Kyler Hasson - Playing His Game
Kyler Hasson (Kyler@hassoninvestments.com) stops by The Business Brew to discuss how he has morphed as an investor and as a Registered Investment Advisor. Kyler is one of Bill's good friends and they've chatted about investments for a number of years now. Kyler is an investor that has gravitated to high quality businesses. He has also gravitated towards a less concentrated portfolio in order to fulfill client objectives. We hope you enjoy listening to the two of them sharing lessons they've learned.
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+ Transcript
Bill: This particular episode features Kyler Hasson. Kyler is a hilarious person, cracks me up, more importantly than that, well, not more importantly, but for purposes of investing, I find him to be very thoughtful. I've enjoyed getting to know him over the past couple of years, and I've enjoyed watching him become a better investor, a better steward of other people's money, and somebody who's really open about how he thinks about things and areas that he could improve on, and I just hope that you all enjoy this conversation as much as I did, because I always love hopping on the phone or in this case the mic with him, he cracks me up, great guy.
As always, none of this is financial advice. All of the information contained in this program is for entertainment purposes only. Please consult your financial advisor before making an investment decision. If you need a registered investment advisor, consider Kyler. And do your own due diligence. None of this is investment advice.
With that out of the way, so, Kyler How you doing, man?
Kyler: I'm doing well. Thanks for having me on. I appreciate it.
Bill: Well, thank you for coming on. We've got the technical aspects sorted, and you, I just watched chug a box of bone broth for lack of a better term. So, you're ready to go?
Kyler: Of course.
Bill: Why do you look so good right now? That's a question I've been wondering. I've seen you on your bike. What's going on with you physically? Are you intermittent fasting and all this stuff?
Kyler: A little bit. I work out a lot. I like to ride my bike. Yeah, I don't know. I'm just trying to stay in good shape, eat relatively well. I'm usually hopelessly addicted to sugar. So, I'm trying to stop that. I saw some guy, he had a test, and he's like, "Hey, we want to make sure not eating too much sugar. Here's 10 questions to see if you're addicted. If you answer yes on two, then you're addicted." I answered yes on nine.
Bill: You know what? That happened to me for an ADD test.
Kyler: Oh, good.
Bill: Yeah. They were like, "If you answer yes to more than four of these, you probably have ADD." I looked and I had like eight or nine of them.
Kyler: Right. Well, I just had Twitter. So, that's what's the difference.
Bill: Yeah, that's right. Then I was like, "I don't even know if I answered the questions." Honestly, I wasn't paying much attention.
Kyler: [laughs]
Bill: [laughs] I was focused on something else.
[laughter]
Kyler: Yeah, well, so hopefully I have noticed my focusing abilities has gone down a lot as well. So, that's good.
Bill: Because of Twitter, you think?
Kyler: 100%, yeah.
Bill: Yeah.
Kyler: My attention spans like 10 seconds.
Bill: So, where did you start? Did you start writing on Seeking Alpha when you were a young investor?
Kyler: Yes. I didn't write a ton, but of what I did write, I published it there. I wrote on a blog for a little while. I figured it would be good to own my own content. I know all the companies are doing that. So, I figured I'd do it myself. [laughs]
Bill: You were the OG creator economy?
Kyler: Yeah, of course. I just going to catch up to Disney pretty soon I think.
Bill: [laughs]
Kyler: So, I started writing on a blog. I don't know if you've ever tried to use WordPress, but it's hopelessly difficult.
Bill: Yes.
Kyler: It took me 20 minutes to get my mic to work for this. So, you can only imagine how self-publishing a blog was. That was pretty terrible.
Bill: For some background to anyone listening, Kyler didn't even get the mic to work. We had to call in the big dogs, also known as Kyler's wife.
Kyler: Yeah, she's luckily much smarter that-
Bill: [laughs]
Kyler: -in addition to prettier, more charming, etc., and tech savvy. So that's good. But yeah, no, so, I wrote on the blog for a little while, and then I migrated all the Substack, because they do the backend for you. So, that was much better. I've written one thing.
Bill: Yes. Oh, that's right. You wrote up Altice right on Substack.
Kyler: I wrote up Altice. It was a good-- it would be difficult to start writing somewhere and have the first thing you wrote about go down 40% in like a month and a half.
Bill: Yeah, it's one of those you couldn't do it if you tried.
Kyler: No, you couldn't.
