Pat Dorsey: The Nuances of Investing in Moats (Capital Allocators, EP.509)

0:05 >> Pat, thanks so much for joining me. >> Thanks for having me. >> I'd love you to take me back to the early influences in your life that led you down this path to investing. >> I'm not sure there were any. >> >> I mean, my my my father was a a bureaucrat with the Food and Drug Administration, and my mom taught nursery school. My grandfather did a lot of investing and kind of would show me that mutual fund honor roll, you know, in the journal or Forbes or something.

0:35 But, that's about it. I mean, I wasn't one of these people who, you know, was reading Buffett's letters when they were in elementary school. That those kinds of people always kind of freak me out a bit. >> >> Where did that academic path take you through school? >> So, my undergrad was in political science, subdiscipline called comparative politics, where you're basically studying how different political systems evolve and trying to draw conclusions from that. So, look at a dozen countries that have transitioned from dictatorship to democracy and say, "Hey, can we observe any patterns, right?" Which actually turned out to be, unknowingly, somewhat good training for what we do as investors, right? Because you're looking at different businesses, understanding them in a deep manner, and developing pattern recognition. I didn't know that at the time. After undergrad, I had a couple crappy jobs in finance, just to pay the bills.

1:32 One was with a newsletter, one in a brokerage firm, both parts of our industry that are more focused on making money off of clients than making money for clients. And so, it didn't really sit well with me. So, I went back to graduate school to get a PhD in poli sci. Quickly discovered there are no jobs for PhDs in poli sci, which they don't tell you when you apply. And at that point, I was in Chicago. I'd met the woman who is now my wife and didn't want to leave.

2:00 Morningstar was here and they had a reputation for A being kind of a only investor's side which sat well with me and also being willing to take a chance on liberal arts dudes like me. And so that's I wound up at Morningstar around the time when they were starting up coverage of individual equities. >> So, how did you find your way into developing your investment beliefs at Morningstar? >> So, it's funny when I landed at Morningstar I basically thought stocks were little blinking things with charts attached to them.

2:33 nobody had ever really introduced me to fundamental investing. And you know, like the first day at Morningstar my boss just dropped a bunch of books on my desk, you know, the letters of Warren Buffett and then you know, Phil Fisher and John Train's Money Masters, you know, the usuals. and that was my first introduction into a business as a functioning breathing entity that has complexity and ecosystems and is analyzable in the same way you would look at political system. And I had no idea. And it was fascinating.

3:05 And so that was sort of the the spark that started everything was sort of the idea that, you know, every business is a little bit different and but then they're all trying to do the same thing which is, you know, generate a profit. There's, you know, thousands of different solutions to the exact same problem. And so then studying how businesses solve that problem in different ways was utterly fascinating. But unfortunately at that time you kind of had, you know, Buffett's letters on what makes good businesses and then the Michael Porter work on the five forces. But Porter was a consultant, you know, his goal was to say, "Hey dude, you run a widget company, how do you make your widget company better than the other widget company?" He doesn't never answers the question, "Are widgets even a decent business?

3:54 Which, as investors, is what we're most interested in, right? Because we don't have to invest in the widget company, we can invest in anything we want. And I just I never found anything that gave a a rubric for figuring that out. And so it was just a really kind of cool intellectual problem to solve, and also I thought would be a useful tool for investors as I was building out the platform at Morningstar. >> So what was that initial rubric that you built?

4:21 >> We had data back to the '60s, I think, and looked at every company that had done more than 15% returns on capital for more than 15 years. Totally arbitrary numbers, but the idea was basically, instead of theorizing, let's just look at the data. Let's just go and get the companies that have done this and generated sustainably high returns on capital and see if we can observe patterns. And you know, most of the companies that had done that, you know, could be sourced to some kind of a intangible asset, like a brand or a patent or a government approval, you know, high customer switching costs, like you see with databases, network effects, or scale advantages, cost cost advantages.

5:03 And you know, most of them kind of fit in one of those buckets. And it was like, well, that's what the data says. Let's Let's use that framework going forward. >> And once you had those ideas, how did you then distill it into an analytical tool? >> Moats were basically the the lens through which we looked at every business at Morningstar. And it was partially cuz we felt like it was a just a useful framing for individual investors, who are most of our clients, but it was partially also because frankly, we had a business problem, which was differentiating our research, to be totally blunt. I mean, equity research is a commodity. You know, you take the logo off the top and you don't know who wrote it. And you know, Morningstar was known for mutual funds.

5:49 What did What you guys cover stocks? What is this? So, I basically I, you know, it was kind of scratching an intellectual itch, but also just solving a problem, which was how do you differentiate the the research that you're producing so people know that it's from you and not from somebody else. And so, we just decided that instead of trying to be all things to all people, let's I would argue most sell-side research is, that we would just have a point of view, the same way any buy-side manager does.

6:13 And the point of view was that moats matter. They don't Not that you have to invest in a business with a moat, but knowing whether a company does or doesn't have one is probably useful in some way, shape, or form. And so, you know, we just you know, we looked through every company through that lens and tried to help the customers, which were mainly at that early on investment advisors, RIAs, and individuals understand, you know, whether this was a business that had some kind of durable competitive advantage or not. And doesn't mean it's better, doesn't mean it's worse, but it probably means you want to think about it differently as an investor.

6:50 >> When you went through that analysis, let's say the quantitative part of the analysis, what were the most important metrics that you used? >> It's interesting cuz at this, you know, the the data we were looking at from the '60s kind of through the mid-'90s, late '90s, software companies were not yet a big part of the investment universe. You mean you had Microsoft, you had Oracle, and that was it. We had just a simple return on invested capital metric.

7:14 Today, I would argue actually return on capital is much less useful as a touchstone for does a company have competitive advantage because, frankly, if you don't have any capital, it's pretty and your denominator is nothing, it's pretty easy to generate a high high ratio, right? It's just math. I mean, then there's lots of crummy software companies with high returns on capital. And, you know, so it's just not as useful a metric because value creation in society has generally trended away from capitalized assets and is often created from expensed assets. That building a brand, you expense that, right?

7:57 hiring a bunch of developers and writing code, that's expensed. It's not capitalized. Which is silly when you think about it because it's not as if every bit of code that say Amazon writes is useless after December 31st, which is the definition of what you expense. And that's just patently absurd. But if you gave companies all this leeway on like what to capitalize what not in their in in their code base, I mean, all hell breaks loose.

8:23 >> Are there other important quantitative metrics beyond the original ROIC that you look at when you're trying to figure out if a company has a good moat? >> No. I actually find it's best to stay away from that because, you know, you kind of go down the route of oh, it should have high margins. It's like, well, what about a distributor? I mean, distributors are often beautiful businesses. They have relatively low margins, but they don't have a lot of capital employed. I mean, but they're great companies.

8:48 So, okay, we can't use profit margins. I think that it's really comes down to and you know, okay, free cash flow. Okay, fine. But what if they're reinvesting? What if they're putting capital back into high return projects that have a high NPV? Well, okay. Free cash flow may not be the best metric. Obviously, if a company has gone yeah, a decade with, you know, pretty crummy financial metrics, there's probably nothing much there. But the point is that I think that the bulk of it is qualitative, right? I mean, the bulk of it is understanding what kind of price the company can take if it has pricing power or whether, you know, in some examples, there's you know, what what the Nomad guys called scale economies shared.

