don't really have sponsorship  and that have cheap valuations. I don't know how   that gets resolved, but I I think over time I've  just gotten comfortable of if I own cheap stocks,   good things happen. And so, you know, I'm  not looking at my portfolio and saying,   "Oh, I wish I could sell this stock. (03:33) I wish I could sell that stock."   I still have an idea list of things to buy  cheap stocks that look interesting. So,   I don't know exactly how it's going to play out,  but you know, I'm not not running for the hills,   but large cap stocks look rich to me. Yeah, that's  definitely well said. and it's played out well for   you to uh you know definitely stay long the market  and not try and hold too much cash and whatnot   uh to the best of my understanding at least. (03:57) And you've previously mentioned um   that you'd like to find stocks that have a  clear path to doubling over the next 3 years.   That would equate to essentially a 26% return  compounded. Certainly a a high bar. How about   you share an example or two of how this ends up  working out in practice because I know you're   fairly agnostic to buying say quote value stocks  or quote growth stocks and I even think back to my   days playing sports where my coach would tell  me to just take what the defense gives you.  (04:30) You're not trying to be married  to a certain way of playing or a certain   way of investing. You're simply taking  whatever the market is willing to give   you. Yep. Yeah. So I mean that rule of thumb  of a double in three years sometimes it works   out faster than you expect and sometimes it  doesn't work out at all. So I guess I want to   give you a both good and bad examples of that. (04:51) So um you so like I own Carile Carile   private equity manager probably underperformed  its peers since it's been a public company. They   they botched the CEO transition from the  founders to the the next generation five   or six years ago. They did it did a second  attempt. They hired the former CFO of of   Goldman, Harvey Schwarz, to come in. (05:14) And so like at the end of 22,   it had really underperformed KKR and Blackstone  and was trading for 10 times fee related earnings.   You know, just exiting out the carry, just what  do they earn on their management fees? And I think   Blackstone was like 22 or 23 times at the time and  KKR was at 17 times. And at the end of the year,   I just like to look at different sectors  of like what stocks have lagged the sector   and is there a reason? And I I noticed  at the end of 22, Carlilele had lagged   its peers and it was at 10 times earnings. (05:41) You know, people look for catalysts.   I think CEO changes for underperforming stocks  are are generally good catalyst or can be good   catalyst. And so I thought there were some  easy things that Schwarz could come in to do,   especially since I thought Carlile's  expense structure was too high. So,   you know, I bought the stock and I think I  paid $29 and here it's trading, you know,   a little less than three years later at 65. (06:06) So, it's been a double in three years,   I guess. You know, an example of something that  hasn't worked or maybe hasn't worked yet because   we're not to three years is, you know, I bought  PayPal 18 months ago. Cheap value stock. A lot   of value managers own it. Um, valuations come  way in. Again, CEO changes catalyst. The guy,   Alex Chris, came from into it. (06:25) He ran the QuickBooks   franchise. I thought he could refocus the uh  the spending internally to focus on three core   products. And it started to work. they had  a hiccup reporting Q4 earnings this year. So   the stock's unchanged since I bought it. Maybe  it's up a tick, but it's certainly not a double.  (06:41) So sometimes it works, sometimes  it doesn't. And then, you know, a name like   Robin Hood, which we'll talk about in a little  bit. Like that happened a lot quicker and in a   greater size. So like I think that rule prevents  me from trying to be too cute and buy names that   I think I'm going to make 20% on. You know,  it's just like you only have so much capital.  (06:59) I really want to focus on the ideas  where you can make substantial money and you   know you can tie up a lot of capital trying  to earn 20%. And so I I just try to avoid   those ideas. And over the time period that  you've managed your fund, many would say that   value investors generally have not done too well. (07:20) You know, buying cheap stocks just has not   worked the way it has in the past. And I have this  theory that value investing has always worked,   but the key of value investing is buying companies  that are actually undervalued instead of focusing   on the value factor of low PE, low price to  book and whatnot. So, how about you talk a   little bit about how you think value investing has  evolved in your view and how you've been able to   successfully apply the fundamental principles of  value investing in an era where it seems that just   so few have been able to do it (07:52) effectively.   Yeah, that's a great question. Like I've been  really shocked by the performance of growth   versus value over the last few years. And you know  the mag seven are such good cash flow businesses   and have such big moes like they've really  driven the growth stocks and to the detriment   of value stocks, right? And so the quality of  the businesses have been just so phenomenal.  (08:14) Um I mean I think some value investors  forget or you know sometimes don't apply momentum   as a um a factor that drives returns. So like  really the ideal thing is value plus momentum   drives returns. It's not just cheap.  You have to have some kind of the stock   has to be moving. And so like I I think the  classic value investor air is buy too early,   sell too early, right? Like something looks cheap. (08:40) We can all pull up a chart and see,   oh that chart looks ugly. But value investors  like oh I don't care about technical analysis.   It's cheap. I'm gonna buy it. Whereas I'm more  just aware of technicals as a you know as a thing   in the market like I I don't buy charts but  like I look at charts. We all look at charts.  (08:58) I think the most dangerous is a  fundamental analyst who claims they don't   look at charts and then first thing somebody  does when they mention ticker is they pull   up a chart. Like we all do it, right? And  so like by default you're doing technical   analysis when you pull up the chart. So I learned  this from one of the the PMs early in my career.  (09:15) where I worked for Clover Capital and Mike  Jones who ran Clover Capital. They had a great   fundamental analysis and then when growth and  value went different directions in the late 90s,   they re-evaluated their their investment process.  And they said, you know, we're classic value   investors. We buy too early and we sell too early. (09:33) If we like a stock, we're going to wait   until we see some kind of base in the in the chart  before we start buying the position. And on the   exits, we're not going to just sell when things  hit our price target. we're going to wait and   we might sell a little bit at the price target,  but then if the chart looks good, we're going to   let momentum run and you know, maybe the market  will walk it way beyond our expectations and so   we're just not going to cut off our returns. (09:57) And so, you know, that goes back like   it's the same thing of um Peter Lynch of, you  know, you don't want to cut your flowers and   water your weeds. All those sayings kind of  get to the same thing of you have to let the   winners run. And so, I think that's something  that I apply pretty well. And uh you know I   do it from a riskmanagement standpoint. (10:14) Like if I buy a stock and it goes   against me, I don't automatically buy it. Like  I I just think, okay, the market's telling me   something. It's not that I will never buy a stock  that's down, but I just am very disciplined about   saying no, I have some edge to buy a stock that's  gone against me. And that's kept me out of like   dumping a lot of good money after bad. (10:36) So those are just some things   that I think about that, you know, other  errors I see value investors making. Yeah,   when I look at the the chart for PayPal, it sort  of went into the stratosphere back in, you know,   2021 when everything's taken off. It goes from  100 bucks a share to over 300 a share. And then,   you know, once that sort of tech bubble popped  in November 2021, you see PayPal stock just come   straight down the way it was going straight up. (11:03) Um, so when it comes to PayPal,   you're sort of waiting for it to form a  base before you get comfortable entering.   