Bill: Yeah. You know what I liked about the Altice discussion, too, was you and Andrew Walker, I thought it was a fantastic podcast, and I liked how it took about 55 minutes to say anything positive about the stock or the company. It basically, it was you guys ripping them apart for 55 straight minutes, and then-- [crosstalk]
Kyler: Yeah. It turned out that most of those minutes were right.
[laughter]
Bill: Oh, Lord. Well, sometimes that happens, man. I was caught in that one, too. So, I understand-- I think I understand what you see. I don't know man. What's the best way to tackle this? Should we talk about why Altice was the siren song that got you back into value investing bad ideas or should we talk about where you came from or where you're at? You choose, you call it.
Kyler: Well, I guess, I could start with how I got started, and then that could maybe work in. I'm a registered investment advisor. But most of my business is portfolio management. So, I have individual clients, I manage separate accounts for them. They mostly have the goals of-- most individuals, which is, "Hey, I've got some money, I need to do some financial planning which I do upfront. Then, I just want to make a good return on my money." So, that's how I operate. I started investing in I think 2013 and over maybe five or six years, made a, I'd say a bit of a transformation. I realized-- When I started, I literally just thought, "Hey, listen, I need to go out and I need to crush the S&P 500 or else people are just going to fire me." That's not quite how individuals work to my surprise, maybe it's obvious on this side, but they generally want for as much as I think about portfolio management, probably the most value I add that people are to make sure they set up their financial lives really conservatively without a lot of debt, all those things, and then make sure they don't do anything really dumb, which any kind of speculation, a lot of my more well-off clients, they see a lot of very high fee real estate deals come across their desk. We generally try not to do those. We do a good one, but I don't really see any good ones yet. Different startup ideas, all this stuff.
So, the first thing is, I really just try to make sure they don't do anything like explicitly dumb, which is harder than you might think, but then with truly long-term money that they do have. The second piece is, I just want to make sure it's mostly invested in productive assets for the long term. Either that's they want to do some real estate themselves or they want to invest in stocks with me. They don't really care about benchmark quarter to quarter. They obviously care about their returns over time and that's what I really try to generate for them, and just by chance I think I was fairly young when I started trying to raise some money, maybe the one differentiator I had compared to most other more experienced better investors is that, I could really personalize things for them and I have a lot of clients that make some money and live in California. If you live in California, your tax rates, especially marginally are very high.
Bill: Yeah.
Kyler: That can be 55% on short-term gains, 36% or 37% even on long-term stuff.
Bill: That's insane. I say, this is somebody in Florida.
Kyler: Yeah. I had one move to Texas and I was, "Thank you. It helps. That makes my job a lot easier."
[laughter]
Bill: Now, I can make start making decisions from first principles. [laughs]
Kyler: Yeah, exactly.
Bill: High turnover strategies, it's amazing to see how much tax drag screws you which is something that I would do well learning a little bit from, and maybe just going back to Papa Buffett and hiding in Berkshire for a while rather than dicking around with some of these other ideas. I'm getting a tax bill on Qurate. I'm finally finishing my taxes. It's a pain in the ass, man. It's a nice problem to have, but Pythia actually said this to me when I was pitching it, and he was, "Look, man, it could work for sure, but the tax bill is going to be huge," and not exactly rocket science that he pointed out. And I wasn't really focused on that at the time because I was focused on how good the investment opportunity is, but the pain of cutting that tax check sucks.
Kyler: Yeah, that's exactly right. And you live in Florida?
Bill: Yeah.
Kyler: Just thinking how much worse it would be if you're in California? [laughs]
Bill: Well, dude, when I found it-- No, that's not true. I was in Florida when I found it thankfully and I had already moved residence. Because I was in Illinois for the first half of that year. It could have been a lot different.
Kyler: Right. Yeah. So, I guess another way to say it is if you are a high net worth investor in California, and you invest in hedge fund, and it turns over its portfolio once a year, say all your gains are long term, they make 20% net returns, you're making roughly 12% or 13% after tax. Obviously, the difference between 20% and 12% or 13% is compounded over time is huge. So, I think my strategy changed a few years in when I realized, you know what, listen, I can buy a good investment in a good company and it can double, and after the tax I have to pay if I want to sell it, once it hits fair value, it's going to take a big chunk out of my return.