9:32 where, you know, the the benefit is not taking price, but passing scale benefits along to customers. You know, Costco is kind of one of the canonical examples. Medline, which recently came public, is another great example of basically passing on scale benefits to customers. So, again there, even saying, "Oh, gee, moats are all about pricing power." Well, no. They often are. and so, it's squishy, and that's why I think the qualitative angle is so much more useful than a quantitative metric.

10:05 >> What are some of the other really important qualitative angles that you look at? >> It's obviously going to depend on the business, right? You know, switching costs can cut both ways, because if you high have high customer switching costs, then probably your competitors do, too. And so, it's pretty hard to get people to switch. And so, you know, you you you have trouble growing in the in sort of really high switching cost industries a lot of times. You know, network effects are often held up as kind of like the end-all, be-all of moats.

10:34 But, network effects can degrade, right? People leave the network, the value of the community diminishes. You have to distinguish between, you know, sort of radial networks, like I Western Union, or nodal networks. It's just complicated. >> >> And you know, and that's one of the But, that's honestly one of the fun things about it is that over time, you kind of start to again, like all in like everything in investing, develop pattern recognition. I mean, you know, the the great traders that you read about in Money Masters, you know, I mean, they develop pattern recognition. Like, "Okay, I've seen this macro story before, and here's how it usually plays out. So, I'm going to make this bet." I I think analyzing competitive advantage is the same thing. I mean, the more companies you look at, the more likely you are to say, "Okay, I think there's something here."

11:22 And then you try to think through, you know, why? Is it a government approval? Is it a switching cost? Is it scale economies? But, there's something that the company There's some foundational attribute, right? That enables the company to withstand competition and basically defy the laws of economic gravity and sustain high returns on capital in a competitive world where both in theory and empirically, most companies don't do that. You know, most companies do revert over time to cost of capital.

11:57 >> As you looked at those businesses in that first circle analysis or even today that sustained that advantage, those high returns compared to those who maybe had it for a while and then lost it. What are the distinguishing features that you saw in those two groups? >> I would say one commonality is what the lean community calls voice of the customer. You know, always paying attention to the customer and adapting to their needs.

12:30 And that's where pricing power can become abusive. What they do is they enlarge the profit pool. And that then says, oh gee, this might be more attractive for somebody to come in and try and take part of those profits because you basically, by overpricing, said there's more money here to be garnered. And so I think companies that abuse pricing power, they tend to You're seeing this right now with Adobe, frankly. There's a little bit of an AI problem here as well.

12:56 you know, but had they not been so aggressive in pricing over time, would the customers be as willing to switch to new AI tools? It's an interesting counterfactual to think about, right? But I think the company custom companies that have done well in riding through changes in their in their industries and ecosystems have generally listened to the customer, attempted to you know, not add more than they've taken, but at least if they're taking five in price, adding three in value, if that makes sense. You know, if you're if you're adding five in price and if you're taking five in price and adding zero in value, over time that catches up with you, I think.

13:40 >> How do you think about the power of brands when it comes to moats? >> So, that's a cool question cuz it's sort of I think that's a lot of early investors, certainly mine, initial introduction to what is a moat from you know, like from Buffett's letters a long time ago. I'm talking about the inevitables with Gillette and Coke and whatnot. I've historically invested less in consumer-facing businesses because I don't feel like I have a real good feel for what a good brand is and I don't know for whatever reason, but I think it's useful to kind of distinguish brands in terms of you know, the classic Coke or Gillette kind of lowering your search costs, right? You know, that basically you go to the shelf and you see the label and it's what you want and you don't have to spend a whole bunch of time thinking, "What do I want?" I you just grab it. You as the consumer can decide to defect with no cost to you, right? I mean, if you say, "Okay, I would rather try President's Choice Cola than Coke." Like you can do that and if you don't like it, you go back. Big deal.

14:37 But then if you think about like a luxury brand, that's more consensual, right? Like I'm I'm not wearing a Rolex I don't have a Rolex. I mean, this is theory. >> >> you know, I'm not wearing a Rolex because it tells time better. It's because I want people to know I have money. Right? It's a I I'm signaling something, but that signal value is only useful if everybody else agrees that a Rolex has signal value. If I decide one day to say I'm going to wear some no-name watch that nobody's ever heard of that cost $100,000 cuz I want to signal my wealth, if nobody's ever heard of it, I don't achieve that.

15:15 We all have to agree, right? Because if I and and so if I defect, there's a cost to me, right? If I defect out of that luxury positioning ecosystem, the cost is nobody nobody gets the signal value. Cuz they've never seen the heard of the watch. and so that tends to make the luxury moats I think very durable. I mean, luxury hasn't done well recently, but I think a lot of that's because you've had a demand source in China drying up and alternative luxury brands being developed in China.

15:44 But the value of of Hermès is the same as it was two decades ago. you know, which is signaling wealth and signaling I suppose taste as well, of which I have little, so I've never really understood brands that well. >> Are there other applications of brands beyond that easier for choice and then this network signaling effect? >> You know, there's sort of the stamp of approval, right? I mean, if I went up and started out Pat's bond rating agency tomorrow, I'm not sure anybody would care.

16:16 You know, whereas of course, you know, Moody's and S&P, there's a value to that, right? That's been developed over time. That people see that Moody's has rated the bond, that S&P has rated the bond, they'll pay a lower interest rate than if the bond is rated by, you know, Pat's rating service or Ted's rating service. If you want to chart up that as a as a as an capital allocators adjunct. And so I think that that signaling value is high. And so that's another interesting it's a little bit more like a luxury brand I think where if I defect out of that ecosystem and say, "Oh, I I would rather use somebody else's stamp of approval. I'd rather use, you know, Pat's bond rating."

16:53 Nobody cares. You're not going to get the benefit of the of the rating. >> I'd love to ask you about the impact of management. You know, you start with the Warren Buffett line that you want a business so great that any idiot could run it cuz eventually someone will. How do you think about the importance of management with moats? >> You know, that's probably been the biggest evolution in me as an investor over the past decade. You You I would say when Dorsey Asset launched in 2014, I was probably 60/70 moat and 30 management. So, you want to kind of weight things, and I'm probably the reverse today.

17:29 And that's largely because I've seen just how poorly people can behave and how much damage they can do to even a great business. and you we only need 12 stocks. So, like why suffer with the people who don't really know what they're doing when you can you know, partner with people who do know what they're doing. You know, I think management is is is hugely important, and I actually think that phrase from Buffett has probably done more harm than good over time to a lot of investors in not interrogating the quality of management or maybe under waiting signals that maybe capital allocation is poor, that management's incentives aren't aligned, whatever it might be, because they're so hyper focused on the business. And I guess my attitude is you can have Why not just have both? Good management and a great business, you know?

18:18 >> How do you go about assessing management? >> I mean, for us, and again, this is I mean, gosh, talk about moats being squishy, this is even squishier. My biggest goal is to look for humility. Because I think it's much easier to find management teams who are unlikely to blow up than who are likely to do amazing things. And I'm mainly focused on avoiding that left tail. And I think if you go back and read that whether it's, you know, Theranos or Wirecard or a lot of the great corporate frauds, one or they're just corporate hubris, like in the case of Enron.

18:59 One of the common attributes is people who aren't willing to listen. When the company begins to head down a non-value-creating path, and there are voices in the room saying this is not a good idea. They don't listen, right? So, we when I meet with management, I ask a lot of questions about like what's a do-over? I used to use mistake, but then people get, you know, their hackles up. you're like, what's a do-over? What's something that you might have done differently in the past? Which board member gives you the best advice?