and you um look at some of those catalysts like  the CEO change. Yeah. So I mean I thought the   base had been formed last year like I I bought it  maybe April May last year. We had the CEO change.  (11:21) It had based for a couple years hadn't  gone anywhere. It wasn't really making new lows   and then the stock started working late  last year and then kind of had a setback   this year with the fourth quarter wasn't that  good. They've had a couple of okay quarters   since then. Little bit of deceleration in  the business. like they have one business   that's growing that's relatively low margins. (11:40) So, it's driving the overall company's   margins lower. People don't love when margins  are declining. So, I'm not adding to the position   here. Like, it's still around where I bought it.  It's not making new lows. So, you could say this   base is still forming, but um you know, I I need  more evidence. It probably will be a a better buy   to buy it at 90 after we've get some confirmation  of good news or good things happening.  (12:05) it might be less risky to buy it  higher and let the the market tell you   that they've fixed things and it's on a a good  momentum path. So earlier this year, April 25,   markets were really dropping like a rock due  to the tariff talks. And with the benefit of   hindsight, it looks a fairly similar to the drop  we saw in March 2020 in terms of the severity and   the duration, right? You know, at one point the  S&P was down around 20% before swiftly rebounding.  (12:34) And to take advantage of this, you would  have had made changes to the portfolio rather   quickly. And you know, it's tough to make some  changes if you don't have cash, right? You know,   to fund one position, you're going to have  to sell something else. So, talk to us about   your level of activity during this period and how  that might have impacted the portfolio at large.  (12:54) Yeah, I mean I would say I was  relatively active. Like when things are moving,   um I try to be judicious about how I act, but  I I'm not afraid to if I see opportunities to   move stock. So, you know, in the the two days  after liberation day, the KRE regional bank   index ETF was down like 13 or 14% two days. (13:16) And I think that's the playbook that   the macro investors have of recession risk  goes higher, sell regional banks. And I have   a fundamentally different view like this is not  2006207 as far as what the credit books look like   at regional banks. The capital and liquidity is  so much better than it was then. I don't think   in the next recession banks are going to fail. (13:34) Like I just I just don't I mean there   might be a few banks that fail, but I just don't  think it's going to be the whole industry goes   down. And so I used that when you know it was  a little scary because I was like okay what   is he doing with these tariffs? like is he really  trying just to crash the economy or and clearly in   the following week it was clear that he didn't  want to crash the economy and he was going to   not be dogmatic about imposing those numbers. (13:58) I think the catalyst was he he gave a   delay like a 90-day delay and so that pushed  out the tariffs from April to to July and so   the market rallied there but like when we got  that indication I covered a lot of my regional   bank shorts like I'm long a bunch of regional  banks I'm short some others you know ones that   I think don't have as strong a management have  higher valuations may have done an acquisition   that I don't love so I'm just generally  short a bunch of regional banks and but   some of them got down to you know eight times (14:27) earnings And as much as I might not   like the management or some deal they did  at eight times earnings with them being   down a lot in recent days, I covered  a bunch of regional bank shorts. And   so that benefited me. They ripped  higher after, you know, the delay   and the pause and the tariffs being imposed. (14:45) But those are super stressful times.   Like it's where you make the performance. You can  make a lot of performance those by being smart.   But you can also mess things up and you know your  emotions affect your decision-m so you just have   to take a deep breath and say okay here's if I was  the only investor in the fund what would I do like   try to ignore that I'm dealing with people's money  like I don't want to put too much more pressure   on myself I'm already down like just let's do  the smartest long-term thing we can and just  (15:15) trying to manage those emotions  and then also earlier this year I attended   the Berkshire Hathaway annual meeting in May  and at the end of the Q&A, Buffett announced   uh unexpectedly that he would be stepping down  as CEO of Berkshire at the end of the year. And I   know that Buffett has had a big impact on you. (15:36) If I going off memory, I think you   mentioned last time that uh after reading  his letters, you decided that you wanted   to become a fund manager. You can correct  me if I'm wrong there. Perhaps you could   talk more about how Buffett has influenced your  investing over the years. you know, Buffett has   been super important to my investing career. (15:54) So, you know, I read Roger Loenstein's   The Making of American Capitalist, which was  really the first Buffett biography that came   out in 1995. Um, you know, the internet really  was just getting started then. So, there wasn't   as much information about Buffett as there is  now. And so, like that was really eye opening   to understand his career and his investing. (16:13) And so, I really appreciated that.   And then when I went to business school at the  University of Chicago, one of my classmates,   Dan Klowski, who used to run the Janice  Contrarian Fund, um he took us all to   the Birkshire Hathway meeting. So I went  to the May 2000 Bergkshire meeting and it   was right at the peak of the internet bubble. (16:31) So it was super interesting like at   the time Buffett was 69 and he was it was so  surprising to me. He was so energetic and so   jovial and you know thoughtful about his answers  and I just thought it was a huge gift that you   have this billionaire super investor who's sitting  on stage answering all questions for six hours and   um and so I guess that was also the meeting  where he said if I had a million dollars I   guarantee I can make 50% a year and that was you  know it's a shocking statement right like it's   easy to dismiss it of like it's arrogance but (17:04) I took that comment and thought about   it like what would cause him to say that like  how would he do that and you know looking back   early in the the Buffett partnerships I know  he had much higher turnover than he does now   right I mean he's due to size he's buying high  quality companies and owning them for decades   right but when he ran much smaller sums he  was turning over his portfolio and you you   can either make a lot on a stock or you can make  a little bit on a lot of trades and I think if   he had a million dollars he'd make a lot of (17:36) small smaller trades and you know I   don't mean smaller like 10 or 20% and  like he'd buy things and they'd be up   40 or 50% and he'd just cycle over the  portfolio and then he'd also use leverage   um you know he used leverage in the early days  of the Buffett partnership he uses leverage at   Bergkshire it's just float leverage it's not  you know debt leverage um and so thinking about   those things like how could you do that so like  in the early days of my hedge fund when I was   you know trying to put points on the board (18:04) like I turned over the portfolio   some and you know then there's I'm just not afraid  of trading when there's opportunities and kind of   just hearkening back to that that Buffett quote  of like turnover can generate returns and so I   think a lot of investors just think oh you have  to be buy and hold and you get wedded to these   positions like if it's not working you don't you  need to stick with it like you can move on to the   next thing another idea um sometimes you see a  lot of opportunities you're not stuck in your  (18:32) existing positions you can turn over your  portfolio and that will actually generate higher   returns. Now, there's certain environments where  with trending markets or or things that are not   moving a whole lot, turnover is not helpful.  