So, then I realized, "Well, you know what, why don't I just try to buy things that-- and I know this is sort of a boogeyman, but what if I can buy things that I can just plan on never selling?" I can get the returns, and I don't have to pay tax, and hopefully, I can defer it either a really, really long time or just never pay the tax. I think maybe in 2018 or so, I really internalized that after buying some good not great businesses, and making some money, and paying the tax, and see how it hit the after-tax IRRs, and tried to move into, identify the 50 best companies, and by best, very durable and should be able to grow for a long time. Then, I really liked the micro economics. I don't think competitors are going to pop up. So, if I can own those kinds of companies and not sell them, then my after-tax returns, which is how I raised the money in the first place telling my investors, "Hey, I can make you good after-tax returns. I can try to optimize those." Now, I own a few good things and mostly don't touch them. Then use some other things as well, but that's the base of it.
Bill: Yeah. I like that, man. I have a disease where I like cheap stuff. The problem was saying that out loud is cheap is predicated upon what it's worth, and then the probability of realizing what you think it's worth, and then the probability of selling it at the right time when it hits what it's worth, it's a tough game. I need to be a little bit more comfortable just being patient. That would be my weakness in my Achilles heel, which is I don't know that I'm unique in that. But it's nice to know that about myself. I got to go through the last five years of what I've done and figure out what my turnover is. I know, part of me is hiding from it because I don't want to know the answer. But part of me knows the answer, which is why I'm hiding from it.
Kyler: Yeah, exactly. I think it's a good point. It's like a lot of maybe old school value investing is, "I'm going to buy an asset that's worth a dollar and I'm going to buy it for 70 cents." Some people shoot for buying things really cheap, say, 50. Let's say, you're buying something at 70, and you think it's worth a dollar, and it'll take a year to get there, that's a, what 40% return if you're right. But if you're paying all that tax, it's about 25%. So, it's a 50% chance you're right and a 50% chance you're flat, then you're expected value IRR and that's about 12%. So, something that looks super attractive after you take the tax into account and pay full freight on that, it's like, wow, if I can just find something that will compound at 12% for a really long time, you'd probably rather just do that.
Bill: You're 100% correct. I think that the thing that makes me nervous, to be fair to myself, I have gotten much better at this than I used to be, a lot of the turnovers in the first three years, but I still have too much. Regardless, there's this thing in me that worries about being right for the first three to four years, and then just getting like blindsided. So, you take an asset like a Peloton, and I fully understand what that asset is today, and I think I understand where it can go in the future. But, boy, if something changes, it wouldn't surprise me.
So, maybe the answer is, well, then you just move on to a different asset. But the only reason that I pulled that one out of thin air is, I perceive it to be one of these really long duration for lack of a better term bets where the real bet is on the operating leverage on the back end of things. That stuff makes me nervous. I think I probably be better playing where I think you play, which is when S&P got pretty cheap when they had the acquisition going on. It's like your current cash flow base gives you a margin of some protection, and then maybe there's a little bit of sizzle on top of that.
Kyler: Yeah, I think that's right. It's actually, it's a good point. I think where I try to get paid is years five through 10, 15, 20. S&P Global, our good friend, Jerry [unintelligible [00:16:28] was in the process of buying IHS Markit, and the stock sold off a little, and it got not terribly cheap, but maybe close to a 5% free cash yield on the combined entity. I was not of the opinion that that was a terrific deal for S&P Global. I think their credit rating business is like the best business in the world. That being said, I think they're going to do pretty well on it, maybe slightly worse than their business would have done by itself. But also, it's like they went from owning S&P Global was one monopoly and three very strong oligopolies, and now they have eight or nine monopoly, oligopoly businesses. It's just like, sure, maybe they'll make a tiny bit less money, but on a risk adjusted basis.
Bill: Yeah.
Kyler: You have eight or nine bulletproof businesses. I can see the appeal on that. So, as an investor, that wasn't one where I was like, "Well, listen, I'm going to make the hugest IRR is I've ever made in my life." But it was a lot of in my opinion, very durable cash flow streams that should grow over time. I think my IRR will be hopefully 10% or 12%. But for a long time, I feel pretty confident in many of those businesses that 20 years out they're going to look pretty similar to what they do now. If I can find that and it's something that I'm able to hold, I'm willing to pay up a little for it to get those after-tax returns in the out years.