19:28 Which of your immediate reports is the one you least hate to lose? And you can sort of see how do people talk about their team? How do they talk about the people around them? How do they self-reflect on what might have gone differently? Or do they just think they're amazing and the business couldn't survive without them? Which is probably not true and it's probably bad it's probably a bad signal. I mean, that's that's one huge thing.

19:54 Another one, which I think is less common in the US, but more common outside the US, is conflating the business and the person. There's a amazing Australian business I looked at many years ago where, you know, the CEO owned the headquarters and leased it back to the company. And like that was sort of an artifact of how the company had started when it was a startup, but it's kind of like, yeah, once you grow up, you don't need to do that anymore, right? And it's like economically immaterial given the size that the company had become, but it just sort of indicates that, you know, someone is at the margin not making choices that benefit outsiders over themselves. They just kind of want it all if that makes sense. And again, I think that's where >> >> you just if if they're willing to let things slide in that way, what else is happening underneath the hood, right? What other choices are being made inside the organization that you don't know about and you will never know about that could be leading the company down a path with left tail results.

20:56 >> You mentioned alignment and that's a great example of misalignment. I'm curious how you assess alignment at a deep level. >> I versus we is one thing. you know, if if the if the if managers talk about the company as if it's them, like as if they own the company, instead of, you know, owning a half a percent of it via options, which is usually the case, that's usually a bad sign, I I find.

21:26 Because that means they're more aligned with themselves than with external external with with external shareholders. Looking at kind of incentive plans in corporate actions, you know, are are they aligning themselves with creating value for customers and shareholders or creating value for themselves? And that's kind of, you know, like I've seen companies where they're sort of they're domiciled somewhere in the large corporate headquarters, and then, you know, new management comes in and they decide to move it to somewhere sunny and warm.

21:56 And kind of, you know, that you're sort of prioritizing yourself over all those people who work for you who are going to have to either uproot their lives or find a new job, right? Alignment is it's it's a tough one. But I do think it it's it at least co-varies with humility. Even if they're not exactly the same thing, I think the Venn diagrams do overlap. So, by looking for a willingness to listen, a willingness to take outside counsel from either their management team or the board, willing to reflect on their decisions and the path not taken, I think those generally take you down the path of alignment versus not.

22:35 And then the I think it's super important because I mean, there's a I mean, I'll call it out, but look at the example of CoStar. They killed it in commercial real estate data, then they killed it again in apartments, and so the pattern recognition was, well, when they go into competing with Zillow, they're going to kill it again. But, you know, we spent a bunch of time analyzing the business and and management, and our guess was that they wouldn't shut down spend even if it wasn't working because they'd never experienced failure.

23:05 They'd never had to pull back and you know, the CEO in that case you know, is very successful. But for a founder, he'd largely had sold stock along the way. So he didn't retain a large ownership stake in the company. So if all that spend and competing with Zillow didn't work out Sheryl was probably going to suffer more than him because he'd been cashing out along the way. You know, and so that fact pattern said, well, I'm not sure that the alignment is there.

23:34 And so that's probably not somewhere we want to play. >> There are a couple of dynamics you touched on with a founder CEO. That's one in CoStar, the I versus we can imagine getting conflated. Have you thought about founder run businesses? >> I don't think they're any better than non-founder run businesses. I think it's an outgrowth of the degree to which Silicon Valley likes to self-promote on venture capitalists who are at heart promoters like to self-promote and that you know, they we put founders on a pedestal.

24:06 And and we think that I mean you remember when the Chesky you know, founder mode talk or whatever it was went went went viral. I hate that. It's terrible. The skill set of a founder is very different than the skill set of a manager. Right? A founder comes up with an idea and then needs to inspire people to give them capital and inspire early employees to work for them for probably relatively low immediate economics, right? And to believe in something, to believe in a dream, in something that's going to happen.

24:37 That's a very different skill set than managing 5,000 employee organization earning, you know, several hundred million in revenue. There's just complexity that goes with that that does not apply at the startup level. It's not that it's necessarily It's not that running a starting a business is not easy. It's not, but But a different set of skills. And you've seen some founders, I think Zuckerberg is a pretty good example, who've evolved. You know, they kind of they they had that skill set of the founder and they evolved to become good managers as well. But not everyone's going to. And I've seen plenty of founders who you're like, well, this person should be alive. They own lots of stock, whatever. And they just do the dumbest things because they don't listen to anybody, right? They mean you know, because they won a lottery.

25:21 They became generationally wealthy from an idea they had. And more power to them. That doesn't mean they're well suited to run a $50 billion company. They might be, they might not. So you got to I think assess it on a level playing field. Shoot, look at Larry Culp at GE. Did he found GE? I don't think so. Has he done one of the most phenomenal corporate turnaround jobs in history? Yeah. Some non-founders are hired hands and that's not good. And some founders are terrible managers.

25:52 And you've just got to interrogate them on a level playing field and not privilege someone or give them the benefit of the doubt because they're a founder. I think that is a huge mistake a lot of people make. It's one of I've certainly made and I've tried to learn from. >> How have you thought about managerial style as a lens at looking in the success of someone running one of these businesses? >> There's a subset of managers who are kind of in the trust me category, right?

26:19 Like you you're almost as an investor you're betting on the person as much as you are betting on the business. You know, you're betting you know, this person's it's their second act, right? They've had a successful business, they've sold it, now they're starting another one. And you're kind of willing to maybe because this person is quote unquote a money maker, you're kind of willing to maybe overlook some related party stuff or some, you know, excessive compensation.

26:47 And that's totally reasonable, right? I mean like that that is a style of manager that history has shown can create a lot of value for shareholders. It is not a style of manager we tend to gravitate towards, and that's just personal choice. That's the chocolate versus vanilla thing. I don't think they're good or bad. I do think they have greater risk of left-tail outcomes. Of kind of, you know, not listening or taking the company down a path that >> >> destroys value and not changing course when things are observably not not going well. And that's just especially in a concentrated portfolio. We have to think about kind of that left-tail risk a little bit differently than if we ran 50 stocks, right? You know, I mean it's just if you run 50 stocks, okay, fine. I'll I'll take a 3% bet on somebody who might be the most amazing money man most amazing manager of all time, but there's a little some of that left-tail risk.

27:42 >> 12 stocks, it's a little harder. >> >> Yeah. >> It hurts. >> How do you think about capital allocation as a skill of the leader of one of these businesses? >> Rare. I mean, you think about it. How does someone get to be the CEO of a Fortune 500 company or a Euro Stoxx 50 company? By demonstrating skill as a capital allocator all through their career? I mean, that's a giant pile of hooey. They do it by being a good self-promoter, a good car corporate politician, and you know, skilled at whatever their job is, running division A or division B or whatever it is.

28:20 >> It's not because they're allocating capital. >> It's almost kind of weird that you kind of you kind of people rise up through the ranks, get thrown in the CEO seat, and then you're like you're supposed to allocate capital. It's like, well, they've never had to do that. >> Right. >> Right? It's a little weird if you think about it. And so again, I think it's like founders versus non-founders. Just believe nothing and you know, trust but verify or I think that was the phrase.

28:42 >> Trust but verify. >> Trust but verify. Thank you. Thank you. Maybe they're a capital allocator, maybe not, But, you can't assume anything. And I think that the evidence shows most are not. You know, I mean, I think there've been large academic studies of like corporate buybacks. And the favorable interpretation of the evidence is that they've neither created nor destroyed value. The less favorable interpretation of the evidence is they've on balance destroyed value. You know, and you look at some of the larger McKinsey studies of corporate mer you know, acquisitions.