But in markets that are moving, opportunities   present themselves and turnover is not bad. (18:50) So I I think the other thing that that   struck me that Buffett said that I don't hear a  lot of people talk about at one annual meeting   and I don't remember if it it was definitely in  the early 2000s like I don't know if it was 2001   or 2002 but he said something along the lines  of if he had to change anything in his career   he would have been more optimistic and taken  more risk which is pretty amazing for him to   say because he's a known as a permable like he's  super optimistic about America and the economy   and he's long stocks in a leveraged way right and (19:19) so like for him to say I should have taken   even more risk. I think that I don't hear people  talk about that but like that has changed how I   think about the economy. Like I think there's a  lot of people who are talented in this country   and around the world that are acting in their own  economic interests and that creates value for them   and for the economy and for the stock market. (19:40) And so I think it's it's better to be   a permable than a perma bear, right?  you optimism makes you more money.   And so I try to try to remember that. I  mean, being bearish sounds sophisticated   and like you've figured something out that's  going to but the timing of that is so hard.  (20:00) And so like it's better to be optimistic  and I try, you know, I I use a little bit of   leverage in my portfolio. I try to I invest in  some companies that are not the highest quality.   And I just I'm trying to be long-term optimistic  and that good things happen to the ones that are   optimistic. So those two things like how would  you get 50% of your if you managed a million   dollars and being long-term optimistic. (20:23) Those are two things that I've   taken away from Buffett that I don't hear a  lot of other people talking about. Jim Ran   once said that you're the average of the  five people you spend the most time with.   And I really could not agree with him more.  And one of my favorite things about being a   host of this show is having the opportunity  to connect with high quality, like-minded   people in the value investing community. (20:45) Each year, we host live in-person events   in Omaha and New York City for our tip mastermind  community, giving our members that exact   opportunity. Back in May during the Bergkshire  weekend, we gathered for a couple of dinners and   social hours and also hosted a bus tour to  give our members the full Omaha experience.  (21:07) And in the second weekend of October 2025,  we'll be getting together in New York City for two   dinners and socials, as well as exploring  the city and gathering at the Vanderbilt 1   Observatory. Our mastermind community has around  120 members, and we're capping the group at 150.   And many of these members are entrepreneurs,  private investors, or investment professionals.  (21:29) And like myself, they're eager to  connect with kindered spirits. It's an excellent   opportunity to connect with like-minded people  on a deeper level. So, if you'd like to check   out what the community has to offer and meet with  around 30 or 40 of us in New York City in October,   be sure to head to thespodcast. (21:49) com/mastermind to apply   to join the community. That's the  investorspodcast.com/mastermind or   simply click the link in the description  below. If you enjoy excellent breakdowns   on individual stocks, then you need to check  out the intrinsic value podcast hosted by Shaun   Ali and Daniel Mona. Each week, Shawn and  Daniel do in-depth analysis on a company's   business model and competitive advantages. (22:16) And in real time, they build out the   intrinsic value portfolio for you to follow along  as they search for value in the market. So far,   they've done analysis on great businesses like  John Deere, Ulta Beauty, Autozone, and Airbnb.   And I recommend starting with the episode on  Nintendo, the global powerhouse in gaming.  (22:36) It's rare to find a show that consistently  publishes highquality, comprehensive deep dives   that cover all the aspects of a business from an  investment perspective. Go follow the Intrinsic   Value Podcast on your favorite podcasting app and  discover the next stock to add to your portfolio   or watch list. Yeah, that that's so well put. (22:58) And you know, I just love how you looked   at someone like Buffett and you uh launched your  own hedge fund. Being the sole investor at day   one, just figure it out, trading a lot when  when there's a lot of volatility and whatnot.   being willing to bet big when you find the right  opportunities and it's certainly worked out well   for you and Buffett is uh also an investor  in the financial sector you know he's been   very involved with insurance and the big banks  has major investments uh in that arena and uh   that's exactly what your fund is focused (23:28) on is the financial sector and   this can be pretty broad you know you have  banks brokers asset managers insurance rates   etc what pockets of the market are you finding  the most opportunities today. Yeah. So,   I I I think small midcap banks are still  an opportunity and I think, you know, they   became an opportunity after the Silicon Valley  first Republic implosions and they've done okay.  (23:55) I think there's more to go. They're  still cheap relative to their history. I   think they still have the headwind of the  the yield curve. And with the yield curve,   I think about really what benefits the banks  is the spread between the overnight rate and   the 5-year Treasury. So right now that's inverted. (24:10) It's, you know, the fiveyear is like 368   and the one-mon treasury is like 408. So it's a  40 basis point inversion. If that was steeper,   I think that banks would make more  money. Their margins would be wider.   If we go back to 7 years ago, you know,  2018, that spread was 80 basis points.  (24:32) And so the overnight rate was 80 basis  points below the 5-year rate. And now we're 40   basis points inverted. like that 120 basis points  swing is a big inversion, a big headwind for the   regional bank. We get a little bit of steeper  yield curve with a few more rate cuts, which it   looks like we're going to have and I think banks  can make more money and then the multiples can   also go up. We also have deregulation coming. (24:53) Um, bank mergers are getting approved   faster. I think there's going to be more  M&A activity. I think another area that's   super interesting is we've talked about with  PayPal's fintech. So fintech names are just,   you know, they used to be growth  names in 2021. They've fallen   out of favor. Everybody hates fintech. (25:09) The valuations are super compelling.   They're cheaper than the big banks. So like  they're a lot of single-digit PES in fintech,   you know, whether it's WEX or PayPal or  Global Payments. And so they convert a   large majority of their net income to  free cash flow. I just don't think it's   sustainable that the valuations stay down here. (25:30) And then the the third area I would say   is I've started investing more in European  banks. You know European banks have been   terrible for 15 years. 15 16 17 years. So finally  last year you know I've owned Barclays for about   six years. Last year it worked. I looked  around at other European banks and started   buying the French banks early this year. (25:52) And you know the French banks I   had fortuitous timing but the BMP was trading  for 60% of tangible book and society general   was trading for 35% of tangible book and you  know the CEO was 50 years old and had been in   place for two years. So again as CEO's catalyst  change so they've both worked this year and I   think there's more to go on on European banks. (26:14) So those are the three areas I'd been   most focused on recently. I'm glad you mentioned  interest rates there because we're recording here   on September 18th. Uh yesterday the Fed announced  a 25 basis point interest rate cut and in your   letters you wrote last month that you believed  that the Fed should cut interest rates twice this   year which is likely 50 basis points total. (26:40) So what signals do you look for   uh to determine these sort of interest rate  changes other than maybe just the yield curve   and how do you see these interest rate cuts  impacting the economy? Yeah, I think interest   rates are restrictive at this level. Like I think  there's you we have a bifurcated economy. We have   the AI non-interest rate related sectors. (27:01) They're humming along just fine. And   then we have interest rate related sectors like  whether it's housing or autos that are struggling,   right? And so like existing home sales were  bouncing here just below 4 million units a year.   