Bill: Yeah, that makes sense. How do you think through mean reversion and how these oligopolies have shaken out? and I guess the real question is, I tend to think we may have entered a period where there's either too much regulatory capture or there's been too much consolidation. If I actually believe that there was a willingness to break that up, I'd be a little bit more nervous about mean reversion. But I think some of these oligopolies are kind of set. I don't know that the market is worse off for it to be fair. But if I'm looking back and I say, "Well, historically, the profit pools have been competed away," I don't know how do you think through whether or not the profit pools are going to stay for 10 to 20 years or how do you monitor something like that? How do you think about these, watching these positions?
Kyler: I'd say, it's case by case, I'm a very, very bottoms up person, I don't have very strong top-down views on anything. I think it's a very real risk to watch out for. I think it's interesting when you're looking at an individual business, it's easy to say, "Well, hey, I just want to own the best businesses and just leave it at that." But I think you have to realize that there is risk and everything. There's obvious risk in buying businesses that suck. There's obvious risk if you buy a super, super profitable business, there's competitive risk and there's regulatory risk. I don't think that you can hide from all risk when you're investing in a company. We could think of a million bad businesses and they're that's obvious, but if you own something like a Google or an Amazon, that's a huge business that dominates its markets.
You would be a little crazy to not think, "Well, hey, there is real regulatory risk here and that's important to keep in mind. It doesn't mean that you can't own something, but you have to take into account," I think and then, of course, anything else very profitable, you need to worry about the competitive risks, so like TransDigm. I've owned that for a long time and their return on tangible capital is 100% pre-tax or something close to that. Obviously, they charge high prices and so if you're looking at that business, you just need to focus pretty much all your time on how people can come undercut them, all those worries. So, I just think there's risk everywhere.
Bill: Yeah.
Kyler: And you have to understand them and understand that nothing's bulletproof. I think sometimes I see investors are just like, "Well, it's such a great business, there's no risk." That's just not right. If you can't figure out what the big risks are then sooner or later I think you can get steamrolled because you're probably-- [crosstalk]
Bill: Yeah. You'll find out what the big risks are when they materialize. [laughs]
Kyler: Yeah. I think the big risk is, if I think something is no risk, then I may put a shitload of money into it, and then there are some risks somewhere and sooner or later something's going to happen and you realize, "Oh, I took more risk than I should have." I think it's Howard Marks that story. He's like the horse better went to the racetrack and there was only one horse in the race. So, he mortgaged the house and then-- [crosstalk]
Bill: And then the horse dies or something in the race.
Kyler: Yeah. The horse jumps the fence and so he loses all his money.
Bill: It's funny.
Kyler: It's kind of like that.
Bill: Yeah.
Kyler: Yeah. I own Google and I own a good chunk of it, but, under the wrong regulatory environment, there's certainly some things that regulators could do to that business. So, it's not like, I have half my money in it. I think you just need to be really cognizant and think really hard of all the ways you can lose and in every single situation there's plenty.
Bill: Something I've enjoyed talking to you about is your move towards a little bit more of a diversified portfolio. Because for a while I think you're more comfortable with concentration and I think we both trended away from that a little bit. Obviously, short of an index here but I don't know. I think that one of the scariest lines that I see people recite and recycle is when Buffett said, " I'd have 50% of my net worth in my favorite position." And I have always wondered if people that listen to that statement understand all of the assumptions he's making behind his favorite position and I don't think Buffett would ever do that without some form of control.
Kyler: Yeah, that's true.
Bill: Like, I don't think Buffett's going to let 50% of his net worth ride on agency costs somehow. Like, that's not how you become him.
Kyler: [laughs] Yeah. I have actually a lot of thoughts on that. The first thing that I don't hear enough people talk about is, you're not nearly as smart as Warren Buffett is.
Bill: Yeah.
Kyler: Not even close.
Bill: [laughs]
Kyler: He's the guy, he ran his hedge fund, and I think people forget and he made 30% net returns for a long time. He is, I think the greatest investor of our generation, or the last one, or whatever. I don't think it's particularly close. So, people are like, "Well, Buffett says this and Buffett says that," and it's just like, "You're not Buffett. You're not close to Buffett," and that's not saying anything bad about you. It's just the universe of people that aren't as smart as Warren Buffett is the whole investing universe so.
Bill: [chuckles] Yeah, that's right.