29:14 Generally pretty bad. And I think acquiring companies in the way of a Danaher or a TransDigm or Constellation, it's a learned skill. You iterate, you go back and say, "Okay, what were our deal assumptions and how did they work out? What do we learn from that? What do we lean into? What do we change?" But, most companies don't approach acquisitions that way. For most companies, it's kind of a a large deal that's often defensive in nature and is something that's done infrequently and often because some investment banker shows up and says, "This company is for sale. You interested?" I would say that generally approach it with skepticism. And the evidence is usually in buybacks, you know, deals that have not gone well and how do they talk about them and did they write them down? The evidence is there, you just got to look for it.

30:08 >> So, with a base rate that doesn't sound like at all that good for the leaders of these businesses, how do you protect against you moving towards the left tail in your assessment of one of these companies? >> I mean, one is you just look at the history of, you know, the M&A history, right? You know, what's worked, what hasn't. Did the deal make sense strategically and what they pay for it? And then, what are the hurdle rates? I mean, I definitely encountered lots of companies where like, "Oh, yeah, the goal of our acquisitions is to, you know, beat cost of capital by year three.

30:42 Ooh. Wow, that sounds great. Sign me up. >> >> But no, but I mean that I that is not an uncommon target. And it's one where like if that's the bar that management is measuring themselves against, they may think they're being quite successful in these deals, right? And frankly, that's their prerogative. My prerogative is just to walk away. And look for a different business, right? So, you know, what bar they're setting in terms of like I think it's a real super important question for companies that are acquisitive. Like what's your hurdle rate?

31:20 You know, and how do you measure that hurdle rate? And then how often do you not meet the hurdle rate and what have you learned from that, you know? I think those are super important questions. Simple things like when companies issue stock or buy back stock, I think are also big tells. Looking at companies where you know, they're when times are less successful for them, they build cash and they sit on it. And then, you know, times are great. And of course, when times are great, the stock's probably up a lot. But now we have excess cash, let's buy back some stock.

31:53 probably not exactly the right behavior that behavior you want to see, right? but I was I would argue pretty common behavior, too. And just being thoughtful in terms of how they buy back stock and how they allocate capital. You know, we buy back just to sop up our SPC dilution. Oh, great. That's that's that's exciting. You're giving with one hand and taking with the other. It's it's not going to get me out of bed in the morning. That's where I think meeting with management and just asking them some of these simple questions, like how do you think about buybacks? How do you think about dilution? How do you What do you What's your hurdle rate in M&A? Cuz that kind of stuff is not in quarterly You know, >> >> but the answers can be very revealing in terms of A what the answer is, and B, have they even thought about it? I would argue there's more than a few companies where all this capital allocation stuff, purchasing stock or issuing equity, it's kind of this afterthought that just sort of, you know, the CFO says, "Well, we should probably do this." And then management go, "Oh, okay." But is it actually core to how they think about how they run the business? That's a tiny minority of companies, I would argue.

33:01 >> What are some of your favorite misconceptions about people who think about moats and analyzing moats in businesses? >> I think one is privileging some kind of moats above others. I You often see kind of, you know, network effects put on a pedestal. Like, "Ooh, this company here." You say, I I see write-ups that, you know, "This company has a network effect." As if you've just said, "This company will be a 30-bagger." It's like, "Well, maybe."

33:26 I mean, I mean, it Let Let Let Let's unpack that network effect, right? And see whether it has anywhere to grow. I mean, like marketplaces have great network effects. But the trouble is, and you've seen this with eBay, you see this with some of the European online listings companies, once you kind of get that market, now what? Right? I mean, okay, this it's a great moat, but if you don't have anywhere to put the cash, I mean, maybe something with, you know, less of a super durable moat, but more places to expand is probably going to be the better investment.

33:57 You know, and so that's where you can't sort of say like, you know, I I want the widest moat possible. It's like, "Well, then the company may not grow." >> >> You know, that may not be great for your portfolio. So, I think that's definitely, you know, one misconception. I think another one is I see this a lot in write-ups where they sort of say, "Oh, this company is this because this brand is really strong." Clothing or restaurants or whatever, where the switching cost is really low. Early in my career, Abercrombie & Fitch was like, you know, the stock. And, you know, it's always kind of I never understood like, "Well, why is it?"

34:30 And this is also cuz I have no fashion sense. Like like why would why would you go there versus somewhere else? And how can they price like that? And you know, and Abercrombie & Fitch had a great run and then eventually, you know, the brand kind of faded and everything just didn't work out so well. So, I think that non-luxury brands, they require care and feeding. You know, they require kind of constant maintenance and just sort of saying, "Oh, this company has a brand."

34:53 Okay, well, let's let's kind of you know, unpack that a little bit. >> I'd love to turn this back to your path. So, you're doing this, you're doing all this work for a long time at Morningstar. At some point in time, you decide to start Dorsi. So, take me through that trajectory. >> We sort of became a victim of our own success at Morningstar, or at least I did. you know, in that our original clients, cuz it was Morningstar's kind of core audience, were, you know, fee-only RIAs and individuals. But then, as we were covering more and more companies, we began getting inbounds from mutual funds and institutional investors saying, "Hey, I kind of like this longer-term mindset you guys take relative to sell-side. I kind of like this moat framework cuz it's kind of interesting. I'd like to subscribe to your research." But of course, we were writing like little tiny, you know, 500-word tear-sheety things for RIAs and they wanted a little bit more, which is totally reasonable. You know, they wanted analyst access and access to our valuation models just like you would with sell-side. And so, we had to kind of build out a whole product for that. I was sort of sowing the seeds of my own destruction, but it was also immensely gratifying because it was the people I'd grown up kind of learning from as investors were now getting some value out of a service that I'd helped create, which was which was kind of cool.

36:08 But, those folks were much higher touch. I was the one on the road with the sales people. I was the one visiting clients. I was the one giving talks and I wasn't the office very much. I mean, like we wanted I think we I think like the last 15 people we hired while while at Morningstar, I never even interviewed Cuz they they they literally couldn't get me on the schedule. And so I began to feel like a talking head, like a pundit, where I was sort of repeating what other people were saying without having any hand in the creation of it.

36:38 And that, you know, being put out to intellectual pasture at age 40 is not a good thing. >> >> And so, you know, I just had a conversation and they were kind of I was like, "Look, I need to be in the office more. I can't be on the road as much." I said, "Look, this is just not the best path for me over the next 15-20 years." so I left Morningstar in 2012. And a couple of our clients, like we we talked about me going to work for a big 40 act somewhere and starting at my own fund or something. But I really didn't know the rest of the investing world. You know, Morningstar is kind of this one little corner of investing that really deals with mutual funds. And there's an entire gigantic world of types of vehicles and types of investing and types of clients that I really had never spent any time thinking about or interacting with. And I figured if I'm going to make a decision over the next 15-20 years, I probably should learn a little bit before I do that. And so I spent a couple years working for a small high net worth firm just while I really kind of figured out what the next 30 years was going to look like.

37:42 And that's when I became much more aware of kind of the endowment and foundation community as one that is not only it doesn't fear concentration, but also is generally more willing to take a bet on people early in their careers because they realize often when you're smaller, that's when the best returns show up. You know, whereas like you have a mutual fund world, you need to have to the 10-year, 15-year track record or whatever. And I was like, "Well, that sounds might be the best route to go down because maybe I might actually get a client in the very first 10 years, which would be kind of good." That was the journey to launching Dorsey as kind of a concentrated firm focused on the E&F community in in 2014.