Whereas in 2021, I think 5 a.5 million  existing homes were sold. And also,   real estate development has really struggled. (27:21) You know, with higher rates,   developers just haven't wanted to borrow at  8% rates to build new apartments or build   new warehouses or whatever we have. So,  the construction economy is slower. Um,   and so I think we really need rate cuts to help  the interest rate sensitive parts of the economy.  (27:40) I'm frustrated with the the conversation  with around inflation. I think there are three big   parts of the economy that are driving persistent  inflation and none of them can get saw by higher   rates. When I think about it, it's housing, um,  college education and healthcare. Like higher   rates is not going to make health care prices go  down or the growth of healthcare prices go down.  (28:04) Neither is it going to affect college  education and the housing like with the the   land use regulations and the nimism and the you  know people the zoning practices and how long   it takes to get things entitled. You know higher  rates aren't going to fix those problems. In fact,   it makes them worse. Like we've had  a slowdown in apartment construction.  (28:23) So how does that get lower housing prices  if we're not going to build apartments? And so I   think there's a disconnect here between, you know,  rates and inflation and what's really going to   change inflation. If we want to get inflation  down, the Fed can't fix those problems. Um,   how do we fix those problems? Like hospital  administration staff in healthcare is   exploded compared to the number of doctors. (28:46) Like why is there so much more bureaucracy   on healthcare? You know, college education  and same thing. Administrators at colleges   have exploded like compared to teachers. We have  so much technological improvements, but we teach   the same number of college kids. Like the the big  elite colleges emit the same number of students   in 2025 as they did in 1990. That's crazy. (29:06) You know, we can deliver education   so cheaply now. Like why are we limiting? Why  do we have capacity constraints on that? So,   and prices would just come down if we could  just um use online teaching to to educate   more people. So, like higher rates are not going  to fix those inflation problems. I think there's   also huge deflationary forces in the economy like  the internet is still deflationary globalization   you know globalization's maybe having a little bit  of pullback with the tariffs and the immigration   changes but you know internet is still a (29:36) huge deflationary force and I think   AI is going to be a huge deflationary force  in the economy so like I think rates should be   lower like I don't think it's going to create  too much speculation like maybe there'll be a   little speculation but the IPO market's  been dead for four years like I I really   don't think there's a problem at the moment. (29:56) Like I know that people are worried about   private credit or just some sectors like that, but  I really don't think that we're that inflation's   going to rocket just because they cut rates, you  know, two times the rest of the year. Yeah. Um,   I believe that Powell said that he was really  looking at the job market when it came to   um, you know, lower interest rates,  wanting to help stimulate the economy   in light of a tighter labor market. (30:25) And, uh, what's really puzzled   me over the past few years is how real  estate has reacted to mortgage rates   going up so much. You know, in 2020, I believe  people were getting interest rates below 3%.   Um and then just recently you see some mortgage  rates are at around 7%. You know that that is a   significant uh increase in the cost of interest. (30:48) Yet the home prices overall haven't   significantly come down and part of that's just  you know there's not a lot of activity. Some   of the more pricier markets like Austin, LA, and  some of those markets have come down a little bit.   How do you think the interest rate cuts are  going to impact mortgage rates and maybe the real   estate uh market overall? Yeah, I think 30-year  mortgages are around six and a quarter today.  (31:13) And so I think if we get a little bit  of steeper yield curve like the short end keeps   going down I think people could potentially  switch into 51 arms and you know I I think   51 arms will get down to below 5 and a half maybe  5% and I think that'll improve some activity. Uh,   you know, I think we have a lot of regional  differences, like you mentioned, Austin, and LA.  (31:38) I think it any of the COVID boom  markets, Central Florida, Nashville, Boise,   Phoenix all boom during COVID, and I think they're  all pulling back here. So, I think the inventories   are increasing. I think prices at the margin are  are down a tick. I think they'll continue to tick   lower because there's a lot of supply and a lot  of people have to move back to work in the office.  (31:57) They can't remote in to work anymore.  So, you know, and then we see New England, the   inventory in New England is almost non-existent  as far as homes. And so, it's, you know, that's   super interesting to me. Like, for a long time,  New England, people were leaving New England, and   now it's it's hard to find a home in New England. (32:15) And so, um, I don't know how that gets   resolved. I don't know if there's going to be  a lot of building in New England or or what   how that gets resolved, but I think some of those  COVID boom markets will continue to trend a little   bit lower. Um, and hopefully they'll get saved  by lower rates and there'll be more activity,   but it's hard to really tell how things will move,  but I think that it's likelihood prices are lower.  (32:38) Maybe they don't go as low with lower  rates. Jumping back to to your recent performance,   you're one of the few managers I've chatted with  who has been pretty successful with shorting   stocks. So at the end of 2024, you had some  fairly significant short positions relative   to the overall portfolio. And during that year,  both your longs and your shorts outperformed   one of your benchmarks, the financials index. (33:03) What were some of the key reasons for   your shorts doing so well uh in a market, you  know, that's going up? Yeah, thank you. I mean,   shorting's hard. Like I think when I look at  2024, the financial index was up 34ish percent,   my longs were up about 43%, my shorts were up  21%. So I still lost a lot of money on shorts,   but you know, on a relative basis, and I use  a little bit of leverage and I'm net long, so   you know, that's how you get to the performance. (33:33) Um, you know, I think shorting's been an   iterative improvement over the years. And so like  to you know respect momentum is when shorts are   going against me. Shorting is hard because you  want to as a value investor you want to short   expensive stocks but those can also be stocks  that have momentum. Um it's trying to find a   mix of stocks that are just not good values and  that stocks that have headwinds against them.  (33:58) And so just trying to constantly improve.  I think the shorty environment's been hard. I mean   for most of the history of the fund that a lot of  the bad financial companies got wiped out during   the financial crisis and so any company that  survived the financial crisis had some staying   power right and so there weren't a ton of shorts  there but like during the spa craze of 2021 there   was a lot of new financial companies that came  public a lot of mortgage companies some fintexs   that came public that were bad values and so that (34:30) improved the opportunity that and other   than utilizing shorts, one of the more contrarian  parts of your strategy is that you're able to get   comfortable with some holdings in the portfolio  using some leverage on the balance sheet. You   know, in the good times, this this can look really  good, but if we ever come across a major crisis,   then that's when these uh highly leveraged  businesses can get find themselves into trouble.  (34:55) So, how do you think about managing  leverage at the company level so you don't   get caught on the wrong side of things when uh  the crisis inevitably hits? Yep. I think I've   made money investing in highly leveraged  companies. It's not super easy. I think   um I guess I'm comfortable investing in a stock  and not being guaranteed I'm going to make money.  (35:19) like I I feel like I have a higher  tolerance to own losers than other managers   maybe. So, you know, like I don't know how  things are going to turn out and losing   control of leverage or having an adverse  outcome due to leverage is certainly a a   way to lose money and I've been comfortable  with that riskreward of the upside that the   leverage presents versus the potential downside. (35:43) But, you know, they don't all work out   and they can quickly unravel. But um it also  keeps management focused and so like when they   they have high leverage they tend not to do dumb  things because they know their margin of safety   is low. So I don't I don't recommend that for  everyone but like that that can be a benefit of   investing in companies with higher leverage. (36:03) You know an example right now is uh   some of the fintech companies like they've bought  back stock and levered up to do it and so they've   stopped making acquisitions to to pay down the  debt. So hopefully that works out for them. And as   a financials fund, you benchmark yourself against  the S&P 1500 financials as well as the S&P 500.  (36:25) So when I look at the top holdings in  the financials index, this includes companies   like Berkshire Hathaway, Visa, Mastercard, and  the big banks. And I was actually surprised to   see that this index was up nearly 30% in 2024  given the backdrop of higher interest rates.   I would expect that you sort of highlighted  the difficult environment for the the   smaller banks of an inverted yield curve. (36:49) So I would expect generally higher   interest rates would lead to slower loan growth  for companies like JP Morgan, Bank of America,   but the big banks seem to have done uh quite well  the past 12 to 18 months. So talk about some of   the dynamics at play here in the industry. Yeah.  So the big banks got a huge gift from you know   Silicon Valley and First Republic failing  like the there was a flight to quality and   the the biggest banks because of their regulatory  position that they're too big to fail and so like   the people depositors are moving moving deposits (37:21) and accounts to the big banks. So they've   had this tailwind of deposit lowcost deposit  growth which is a big win. And then there was   a little bit of watering down of the Basil 3  capital rules. So like there was a a set of   capital standards that were proposed for  the big banks that were honorous and the   stocks were priced because like that capital  rule was going to get implemented and then   it got reduced and so the banks rallied when  that capital rule got reduced and then they   also had the benefit of at the end of last year I (37:50) think they responded well to the incoming   Republican administration thinking that there'll  be a deregulatory environment um and more M&A and   so I think some of the the stories I hear from  bankers about how the regulators act during the   previous administration. I think that a lot  of those um behind the-scenes pressures get   lifted with the current administration. (38:13) So, I think the banks reacted   favorably that they can focus more on business.  You're right about loan growth like loan growth   with higher rates is has been lackluster and  hopefully that's one of the things that we'll   see going forward is accelerated loan growth. But  when rates went up, borrowers are like, I'm used   to paying 5%, now you're asking me to pay 8%. (38:30) I just don't want the loan. And plus,   a lot of borrowers had liquidity from, you know,  the COVID boom and so they just used their own   internal liquidity rather than borrowing at  high rates from the banks. But you're right,   the loan growth has been not that exciting. Um,  but the the capital rules and the potential for   deregulation have helped the big banks. (38:50) Yeah, it's interesting that you   highlight the flight to quality and this  capital and some of these deposits going   towards the big banks because you've  highlighted that you're overweight the   regional banks and I sort of think of regional  banks as these midsize banks. They're, you know,   bigger than the smaller community banks  but smaller than the the largest national   banks like JP Morgan, Bank of America. (39:13) So, one of your top holdings is   First Citizens Bank Shares, which we discussed  back on episode 669. They're one of the larger   regional banks. Um, familyrun, very good company  and very good compounder. So, talk more about,   uh, what makes the regional banks an attractive  hunting ground for you in light of, you know,   the comments you've just made of this this  flight of deposits to the bigger banks? Yeah,   I think regional banks are interesting because the  valuations are so much lower than the big banks.  (39:41) So normally the big banks are the  cheapest and followed by midcaps and then   small caps are the most expensive due to M&A  potential better growth prospects. But right   now we're inverted, right? The big banks  are the most expensive, midcaps are in the   middle and the small banks are the cheapest. (39:58) And so I think that gets fixed with   this the change in the slope of the yield curve.  I think a steeper yield curve will make the the   smaller banks more profitable because they  have a higher percentage of the revenue from   spread income where the big banks have more fee  income. And so I think that increase in spread   income there's not a cost associated with it. (40:15) So like if their margins expand they don't   pay their people more. They may pay the executives  bigger bonuses but like for the most part most of   that revenue drops to the bottom line and it'll  have a bigger effect on the small banks. And then   I also expect the the valuation differentials to  to go back to normal where the smaller banks are   have higher valuations than the big banks. (40:35) But um you know there's definitely   economies of scale in banking. So we really need  the more M&A. We still have 4,000 banks in the   country. Like when I first got in the business  we had 13,000 banks. We're down to 4,000. You   know we're the only economy in the world that  has this many financial institutions. like   most Canada has a dozen or five large ones  but you know a dozen at most banks and so   um we'll see more consolidation and really  the JP Morgan's a remarkable company like   they they're the biggest bank and they're taking (41:09) market share right so they entered Boston,   Philadelphia and DC without buying  any banks in those cities they just   started opening branches and they're just  taking share they I think they even opened   a branch in North Dakota so now they have  a branch in all 50 states But like that,   you know, their tech platform, they can  spend more money and they have the best   um apps and they're just taking share. (41:32) They're easy to do business with. And so   BFA is taking share. Um some of that's from Wells  Fargo. Wells Fargo's had this asset cap so they   couldn't grow. But um they're also taking the big  banks, the big two are taking share from the small   midcap banks. If we don't have more consolidation,  it's just we're going to get consolidation through   organic growth of JP Morgan and BFA. (41:52) And so we need the midcap banks   to get together to have real competitors to  those those companies. It's interesting you   you highlighted that some of the big banks  are still opening branches. I think back to   uh my dad, he loves stopping by his small  community bank. I don't know how often.   Probably at least once a week he's stopping  by just to say hi to his banker and whatnot.  (42:14) And I'll I'll occasionally go to a  bank just to to pick up cash. The physical   location it's convenient, not too far from me.  But when I think of people younger than me,   I'm I'm 31 years old. I'd imagine people that  just are getting out of college, I'd imagine a   lot of them either haven't been to physical  branch uh by their own will or or they just,   you know, use the online banking and whatnot. (42:37) How do you see sort of the online   banking market developing? I know there's  a lot of online banks uh being launched. It   seems like every year I see a new one come out.  So talk more about how that space is developing.   Yeah, I mean, you're right. Like, branch  traffic has declined every year since 2010.  (42:54) So, like less people are going  to branches. Like, even though the big   banks are opening branches, they're in new  geographies. Like, I think if you look at DC,   I think JP Morgan has about 20 25 branches across  the whole city of of DC. Like, it's in Virginia,   Maryland, and DC. And, you know, I would  guess 20 years ago if they entered DC,   they'd probably have to have 80 branches. (43:14) And so, now they can cover a city.   you don't need to go to a branch within two  miles because you only go to the branch a few   times a year. Like you could drive 10 miles to  drive to the JP Morgan branch because you only   do it twice a year. So um you can cover more  geographies with fewer and so that increases   the the competitive intensity of the industry. (43:34) Like we used to have interstate branching   laws where JP Morgan couldn't just enter Virginia.  