Kyler: I think that's a good point on agency costs. I actually think the most impressive thing about Buffett's investing career is, I think he said-- after they lost some money on Tesco a few years back, he said, "We've never lost more than 2% of book value in one idea." Maybe, there were a couple cases, but it was because he used a temporary loss to put the money in Washington Post, which was a thousand bagger. So, I don't think that counts.
Bill: [laughs] Yeah. It turns out, he got out of that one okay.
Kyler: [laughs] Yeah, but he has historically run pretty concentrated and to be an investor in the markets for whatever 60 years it's been and to be concentrated and to not lose more than 2% of your money in anything is really wild and is a testament to just how good he is. Clearly, there's a bit of survivorship bias there. There could have been a situation that he could have lost money and maybe it didn't happen. But still I think that's quite impressive and speaks to his risk management, and probably that there's a lot of things that he could have done that he thought he was likely to make money on, but he didn't because he wanted to wait for something more with less risk or more certain.
Bill: Yeah.
Kyler: I think that's interesting. But I think he says, "Nobody ever got rich off there six or seven best idea or whatever" that quote is exactly and it's like, "Yes, that's true." But I do know a lot of people that got poor off their first idea.
Bill: [laughs]
Kyler: It's like almost everyone if you're old enough. How many stories-- and this is for back to my day job is I manage money for people. I've was thinking about this the other day, how many people do you think have made positive inflation adjusted returns over the last 40 years when both the stock and bond markets have ripped? I don't know the answer. Maybe, it's 10% of people. I'm talking about after fees and tax. It's not a lot because there's a lot of pitfalls and I think the biggest one is being overconfident and putting a lot of money in a stupid idea. I've just like honestly through thinking about all that stuff and I have people and I would invest money for them for a really long time. If you blow up, you blow somebody up. So, if you're trying not to blow up, I think it makes a lot of sense to not be concentrated. It's maybe just obvious, I just didn't think about it in the right ways when I was starting. Maybe, at that point, I didn't know I was a lot dumber than Warren Buffett. [laughs]
Bill: Well, yeah, I think too, it's hard to read somebody that's like your idol for lack of a better term, and then not want to apply the lessons that they're teaching. To me, Charlie talks about being hyper concentrated in having-- his portfolio was wild. You can look back at that portfolio and say, "Well, Charlie had 40% drawdown, so I have to be able to handle them, too," or you could say, "Well, maybe I don't need to have my bogey be making as much money as humanly possible, and my bogey can be just getting to the end of the finish line, and I'll let the geniuses play for who's the smartest."
When Charlie was putting up those returns, he was talking to Buffett like you and I talk or like me and whoever else talk. Talking to Buffett would be a better use of your time than talking to me. I hate to say.
Kyler: Yeah, it's true.
Bill: I know. It's very sad, but it is true.
Kyler: And vice versa, though so.
Bill: Yes. So, you know what I mean? I don't know. I think that people look at the career and the track records, and I don't know it appears to me at least with some of the people that I interact with that, a healthy dose of base rates and understanding of survivorship bias would probably go a long way.
Kyler: Yeah, I think so. I think one more thing. So, one, I might be saying this a little bit wrong, but I don't think Charlie Munger was the most successful investor of individuals money. His returns were great. It might even just be, he didn't want the stress of putting other people through drawdowns which is fine. I don't know if it's like his clients were like, "I hate this. Get me out." I don't know what the situation was. But he had invested for people for 10, 15 years maybe. Perhaps not sustainable. I don't know. His returns were great. Not try and knock those. But it's different than like you say having control of Berkshire and be able to do it whatever you want. I think, like you say, how many concentrated investors do you know that have blown up with something? From earlier you said, we're not trying to use anybody's names, but there's a few big investors today that have had huge positions that they lost tons of money on and some have recovered and some haven't. But you shouldn't use a couple of people that have recovered to say, "Well, listen, if I've got a 30% position and it goes to zero that I'll be able to recover from that," because you probably won't.
Bill: Yeah.
Kyler: I took a class in college and it was on decision making, and it was really interesting. They have every question in the homework and the test was multiple choice. And the way you did it was not, you don't circle A, you say, this is the probability that I think A is right. Hypothetically, let's say, the question is two plus two, and A's zero, B's one, C's two, and D's four, you could pretty much say, "Well, okay, I'm 100% sure that D is right, because two plus two is four. But with these harder questions, if you're really damn sure, you might put 95%. The way the class was graded was, if here I'm 100% sure that this is right and you're wrong, then you fail the class.