38:21 >> So when you took these years of research into moats and had to think about them as great investments into an investment fund, what did you believe Let me phrase it differently. What did you decide you wanted to do as an as an investment strategy? >> So, concentrated because, frankly, that was something I hadn't had the opportunity to do at Morningstar because, you know, we covered 1,718 companies, and you just can't get that in-depth on any of them, right?

38:55 And because moats are qualitative, I think that you can have more confidence in the non-obvious ones when you are able to have the time to do the work, you know, to talk to customers, to talk to former employees, to go to the trade shows, all the usual shoe leather stuff that we know about. You can't do that in a 50-stock portfolio without like some gigantic team, which I didn't want. So, you know, concentrated was really the only kind of way to go.

39:24 In terms of, you know, the the the structure, and we were long only because I I'd never shorted a stock in my life. I I would have no I I would I would be dangerous shorting stocks. That that that was never kind of even on the table. >> What did you decide were your favorite moats to try to identify? >> We've certainly leaned away from consumer-oriented moats, consumer brands, CPG, for example, luxury, cuz I just don't know that I have as good of a pattern recognition there. And I don't know that I'm going to have the confidence in those moats to stick with the business when the chips are down. It's a B2B businesses, you know, you can talk to a dozen customers, and if you get kind of a similar story about the value of the product or service, you can reach pretty confident that you're kind of going down going down the right track.

40:13 You know, consumers, obviously, you would need to do much larger surveys, much larger sample sets, and that's just, you know, technically kind of complicated. But big picture, I think it's when the company has the ability to reinvest back into the moat that we find most interesting because then that whole capital allocation conundrum that we discussed earlier becomes moot, right? You don't have to worry, what will they do with the money they're generating because there's an obvious thing to do, which is put it back into the business. And and it's often at a much higher rate of return, right? You think about it, you know, how many money managers have done 20% returns on capital over a decade?

40:53 Like not a lot, right? But there are tons of businesses with 20% returns on capital. Tons of them. If I've got a choice between company A that is constantly giving me back the money and then I need to go reinvest it in a super competitive public equity market or company B, which can just plow it back into a 20% RO return on capital internal project, well, the math is pretty obvious which one I ought to be choosing, right?

41:19 Not only am I getting better returns with B, I'm also taking risk off the table because they're not going to go out they're less likely to go out and do a dumb acquisition or buy back stock at the wrong time because they have an obvious place to put the money. So, no, I think that that reinvestment runway is something we look at a lot and I think it helps A keep us out of trouble and B it kind of leads you more down the path of the companies that are in growing markets where there's often less competition because if the pie is growing, you're probably not fighting as much for every scrap that's available and where you've got that ability to reinvest.

42:02 >> When you had a universe of 1,700 companies you're following to to get to 12, what filters have you used to narrow that lens? >> To be clear, you mean we kind of had to cover the waterfront at Morningstar. So, I mean that's 1,700 including utilities and oil and gas and life insurance and auto parts and auto OEMs, which are all just not very good businesses. >> >> So, those are kind of easy ones to just kind of throw out. Step A is basically is the industry structurally attractive or not? And I think this is kind of one of the the hard truths that early investors have to learn is that, you know, some industries are just tough.

42:41 And I mean, you got to respect the managers who are in them and got to respect the CEOs who try to make money there, but making money as an airline is just hard. Making money as an auto parts company or a life insurance company or in oil and gas, I mean, you're a price taker. Right? Like a huge parts of your future are not under your control. And again, you can invest in these businesses and do well with them if you develop pattern recognition and understand that world, but it's just it they're not conducive to creating moats. So, that's those are just areas that we largely ignore. And the second is can we understand it? I mean, we're a global I mean, we are global. you know, historically about 30-40% of our portfolio has been outside the US, but we're bunch of folks raised in the US sitting in Chicago. There's a lot of smart investors in São Paulo who are going to understand a local drugstore chain a lot better than we are. You know, so you kind of have to not get over your skis in thinking you can understand things on the ground better than somebody who's lived in that culture all their lives.

43:43 You we definitely sort of avoid stories where the moat is based on kind of local tastes or local regulation where we're just likely to be the patsy at the table, which is not a fun place to be. And that shrinks the universe down pretty quick. And then liquidity matters, too, cuz we're about a billion and a half and you know, with 12 stocks, So, can do the math on kind of, you know, what kind of liquidity we need. And that that shrinks the world pretty quick.

44:11 And so, there's probably 3 400 companies kind of in our universe of companies that are investable for us. >> How do you think about the relative merits of a company inside the US where you understand the structure, understand the culture, and businesses outside the US? >> There are two benefits that US companies enjoy that non-US companies do not. One is called the SEC, which is the nastiest securities regulator on the planet, and which is great for us as investors.

44:41 You know, if you see a company that say might have had the choice like had a choice to invest like if you anytime you look at a say a software company and it's listed in London and maybe it's not like a super UK-centric company, you kind of got to ask, why didn't you choose to list in the US? Right? Like why would you not list here and get the higher valuation and access talent? And frankly, also just I mean, you saw this with what BaFin and Wirecard? I mean, good lord.

45:11 Unbelievable oversight by the regulators. Unbelievable. So, if something's listed in the US, you're probably going to get better disclosure. You've got a higher level of confidence that there's not related party transactions or off off, you know, off-balance sheet hooey going on. And that's a great thing for us as investors. And the second is, I think on balance, as much as they as as overpaid as they are, and 99.9% of American CEOs are vastly overpaid relative to the value they create, they're generally better managers and they're generally better at capital allocation than you see outside the US. I mean, you don't tend to see, for example, like a US company buying back stock and paying a dividend.

45:56 Like that's just like weird. >> >> Like why would you but I see that all the time outside the US. Because, you know, dividends are kind of sacrosanct in other in other investing cultures. And then you see buybacks happening as well. It's just It doesn't make any sense. I mean, some of that also is that generally speaking, corporate talent comes to the US because they get paid a hell of a lot more. You know, I mean, if you're a really good manager and in in in in in any industry, running a US company, you're probably going to make 5x what you would make in in running a a sizable European company. And that doesn't mean that we don't have idiot managers in the US. We do. And that doesn't mean that there aren't talented executives in Europe, but there are.

46:40 But on balance, I've found that I've had fewer head-scratching meetings with management in the US than I have outside the US. >> So, as you walk through this, it sure sounds like non-US could be in the Buffett too hard pile. So, what does it take for a non-US business to get you excited? >> I mean, it's got to be a phenomenal business. And they do exist. I mean, you know, our largest position right now is ASML. You know, I mean, a monopoly on semicon on a key part of the semiconductor value chain. Hm, that's that's pretty hard to overlook.

47:12 >> >> All right? It's They're also very well managed, in fairness. I mean, it's not just sort of like they have this great monopoly. They've been very good capital allocators and very disciplined over time. We've done a lot of work on the the aerospace ecosystem with Safran and Rolls. And you can argue about, you know, management at Safran to some extent, the disclosure's not so good. But at the end of the day, they've got one half of the CFM56 franchise.

47:43 You know, and that is on a lot of 737s, and it ain't going away. So, So, I don't want to say that the bar is higher. It's more that I mean, these tend to be global businesses that we're looking at that just happen to not be listed in the US. And but I do think it's important to keep a all an open aperture. And we would I do see mispricings a lot. Where, you know, the US listed analog might have be trading, you know, four five turns higher than the European analog.