like when those interstate branching laws went   down, people could, you know, banks could enter  new geographies without buying banks or without,   you know, or just letting them  go into any geography at all.  (43:51) So, the competitive intensities  increasing in banking. Online banks are,   you know, the real threats of profitability  of banking. Like, they're paying higher rates.   They're easy to do business with. There's ways  that um, you know, they give you credit on your   deposits faster than the legacy banks. like  the online banks are just going to take share.  (44:12) So, it's a it's another way to increase  the competitive intensity of of banking. And when   I say increase competitive intensity, that means  margins going down, returns going down. So, I   mean, I think the long-term trajectory for banking  is lower returns. And um that's why banks aren't   the greatest thing. Like, I run a financials fund,  but I would never just say, "Hey, let's go invest   in the KRE together for the next 20 years. (44:35) " Like, that's not a great strategy.   Like there there's some banks that are wellrun.  We can invest in them. We can invest in banks when   they're cheap. We can't just invest in the average  bank for the next 20 years. Like that's just it's   not software. It's not semiconductors.  Like it's an average to below average   industry that where returns are going down. (44:54) So, you know, I'm just aware of that. Like   I'm not a permeable on banks. There's times to own  them. I think right now is the time to own them,   but it's not always the case. Yeah. I almost  wonder if you're not giving uh the banking   sector enough credit. I know you find a lot of  good banks that are out there and you know you   look at the large banks, the midsize and small  ones and you're say hey there's quality banks   within all these segments but I'm going to buy  the cheap ones, right? And uh you know that's   what I also appreciate about your strategy is (45:24) is looking for potential and opportunities   for multiple expansion and generating  returns for your investors. And it it   seems that you know within your fund you'll  have say the really highquality businesses   like the first citizens of the world that  are bound to grow for a really long time   might not be the cheapest company either. (45:43) And then you also have you know we've   mentioned plenty of stocks today that are just  too cheap. Once they reach a certain valuation   you're happy to part ways with them. What do  you think that sort of mix looks like in your   portfolio of some of these highquality names  you can see yourself owning 5 10 years from now   and and other names that um you'd be happy  to part ways with if the valuation reached   a certain level? I mean, I think um I mean I  think it's like 30 or 40% names that I kind of   think of as like enduring. I'm going to hold them (46:12) for a long time and then you know 60 or   70% it's like they're for sale at the right price  and uh keep that turnover of the portfolio and   moving on to the next cheap stock or cheap sector  within financials going. I think um yeah, I think   that's probably the mix of you know I I worked  for a man before I started my fund I worked at GCM   and the PM that I worked for was a guy named Herb  Ellers and he used to preach like if you ever own   a stock in a great company never sell it and so  you know very much a Charlie Mer investment style  (46:45) of and uh so I do keep some of my  portfolio in stocks that I'm like I just   want to own the stock for a long time so So, let's  talk about Robin Hood. So, I feel that only a true   master of their craft can make money shorting  a stock and then turn around not too long after   and go long before it becomes a multibagger. (47:08) So, that's exactly what you did with   Robin Hood. Uh, this is a stock you bought in  November of 2023. Um, and you actually still hold   a smaller position today. Not as big as it once  was, but since November of 23, the stock is up   over 14 times in less than 2 years. It's just not  very common uh you see a stock go up that much,   let alone own a stock that goes up that much. (47:30) So, let's walk through this story.   It was in 2021, uh, Robin Hood went  public and at some point after that,   you ended up going short the stock. So, talk about  what you were seeing at that time. Yeah, I mean I   think it was a response to the environment like  there was a lot of speculation the spaxs were   coming public like there was a lot of junky  companies coming public and a lot of inflated   valuations and just a speculative frenzy in 2021. (47:57) And so, you know, shorting Robin Hood,   like I I thought the valuation compared to where  they were in their business was high and uh they   were losing a ton of money and the valuation was  high and I just thought I thought the speculative   bubble was going to recede and so it was an easy  way for me to participate in the downside there.  (48:17) And, you know, I shorted it down.  I knew they had $8 a share in cash and I   shorted it from 25 down to 10. And then at 10,  you know, with $8 a share in cash, I was like,   there's no that the shorts done and but I  continued to follow the company. I, you know, I   like brokerage businesses and I was impressed with  the the changes they were making to the business.  (48:36) They put up a couple profitable quarters  by reducing costs, introducing some new products.   I really like their product roadmap for  introducing new products. I was like, they   could accelerate customer growth with all these  new products. And then I just got an opportunity.   They reported the Q3 of 23 earnings and there  were two environmental reasons why they missed   the quarter and I just thought they were temporary  and it it traded down to the $8 where I bought it   and they still had that $8 a share in cash. (49:04) So, you know, just being flexible   and understanding the business and also like  technically it had built a big base like it,   you know, I I had covered in March of 22 and from  March of 22 to November of 23, the stock kind of   was flattish and it had built that long base. I  got fortunate that it took off soon after I bought   it and that was just good timing, good luck. (49:28) But, um, you know, it had built that   base. I didn't think there was much downside and  had it kind of treaded water, put in its marked   its time to to move make a move higher. Yeah.  And you know what really stands out to me here   in your your approach and I think a lot of you  know the alpha you're generating in the fund is   just being aware of sentiment, right? You can  have a great company that isn't a great stock   to buy and you can have a an average company  that can be a great buy because the sentiment   is just so bad. So in 2021 uh sentiment overall (49:59) across all any technology stock was just   too much and it was you know assuming you believe  that markets are rational in the long run then   um it can make for a good short in your case. And  on the other side when you know a good company   just gets way too far beaten down. It's trading  near tangible book value that can make for a lot   of asymmetry because the sentiment is just so bad. (50:22) So talk more about you buying it in   November of 23, near tangible book value, and  then how the company developed since then and   and became a huge multibagger. Yeah. So they mean  they a couple weeks after I bought the stock,   the SEC approved the Bitcoin ETF. So the crypto  market started taking off, right? And so Robin   Hood's one of the few ways to participate in the  crypto market without owning Bitcoin directly.  (50:46) And so they got some benefit there.  And then their product innovations they they   had customer uh growth accelerate. Customer  deposits went from like 18% of assets to 40% of   assets during 2024 it was. And so that really got  growth going and they continued to introduce new   products and activity ramped up and then you know  crypto trading exploded after the election and   um but they've continued to introduce new  products and some of the products like are a   little bit shocking that like until the fall  of 24 you couldn't open up a joint account  (51:21) with your spouse like you had each  had to have individual accounts. So some of   the products were not rocket science. They're  just getting around to all the things you need   to offer as a brokerage firm and um you know but  they introduced futures trading. I think they're   just introducing short selling in the coming days. (51:39) So and then this goes back to um you know   I held on to the stock for a long time. The uh I  started hedging it late last year and through this   year and I'm almost completely out of position.  