Bill: Wow.
Kyler: Yeah, you fail the class. Point being, you're not 100%. So, don't put 100.
Bill: I like that.
Kyler: Yeah, it was graded on a logarithmic curve. If you had no idea, you'd say, 25% for each and you'd get a little bit of the points off. If I said I'm 2% sure that this one's right and it is right, you're getting negative a lot. It was a way to, I actually need to put how certain I am, and of course, you know, 20-- [crosstalk]
Bill: Wow, dude, what a good class?
Kyler: Yeah, it was really cool. No joke, I got how many times, what percentage of times you think I put 95% or higher and I was wrong 10 or 15% of the time like way too much. It was really interesting I think I got a half a letter grade worse than I should have just because of overconfidence. No surprise there. Probably, I'm sure most of class did. But it was just a really interesting way to think of what you know, how sure am I actually of something.
One thing, I think about investing is if you're relatively young, you might have 40, 50, 60 years. If I'm pushing the limit every year, I only need to be really wrong once or twice in order for my results to not be very good. I'm wrong on things with some frequency as we all are. I never use leverage. I try to make sure my clients like they have big cash balances and don't need the money. I try to do everything I can to make sure we're going to survive, and obviously you need to survive and do well enough for the effort to be worth it. But you have to survive first. If I've 50 people that invest with me, and after 15 years, they're like, "Well, hey, listen, we made 8% with you and we could have made 9% in the market." That's going to be okay. I didn't ruin a bunch of people's lives. If I zero their money or lose 75% of their money, because I was an idiot, then that matters. I have a bunch of people who are like, "Hey, this was, you know, for my kids to go to college and you fucked it up."
Bill: This is interesting. I'm going to hijack this conversation and talk about what I want to if that's okay. I've been thinking about the pressure that I put on myself to justify active management. It has been that I've got to outperform the S&P or else I'm wasting my time. I think that, that is creating bad decision making in me and I really like how you said that. Because at the end of the day, if I realized 7% and 9% was the return of the S&P or whatever, I understand how compounding works. I get it. But I've said it a number of times, the only thing that I have strong opinions on right now is that, as a basket, these high-priced software stocks are risky bets to say the least. I don't know that they're going to crash, I don't know anything about any individual company, I just think, historically speaking, you buy things at these multiples, it tends not to work out very well as a basket at least over a three to five-year time horizon. I don't know.
People want to come at me about the NIFTY 50. If you had just bought those 50 years later, you would outperform while you had to live through a whole lot of underperformance. So, there's a big assumption and being able to do that. So, I think to your point doing something that your clients can understand and getting them to the finish line is the number one concern from a personal investing standpoint. Now, if you're a hedge fund manager, it's a completely different conversation. You got a different bogey.
Kyler: Yeah, that's right. I think that's one thing, I think a lot of people talk past each other. I invest a certain way because of what the people I invest for need. Like I said, maybe when I was just starting, I didn't quite appreciate that enough. But I invest the way I do because that's what my investors want. I've never raised institutional money, I presume that if I have money from five or 10 institutional investors and I'm long only, and they invest with 20 people like me, they don't want my 10th best idea. They don't want my 15th best idea. They want concentration. And so I think we can look at people searching apps and say, "Man, look at how concentrated they are." That's insane.
Realistically, it's probably what their investors want. I really try not to judge other people. Listen, there's this older guy in my office, I joined this RIA a few years ago-- Registered Investment Advisor a few years ago. These guys helped me out with lot of things. They're a little older, they've been on the street, they know some stuff, and they were going to handle my back office was the main reason, but now, we're good friends, and we talk investments and stuff, that it's been a great partnership. There's this other RIA, this guy, that is there and his strategy is, he's got some sort of moving average crossover. He's like a trend following guy. He'll get in and out of the market from time to time. But when he's in- [laughs]
Bill: He's all in?