48:16 Just because, you know, there's large pools of capital in the US that just don't invest in non-ADR securities. And so, building the operational infrastructure to enable you to own local common, even if that's only two out of 10 opportunities that you participate in, that's two you wouldn't have had. Right? If you had If you hadn't bothered to do that. So, it's about keeping an open aperture, but not lowering the bar.

48:46 >> I'd love you to take me through your research process. So, there's so many nuances you describe in how you like thinking about these businesses and management teams. What How does that play out within the organization? >> Yeah, so everything starts with the very creatively named quick idea, which is exactly what it sounds sounds like. Just sort of it could be a few sentences, it could be a page, just sort of what's interesting about this business, what does it look like the moat is, and what could the opportunity be? You know, super easy.

49:16 And then maybe a third of those we I green light for what we call a first pass memo, another creative naming, which is about a week's worth of work, where we try to look at, you know, the moat, critically the vector of the moat, like is the competitive advantage getting widening or shrinking? What are the key debates? Like what what are the areas where we might have a variant perception on this business? What's the runway for growth? Cuz that's the thing we really prioritize and and what we look at. And then any red flags on management, and then kind of a scratch valuation.

49:49 It gets posted to our internal research system, and people ask offline Q&A, and then we meet on it. We tend to do a lot of offline Q&A on memos because I find that it makes the meeting more robust and more discursive and more of a back-and-forth because you're not asking, "Oh, I didn't see what segment margins are for that thing. What was that write-off in 2014?" So, just we just take care of that offline. It's much It just makes for a much more robust conversation. and then, you know, it's just about, okay, is this the droid, you know, is this the droid we're looking for? And if it is, we try to figure out what the correct research vectors are. you know, is it talking to farmers? Is it interrogating clients? Is it understanding their supplier base?

50:35 It's different for every company, and I think that you kind of have to not approach every company with like a template, but sort of say, okay, now that we've understood kind of what this company what what is likely to be important for the the the thesis, how do we answer the key questions? And then, you know, try to go out and do that. >> You've had next to no mention of valuation. Just a little bit of a scratch here and there. How do you think about valuation of these businesses?

51:03 >> Coming out of Morningstar, which is a little bit more of an academic flavor to it, I was very sort of canonically focused on kind of, you know, Damodaran-style DCF. That wasn't good. Because people have used multiples for a long time to great success, and there's a reason for that. And so, I would say that today we tend to use multiples as our primary touchstone and then do a a three-stage DCF kind of as a as a as a backup, almost, just to see where there are big differences because the thing that a DCF actually, interestingly, is quite poor at, even though people think it's very long-term oriented, is that mathematically, a DCF assumes that the multiple fades, right? It assumes that, you know, returns on capital fade to cost capital.

51:51 But if we're looking for moat-y businesses and we're trying to only really own businesses that are likely to, quote unquote, beat the fade and sustainably have high returns on capital, the DCF may not be the best tool cuz it might actually like undervalue the business. And so you wind up suffering an opportunity cost cuz you don't invest in things you should have, right? And so I think it's it's really important just to be, you know, with Catholic and mean not just the church, but, you know, Catholic in terms of, you know, open-minded in valuation.

52:25 And sort of say, "Okay, commercially, how has the market historically looked at this company? Is it EV/EBITDA? Is it EV/EBIT? Is it free cash flow yield? Whatever. Okay, empirically, that's what people seem to care about. So let's not fight city hall. And, you know, look at that and make sure that we understand where the multiple is on that in that framing, but then back that up with a very thorough three-stage DCF. So we understand that there are those two are really far apart. And if they are really far apart, you probably got a problem, right? They should at least be in the same neighborhood.

52:58 >> So when you bring this work together, what goes on in your head when you're deciding to bring a new name into your portfolio? >> Well, the first thing is opportunity cost. You know, because, okay, so you've got a set of things that you own that where the thesis have in, hopefully in many cases, progressed along the way you thought and probably in some cases not progressed the way you thought they were going to. And you got expected returns for all of them, right? You mean you have you're expecting to make Z per year out of companies A, B, C, and D in your portfolio.

53:32 I think the hardest thing is to really be careful about endowment bias because I think it's you know, there's I mean, there look, there's a lot of the behavioral empirically demonstrated behavioral finance evidence that we overvalue what we own. >> Right, the famous >> coffee mug study. And I think it's really easy to do with your portfolio as well. That okay, you know, you know, we're familiar with this company, we've owned it for a while, and you kind of don't put it on a level playing field with the thing that you don't own, but that you have, you know, done a lot of work on. And also, I think that, you know, low turnover sometimes gets put on a pedestal, like the platonic ideal of the investor is, you know, you buy a few stocks that are wonderful and compound, and then you sit around reading annual reports for 10 years and watch the money roll in.

54:17 The reality is, of course, very different. And but it's hard to admit to clients, well, we were wrong about this, or, you know, we found a better opportunity over here, cuz you might look indecisive, your turnover numbers might go up. If you have taxable clients, they don't get they kind of don't like that. So, yeah, I mean, anyway, for but for so for us, it's really does the thing that we don't own offer either better returns or portfolio diversification characteristics that improves the portfolio.

54:47 Cuz I think that you want to always be thinking about like you shouldn't change the portfolio unless you make it better. And making it better could mean a higher return. That's a good thing. But it also could mean introducing factor diversification, right? And that's a good thing, too. And so, swapping out something that maybe even has a slightly lower expected return, but offers really good factor diversification, or is, say, acyclical, so that will be available as a funding source when everyone decides the world's going to pot, that's super valuable, right? But that's you've made the portfolio better in some way.

55:22 >> Have you thought about position sizing? >> So, our max size is 15. There's no magic to that. Just a number. >> >> But that means that, you know, maxed out we'd be about eight stocks. We've historically owned between 10 and 15. And the 15's a hard number. That's sort of one in one out. I think being being a little bit concentrated is being like a little bit pregnant. You either are or you aren't. and so you you you see a lot of people as more capital comes in, they become less concentrated over time. And we've sort of, you know, made a promise to our investors we we won't do that.

55:58 So, kind of max is 15 and that would be a business where, you know, we think management's an A+. We think the moat is phenomenal and there's a runway for reinvestment. And the expected return is exciting, well above our 15% hurdle rate. Cuz otherwise you shouldn't own a very large position. All right? I mean, if even if management's great, the moat's great, and the runway's great, if it's priced appropriately, we either shouldn't own it or it should be a smaller position. I mean, that's just that's just that's pretty simple.

56:28 We've started some things more closer to the nine or 10 level. Most things will start probably closer to six or seven just to give us dry powder. if, as does happen, things don't go the way you expect, and then you you you need average down. >> You mentioned earlier on that maybe the most important aspect of a CEO of a portfolio company is humility. And I I'm really curious about the lens of balancing the confidence and conviction you need to have concentrated positions with the humility that you might be wrong.

57:01 >> Yeah, that's a tough one. because the the line between confidence and stubbornness in our industry is very very thin. And you you you have to have confidence just to own equities at all, right? It's a residual security. I mean, we're the last we're the lowest guy on the capital stack. Everybody gets paid before the equity holder. I mean, there's a wonderful book by Elroy Dimson called Triumph of the Optimists about the history of equity returns. And I think that title is very telling cuz it's Triumph of the Optimists. It was the optimists who believed the future would be better than the past and owning equities as opposed owning bonds or something with more security. So, you have to be an optimist.