I still have a a tag end piece if it becomes a   meme stock and I'll benefit a little bit, but um  it you could argue it already has become a meme   stock to some extent, but it's just avoiding that  value investor um mistake of selling too early.  (52:04) It hit my price target, I'm out like  just market can take stocks a lot higher than   you you think. And then also like the stock got  up to I think it was like $30 late last year   and I did a you know I think earnings estimates  were about a$150 and I looked at the the models   and I could get the $3 in 2026 and so I was  like okay the stock's way up at 30 bucks but   I can see in two years they can earn three bucks. (52:35) It's 10 times earnings that you know even   though it's made a big move there's still a lot  of upside here. So like my three bucks estimate   for 2026 had some pretty bullish assumptions  about customer growth and training activity.   And so like it was not three I'm not saying $3  is the base case, but I'm just saying like okay,   what are other people seeing? Like what's the  potential upside? And just being comfortable   of like, okay, ignore where the stock's been,  where could it go, what are people looking at it.  (53:02) You know, people who are buying the  stock at these highs, what are they thinking?   and and just being comfortable with momentum  and stocks that are moving higher probably   continue to move higher. But, you know, that's  an uncomfortable position for a value investor,   right? The just letting stocks go up. (53:19) But that's what you have to do   to keep your returns intact. Yeah. And the past  couple years, I think uh one of the lessons for   me is just understanding how powerful operating  leverage can be. So, a few examples that come   to mind of some businesses that, you know,  maybe don't care about profitability since   they're early on in their life cycle and then  once they built up uh their customer base,   then they can start to pull these profit levers. (53:46) So, a few that come to mind are Uber,   Spotify, and Robin Hood. So, looking  at Robin Hood financials, for example,   if we just look at the net income line, 2021, they  were losing over $3 billion. 2022 they're losing   a billion but in the last 12 months net income is  1.7 billion. So um you know as revenue is growing   the profit side can really ramp up significantly  since a lot of their um they can have a low cost   base right since it's very much a tech platform. (54:15) So that's one of the lessons I think that   I get from looking at a stock like Robin Hood  when the market doesn't appreciate the level   of operating leverage and just being patient  with letting that profitability come through   the bottom line. Yeah. I think that's well put.  I think there's another stock that I have that   has a lot of operating leverage and a lot of  financial leverage is anywhere real estate and   um this is the old realy they own coal banker and  that is a fixed cost they run it as a fixed cost   business and then the the commissions are variable (54:44) based on you know volumes of real estate   transactions. So like this stock is way  down from where um it was a few years ago   when the housing market was booming. And I  think people are just coming around to the   fact of like okay you have financial leverage  on top of operating leverage and the evidone   numbers could explode here if we get back  to 5 million units of existing home sales.  (55:09) But that I agree with you operating  leverage is a lot of times underlooked as a   a potential upside. So, uh, I also wanted to  be sure to mention Interactive Brokers. I'm   a very happy customer of Interactive Brokers.  Uh, they're in the discount broker business,   in the broker business just like Robin Hood is. (55:30) And, uh, they are founderled and their   founder owns a significant  part of this business. And,   uh, I believe that's one of the concerns with this  business, I think, is what's going to happen with   a lot of the shares he owns. But I've been a bit  disappointed not to participate in this stock's   uh spectacular run over the past couple of years. (55:49) They've been organically growing their   customer counts over the years and uh the market's  finally taken notice. I'd be curious to get your   thoughts on Interactive Brokers. I don't believe  you've owned it, but uh you have looked at it from   based on what you've said off air. Yeah, I do own  a few shares in the mutual fund that I manage, but   I don't own it in the hedge fund, unfortunately. (56:07) It just was a little bit too disciplined   on the price I was willing to pay and it ran  away from me. I was looking at it the December   of 23 after I bought Robin Hood and it's been a  phenomenal stock and it's a great business. I've   been a customer too. I use it as a prime broker. (56:24) They've been super helpful in in helping   me with my business. I think they keep cost low.  I think the fixed cost nature of their platform   gives them a lot of operating leverage. I think  it's a conservative balance sheet. you know,   I think their credit ratings higher than Morgan  Stanley's and so I think that's super interesting   as far as a safe place to custody assets. (56:45) Um, so I think it's very efficient and   it's a great business. I wanted to also be sure to  touch on Wex Inc. So, in your most recent letter,   um, you highlighted your thesis on this company  and for anyone that's interested in checking out   Derrick's commentary. He sends out his letter  to, um, those that sign up on his website,   and it's been very useful for me to follow along. (57:07) So, talk a little bit about WEX, Inc.,   what's this company do, and what's your thesis  on, uh, adding it to the portfolio? Yeah,   so um, WEX is a is a financial technology  company. They they issue fuel cards. So,   they have three businesses. 50% of the  business is fuel cards. So you own a a   fleet of trucks with your service business. (57:27) You give all your drivers a WEX fuel   card. They have to type in a password and the  car mileage or the truck mileage when they get   gas and just reduces waste or shrinkage  on your part as owning a a small company   fleet. They're not filling up their personal  car with the gas card. And they give you a   lot of data of how to evaluate your drivers. (57:47) And so that's been a a good business.   They've used some of the cash from that business.  They bought two other businesses. They have an a   health savings account business which is you know  a high multiple business that it provides lowcost   deposits. They actually have a bank where the the  lowcost deposits from the health savings accounts   fund the receivables from the fuel card business. (58:05) So there's nice integration there. Then   they have a corporate payments business which  has had some struggles. You about half the   corporate payments is about 20% of the business  and half of that 20% is servicing online travel   agents. and both Expedia and Booking.com  have brought some business in-house and   so that's been a little bit of a struggle  but the stock has not done anything for   eight years and so the valuation's come way in. (58:30) It's trading for eight times a year but   uh they did a tender offer at $154 a share earlier  this year. Um they've publicly stated they're not   making any more acquisitions because they're going  to focus their free cash flow on paying down this   debt that they took out to buy back shares. The  CEO bought some shares. there's been an activist   involved for about three years and so I feel like  the activist is watching management and management   is aware of the activist so they're not going to  do any anything that is non-shareholder friendly   and I think valuations come back up and so it (59:00) was weird like they they closed the   tender at the end of March and then  with liberation day the stock traded   through the tender price and so it  traded down to $120 a share which   was kind of crazy to me given that  the company just bought back 10% of   the shares at 154 so you know It's up from that. (59:16) The stock's trading around 170 175 right   now. It's still eight times EP, but uh I think  we just need some more time. I think management   is also doing a good thing of reinvesting  a little bit in the business. You they've   started spending some more marketing dollars  in the fuel card business and have also hired   some salespeople in the other two businesses. (59:35) So, I think revenue growth is going