57:37 But, you also have to be very willing to listen to disconfirming information and then potentially and be humble enough to say, "Okay, I was wrong." That original hypothesis I had, the weight of the evidence says, "No, that's actually not the way the world's going to play out." And, you know, that is a decision better made sooner than later in in most cases. One thing that helps with that for us is that we have a pretty a team-based environment.

58:07 And, you know, I think you're less likely to miss a valuable perspective if you invite debate. If you listen to the people around you, if you actively solicit their position their their opinion, rather. And then if you they know that opinion is valued, right? If you just ask them and then like never act on that, then it's kind of an empty ask. And then framing conversations as truth-seeking, I think really helps it all as well in staying humble.

58:39 A lot of times debates can be even about who's right and who's wrong. And I think that's a really really dangerous way to approach a conversation in investing. Because the goal is not to be right or wrong, it's to iterate closer to the truth, which is probably unknowable. That also, I think just framing it as every debate being truth-seeking in the service of making a better decision for the client as opposed to proving somebody right or wrong so that you score political points or they get more of the P&L, I think s- just structurally enables a bit more self-reflection and and and humility.

59:19 >> What ends up being the difference between something that's in your portfolio and something that is really really close, but doesn't quite make it in. >> Sometimes it's just a personal comfort level. Because at the end of the day, when the numbers are flashing red and the news is bad, I've got to make a decision. Like that's that's my job. And if I just don't have a good feeling about the business, if I don't if there's just something nagging at me about it, whether it's management or the business model, the analyst can do all the work, they can be super confident, they can have everything lined up correctly, but if I'm likely to make the wrong decision when making the right decision is super valuable, we shouldn't, right? And so that there's kind of a I think it's almost a personality aspect that like that like the PM's got to be comfortable with with everything in the portfolio. That's often sort of can be a little bit of an edge case.

60:20 You know, another one can be kind of confidence in the runway. So, things where the business is unlikely to grow a lot, but might have a great mode and a great valuation, because then you're faced with I got to I'm going to do something with the capital. Once it re-rates and we've kind of, you know, made our nut, now I've got to put the money somewhere else. And that relative to a business that has reinvestment opportunities and can is more likely to be able to find incremental things to do with its capital, that's probably a better place to put our capital because we're likely to own it for longer and we're likely to not have to replace it in X amount of time once it re-rates, which then frees up research resources to find more businesses like that as opposed to having to continually like buy things at 10x and sell them at 15.

61:10 >> If you look back over your history, what have been the drivers of your sell decisions? >> Being wrong. Probably the biggest. >> >> Like the sell decisions when the stock is wildly overvalued, you probably made money along the way. So, you're That's not a bad thing. We haven't had a lot of those. Like I mean, we've owned the longest-standing position in our portfolio is Meta, which we first bought in 15. Yeah, 2015. And interestingly, it's never gotten wildly overvalued. It certainly got wildly undervalued at one point in late '22 when it was like nine times EBIT, but I don't think it's ever traded above kind of low 20s EBIT. And there's some reasons for that. It's a It's a maybe it's a less predictable business than some cuz it has to follow kind of different trends in social media and how people like to consume other social content. So, it's had to evolve over time. And so, it's not kind of in that in an inevitable in that sense.

62:09 But so, we've never had to sell that on valuation. But most of our sales have come because we got it wrong. You know, the thesis was wrong. Management said did something we didn't expect. or we thought they were better capital but yeah, I would say that's the bulk of our sales have been driven by errors that we needed to correct. >> So, in this dozen or so years you've been managing money under your own umbrella, what have been the biggest lessons that you've learned from what you knew when you started?

62:42 >> I think the biggest one is you can never set the bar too high. In terms of the quality of the business or the quality of the management team. Most of our errors have come from compromising on one of those two. That either you know, this looked like an A+ you know, we we thought this was an A business and it turned out to be a B- business. Or that we thought this was a phenomenal management team.

63:04 And I would say early on, I definitely fell into that founder mindset of kind of giving founders a pass. and that's that's resulted in some errors. You can never set the bar too high. In terms of because especially in a concentrated portfolio, you just don't need that many ideas. And so like why why compromise? Right? There's just just and and then definitely have in the past and that that's resulted in some of some errors over time. So, I think that's the single biggest one is just never you just you can't set the bar too high.

63:41 that's the biggest one. >> How about any others? >> Selling sooner than later is another biggie, I think. You know, again it's it's it's hard to admit an error. We're just as humans, we don't like to do that. You have to write about it, you have to talk about it with clients. And so I think what that means is that people often wind up hanging on to positions where the thesis is not going the way they expected for too long. Because it's psychologically hard, right? You have to admit you're wrong, you have to talk about the error.

64:12 But I think that history shows we certainly our history does. I think most the history of most portfolios shows that when you think the thesis isn't going right, when the weight of the evidence says this is not going to work out the way you expected as opposed to hoping it changes or hoping an activist shows up and saves your bacon or whatever, just admit the error and move on. Because there's lots of there's other ideas. There's lots of other things you can do, right? Why not iterate towards something you're more confident in than something that has probably gotten cheaper because the thesis is not going the way you expected, but where the likely vector is negative. Just admit the error, take your 12 15 20% loss, you know, whatever the number might be and just find something else.

65:01 It's really hard to do because the kind of you know, you've probably written about the stock and you've you know, expressed confidence in it with clients when you first bought it. And now you're saying, "Whoops, screwed up." >> >> But you have to, right? >> Can you talk more about that weird isn't wonderful? >> That's kind of a lesson from our early years where, you know, we launched we we we launched with a whopping 3 million in assets under management. It wasn't much. I mean, we got a couple of institutional investors relatively early, but we were still pretty small.

65:31 >> >> And, you know, my thinking was was hey, we're really small. We have a you know, we can buy kind of smaller businesses that are not well-known and really undervalued. And you know, that's just kind of that's kind of how we're going to generate great returns. The risk with that way of thinking is that sometimes businesses are small because they've never really succeeded. >> >> There's a reason why they're small, right? and you know, there's also kind of I think there's a psychological aspect of, you know, you're a newer manager and you're trying to sound different. You're trying to kind of add value for the client and say like, "Oh, I own all these things nobody else owns. Isn't that really neat? So I'm like going to be a diversifier in your portfolio or I'm not going to own a lot of, you know, Nvidia or whatever it might be." But all that matters over the long run is returns.

66:17 That's all that matters. And so if you've got kind of the weird off-the-run business that's going to, you know, require some leaps of faith and maybe not offer you great liquidity. And you've got like an amazing mega cap staring you straight in the face at some screamingly cheap valuation. It doesn't matter if everybody's heard of it. Like that's where you're going to generate the returns. Put the money there. You know? So yeah, no, that I think that was kind of a a wake-up call I had and so our first couple of years were okay, but not great. and then in early '16 I wrote an internal memo called better.

67:01 It was just basically we can be better. Like like the structure we are unconstrained. We have couple wonderful clients who trust us. Like, we don't need to be doing weird things just because they're weird. If the best way to generate returns for our clients is obvious, and like we don't sound super cool talking about it because we didn't have to, you know, get on a plane for 8 hours and go talk to a company in some weird domicile, so what?

67:31 >> >> Like, the goal is to make money. I think that unusual ideas often get privileged in our industry. If it's unusual, if it's hard to understand, if like you had to do all this detective work on the balance sheet to find out the value of this hidden asset, that's kind of is a is a sexier pitch for the client than, you know, mega cap X at 12 times earnings. but that might actually be the better route to making money.

67:58 >> Both with those unusual ideas and the idea of selling or selling earlier, have this impact on what you communicate with clients and what they understand, you know, your methodology and story to be. What have you learned about the business of investing and relating to your clients so that they can be with you for the long term? >> You can never be too transparent. I think that's the biggest lesson. I've definitely met investors who like they won't write about positions even when you you you kind of have to pry information out of them about the companies that they own.

68:35 Clients don't like that, right? I mean, like, you think about like a somebody investing with you as a as a manager, they have a much harder job than you do investing in equities. Like, when I invest in a company, I have years of audited financials, I can talk to customers, I can talk to suppliers, I can talk to former employees. Like, when someone invests with us or with any other manager, they're really betting on the person as much as anything else, right? And there's a lot that that goes on in that person's head they don't know. And so, the more you can be transparent about why you're making decisions, what decisions that you're making, it just engenders a huge amount of trust. An enormous amount of trust.

69:12 Because I think it's it's kind of rarer than it needs to be in our industry. We don't play in long short world, but like in most of our clients have SMAs. They can see everything we're doing on a daily basis, you know? Great. Fine. It doesn't bother me. But, I've definitely talked to investors who were like, "I would never allow an SMA. My client can see what I'm trading." And so, well, like why? Why does that matter? I think transparency goes a long way to creating trust.

69:41 And And the other one is, and this kind of goes back to our pricing power conversation earlier, not pricing in an abusive manner. We started with SMAs, and then we launched a fund, you know, and we were writing out the fund docs, and the lawyer was like, "So, yeah, what expenses you're going to run through?" I was like, "What?" You mean you couldn't have the clients pay for your Bloomberg? You know, and like, "Really?" That's ridiculous.

70:06 That's That's what the management fee is for, right? But, you see that all the time, right? But, I think what that communicates is we're rowing in this boat together. We're together rowing in a boat to generate returns for you, my client, and we're we're kind of sharing in the risks and rewards in an equitable fashion. I think that when you do it in a less than equitable fashion, either through things like running too many expenses through the P&L or whatever it might be, again, it doesn't engender trust and alignment.

70:39 >> When you've given all that transparency, where have you seen disconnects in how you're thinking and maybe what the expectations of your investors have been? >> Certainly, because I think we are like I'm more prone to talk about my mistakes, and I'm in a meeting and I'm more prone to kind of help people understand where things have gone wrong and then how we've tried to improve our process or my thinking as a result. I had I've had at least one client say, you know, we have to always calibrate when when you come to talk to us because you leave and then everyone says, why are we invested with this guy?

71:13 >> >> And he and he has to kind of remind the team that hang on, he act like everyone's making the same number of mistakes that he is, they just don't talk about them. so, there's some calibration that has to happen on that front and I've tried to get better about this. You're just helping clients realize that, you know, we're going to do the decision that is best for them. Not that makes us look the best. Sometimes there's an incentive to overweight patients, right? Because, you know, great investors are supposed to be patient. My favorite holding period is forever.

71:47 Famous quote from Mr. Buffett. In a changing world, that's very dynamic, especially if you're investing in growing industries, because growth usually is accompanied by change. I'm not sure that your favorite holding period should be forever. Your favorite holding period should be as long as the thesis holds up. And if that's forever, great, you're a genius. Good for you. But it may not be. >> >> You know, and then I mean, your favorite holding period should stop as soon as your underwriting assumptions cease being valid.

72:20 Then your holding period should stop right then. But again, there's a I think there's a because we kind of canonize this ideal of you know, the guy sitting around reading annual reports, just watching the companies compound and not changing the portfolio at all. And some people can do that. Look, I mean, I've certainly I can think of investors who've had very low turnover and have generated great numbers and they made some great choices, you know, early on building great portfolios. So, it's certainly a very valid way to invest.

72:52 But there are biases around kind of the starting point. Like like you know, what what was the market environment and the opportunity set at the time you started your investing, and that can lead to lower turnover cuz you just had a great opportunity set then. And could also just be maybe those folks are just in the half of 1% and I'm just in the top 20%. Whatever the numbers are, right? but you don't want to damage the client by trying to be someone you're not. You know what I mean? Like you don't want to by striving to be that kind of in that that canonical sort of super low turnover investor, if that means you ignore data or underweight data and don't sell when you should, you're not doing anyone any favors.

73:37 >> After having done this for a dozen years, what are you hoping to achieve in the next dozen? >> I'd like us to be a slightly bigger, only slightly, and better version of what we are right now. It's kind of that simple. I think that some of the things I've learned since our our big drawdown in '22, I give me some confidence that the next decade might look even better than the past, cuz I think I'm a better investor today than I was in 2014. But yeah, I mean I think we've got a good structure.

74:08 Investing is a craft, right? It's not a profession. It's it's it's like woodworking or glass blowing. You know, you there's there is no perfection. You're always getting a little bit better at what you're doing every every time you do make a decision. It's just every year try and get a little bit better at who we are and what we're doing. And so hopefully 12 years from now I'm 12 units better than I am right now. >> >> Pat, I want to make sure I ask you a couple of closing questions.

74:36 What was your first paid job and what did you learn from it? >> Slinging pizza at a Sbarro. in the mall. I remember very vividly wearing my boat shoes. Like they were like I had those white soles. Like those are the nicest shoes I owned. and I remember like going for the interview like in the food court of the mall and being very nervous. And then, you know, I wound up slinging pizza for a couple of years there.

75:01 I will say that if you're going to work fast food, pizza's pretty good cuz there's no grease. Like I had I had friends who worked at McDonald's and like it just got into their pores. It's just awful. >> What's the best advice you ever received? >> I was sitting down with another investor in 2013. Actually in Omaha at at Mr. Toad's. I remember exactly where it was. And he said, "Pat, why haven't you launched yet?" So that was the best advice I ever received was get off your tail and launch.

75:28 >> What's your biggest pet peeve? >> Investing or just in general? >> both. >> In general, rudeness. I think people who just don't have are just so self-involved or self-centered that they just don't think about the people around them. And they were just rude. I just I did Like life is too short. Like like why can't you just like like open like don't let the door swing in my face. Hold it open for me, you know, or do the same for the person behind you. Like little things. Like the just those little tiny things just make life so much more pleasant and enjoyable. and investing, it's probably some of the parts valuations.

76:07 I think they're absurd. If it's a company that's clearly articulated, "Hey, we're going to break up or we're going to sell off this division or whatever." But if it's a company that has given no evidence that these disbarred parts will be separated, I mean, you can howl at the moon all you want. >> >> You know, but it's never going to get realized by the market. so I just I've just never understood those. I mean, I get it I get it if you're an activist, sure. And you can fight to get on the board and break up the company, great. But as like a passive minority investor who might own like 1/10 of 1% of the company, Why does the world care that you think some of the farts is X and this stock trading at Y?

76:49 >> Pat, last one. How's your life turned out differently from how you expected it to? >> Completely and utterly. I didn't grow up in a family of entrepreneurs. I didn't grow up in a family of investors. I didn't really even know this profession existed until I was out of college. so yeah, no, I there's absolutely no way I would have predicted where I am today 20 years ago. No way at all. I'm not complaining. You know, there are people who kind of you they grow up around entrepreneurs, they grow up around investors, or like they go to college and everyone's going into I banking or private equity or whatever.

77:25 And so they kind of have a feel for what this looks like. I had no idea. And so yeah, no, it's all been very unexpected and kind of learning on the fly so in a lot of ways. >> Pat, thanks so much for taking the time to share all your wisdom about moats. >> No, thanks Ted. Thanks for having me. Appreciate it. >>