to   accelerate here. Not in not in huge fashion, but I  think at the margin it's going to be positive. And   um I just think the valuation's too low. Like this  a year ago the stock was at $240. Like we could   easily get back there um with no problem. Yeah. (59:55) I think some of the things that stands   out to me about this this company. I just  think uh being in the financial space,   you sort of benefit from having the opportunity  to just look at a lot of boring businesses that   that aren't doing a lot right. I mean WEX, it's  not a high revenue grower. You're not seeing   exploding earnings like you are at Robin Hood,  but you are seeing some things happening under   the hood where an activist is getting involved. (1:00:16) You know, you're seeing this catalyst   of more share repurchases and whatnot. And um  like you mentioned, the stock trading down to   120. Sometimes the market just uh does some  silly things just on short-term concerns,   whether it's, you know, the economy um  concerns around fuel prices dropping,   fuel volumes dropping, and whatnot. (1:00:35) and someone like you coming   in and and taking advantage of those  unique opportunities. Yeah. I mean,   it's a $4 billion market cap company. It's not  the the largest company. It's not people don't   talk about it, right? I mean, the stock hasn't  done anything. It's flat for seven years. Like,   there's a lot of investor apathy about it. (1:00:54) And so I think the tender offer   for me was really what sparked taking another  look of like, okay, that's a that's a special   situation type event of buying back that much in  stock and really kind of putting the handcuffs on   themselves to like you can't do anything with  your cash except pay down debt at that point.   And so that's a real stake in the ground. (1:01:14) So I think that's the catalyst   and there's you know a lot of people don't  respond to events like tender offers that   are clear signals that there's value there  or at least management and the board thinks   there's value. You know they also issued a press  release or I think in they said in the tender   offer that nobody from management or the board  of directors was going to sell into the tender.  (1:01:35) So that's a pretty strong statement  in itself like so yeah. So, uh, tender offers   are something, you know, to my knowledge, don't  happen all too often. For those in the audience   that might not be familiar, could you just explain  sort of how this works and what a tender offer   is? Yeah. So, you mean the stock was, you know,  $170 and management wanted to buy back a bunch   of stock and so instead of going to a brokerage  firm and buying shares every day in the market,   they said, "Okay, we're going to make a  tender offer." where they ask they make a  (1:02:03) filing with the SEC and they say  okay a month from now we're going to buy you   know 10% of the company this many shares and  we're going to buy it somewhere in the price   between $150 and $170 and investors can go  to their broker and say I would be willing   to tender my shares at $160 or 150 or 170  and they look at like how many what price   is the clearing price of to buy all 10% of the the  company shares and in this situation it was 154.  (1:02:34) So relatively at the low end of the  range. So you know investors shareholders were   willing to give up their shares at a relatively  low price. So it just shows that management and   the shareholders had different views of the  value of the company, right? And so um but you   know I think that to buy back that much of the  stock in one swoop like the management had to   be super confident that they weren't overpaying. (1:02:58) And I think that was a pretty strong   signal that they thought in that range of 150  to 170 they were getting a good deal of buying   buying into those shares. And so buying back  that much stock helps EPS growth, you know,   because you have fewer shares of the same net  income. The valuation was low enough that the   the cost of the debt the fund the tender offer  makes the transaction was low enough that it   was accretive to to earnings growth. (1:03:22) But um there aren't that   many tender offers out there. like there's a  handful each year, but it's a good source of   ideas because companies don't tend to buy back  that much stock unless they think the stock's   undervalued. That's not always the case.  Like not all tender offers work as far as   owning the stock, but a lot of times they do. (1:03:42) In fact, like I think I first learned   about tender offers when um General Dynamics  in the early 90s did a tender offer and Buffett   bought the stock because of the tender offer.  like he he thought that was such a strong signal   that General Dynamic stock was was cheap when  they announced the tender offer, he bought the   stock. Yeah. So, you know, it seems that part of  the dynamic of a tender offer is the company wants   to buy such a significant portion of the shares,  it's more efficient for them to do uh going the   tender route rather than, you know, going out and (1:04:13) buying shares in the open market saying   they're buying 1% or 2% or whatnot. So  that's sort of the dynamic of the tender   is they're buying a significant portion  of the shares back. Is that right? Yeah,   that is exactly right. You can get a lot  more shares in a faster amount of time.   And what's also sort of interesting to me  about this your investment thesis here is   part of the thesis is that one reason why the  company's at such a discounted valuation is   because of the leverage on the balance sheet. (1:04:43) And if you know management's going to   be paying off some of this debt over the  coming years, then you would expect some   multiple expansion naturally from that. So  that's sort of one of the catalysts you're   looking for and and looking for a rebrating. A  lot of times there's deleveraging like I mean   there there's one of the things that makes  private equity so profitable or so you know   have high returns is the use of leverage and  we've talked about leverage a few times but   like this is another example of like there's a (1:05:08) company with leverage and this is   almost like a publicly traded LBL. I think the  leverage isn't as high as what private equity   uses. It's only three and a half times.  You know, it's not five or six times,   but three and a half times is plenty of leverage  to to get leveraged returns from the stock.  (1:05:23) As you know, and investors will discount  the stock while it runs with high leverage, but   then as the leverage gets paid down, they get a  little bit of growth and the debt gets paid down,   it deleverages naturally and then investors  will be more comfortable putting a higher   higher valuation on the company. Excellent. (1:05:40) Well, Derek, I really enjoyed this   conversation again. Uh, very informative for  our listeners. Always enjoy bringing you on.   Before I let you go, how about we give the  audience a final handoff here on if they'd   like to learn more about you and your firm, uh,  where should they go? Yeah, if you would come   to gatorcap.com and sign up for our newsletter  or you can send me an email, derek@gator.com.  (1:06:00) Be happy to send you our our  investor letters. You know, I won't spam   you. I just send out four letters a year with  one stock idea in each letter and uh you know   just something that I'm doing in the portfolio or  some insight that I think I have that hopefully   will be additive to your investment process. (1:06:17) But I appreciate you having me on the   show again. You're super generous with your  time and your questions. I appreciate you,   Clay. Excellent. Well, thank you a lot, Derek.  I I really appreciate it as well and hope we can   do it again eventually in the future. Sounds  great. Thank you. And so you kind of have to   flip your thinking based on the environment. (1:06:37) Like you know the famous Soros quote   of like he questions another money manager  like you go to the office because you think   you have to do something every day. I don't  go to the office every day. I just go to the   office the days where there's something  to do. Like I think it's similar to that.  (1:06:51) Like there's times in the market  where it's very stressful and there's a lot   of volatility and there's things to do and  you have to focus on a very short period of   time of what's going to happen. And then there's  periods of time where the markets are relatively   calm and there's not much to do and you can  be longer term and have a longer term focus.  (1:07:09) And I think October08 was the peak  of you need to focus today on making money