Kyler: -he takes all the stocks and organizes them by highest relative strength and says, "Imma own those." [laughs] So, we barely ever have any overlap. But I remember a couple of times when something I've owned has been ripping, he's like, "Oh, you know, I--" This happened with O'Reilly once, O'Reilly Auto Parts. I owned that for a certain long time, and it just ripped, and I was looking at it like, "If I could short stocks, I'd be short O'Reilly," and he's like, "Oh, I just bought O'Reilly. This thing's gone to the moon." I'm just like, "What?" So, it's completely the opposite of what I do, and how I think, and what kind of risks I'm comfortable with. Of course, over 30 years or however long he's been investing, he's in his 70s. He's like. "Smash the S&P 500." He just obliterated it and was-- you could say, "Well, hey, he was out of the market in the great financial crisis if you adjust, but that's what trend following is for."
Bill: Yeah, that's the whole purpose of what he does.
Kyler: Right.
Bill: That's like saying to somebody, "Well, they chip in out of the fairway," and you're like, "Yeah, that doesn't count. You hit it in." It's like, "Yeah, I know. That's exactly why I do what I did or whatever."
Kyler: Exactly.
Bill: Yeah.
Kyler: Exactly, right. Again, he's completely opposite of me. He's crushed the market. People can do well in plenty of different ways, and I never want to think that my way is the best. People do things differently and that's fine.
Bill: Yeah. I think that's right. I think that it's tough. We've referenced Twitter, right? So, I think that both of us see a lot of stuff on Twitter, and you see the tribes talk past each other, and it frustrates me a little that some accounts that I perceive are just like shilling momentum or whatever. Gain all this following and the rah-rah around some of the stocks though, I watched some of it happened with lumber, and it's weird to know what's going on, and have a view, and then impute what's going on in other places that I don't know what's going on. So, I think a healthier perspective is maybe just to say, I don't know and move on. It doesn't matter. I don't need to get involved with it, they can do their thing, I'm going to keep doing my thing, and that's how it's going to go.
Kyler: I think that's right. I think we all have our behavioral biases, and can go online or read all the books, and [you can figure out 40 or 50. I've always thought it's a very personal thing. There's some and I'm just like, "Oh, I don't do that, and there are some where I'm like, "Oh, I fall victim to this constantly." One of the ones, I think, I'm pretty good at is not being jealous of people if they're temporarily making a lot of money or even if they make a lot of money over 20 years doing something I wouldn't.
People make money in high growth software stocks, maybe it's temporary I don't know, maybe they can continue to make money, but I just don't care. I don't have the skills to understand some of these B2B software names where to your point, you need to be given valuations, and you need to be right in 10 and 20 years. I don't understand them enough to do that and so I don't care. People are double their money in the last-- If people doubled their money in the last 12 months doing that, then that's great and I wish them success. But I do something different, hopefully, in providing value to the people I invest for, and that's kind of good enough.
Bill: What is one that you think you fall victim to?
Kyler: Overconfidence is always a problem. I owned Energy for a long time.
Bill: Oh, yeah. I sent you that message last night and said, "Did you even listen to the message or did you erase it from your mind?"
Kyler: [laughs] I read what you said and didn't look up the ticker.
Bill: [laughs]
Kyler: I probably know the ticker is.
[laughter]
Kyler: It's funny because I told you the Energy I owned and you bought some of it, and I think you've done probably okay, but there wasn't exactly a winner.
Bill: I still like the way you look at that stuff. I think midstream makes sense. The incentives suck in many of those, though.
Kyler: It's I think a good segue. I owned energy for a long time. I think the first thing I did was buy Exxon. Man, the years run together, maybe it was 2016 whenever oil prices were starting to go down, whatever Thanksgiving that was that OPEC just was like, "We're [unintelligible [00:39:09]," whatever. It's interesting because looking back on that decision, I thought, listen, I need to own something that has good returns on capital because it's very capital-intensive business. You need to make sure that whatever you're investing in, they're actually making good returns on what they spend. I want a really strong balance sheet because it's a cyclical sector. They might not be profitable every year, but I think if I can own something with good returns on capital, and a conservative balance sheet, and good management, then through the cycle I should do okay. I thought I was buying Exxon pretty cheap. It turns out their relative returns on capital advantage to their peers was in the process of disappearing, and the upstream business was harder than I thought. So, it didn't work out for those reasons.
But the big sin, the big mistake, this was before I started to diversify more as I owned like a lot of it. I think it was 15% plus position maybe. It's easy now to be like, "Oh, that was dumb." It was, but it was like some of this overconfidence problem, and then to make matters worse a couple of years later, I said, "Well, I like these midstream companies, like Exxon, I've been tracking it and I was hoping they'd really invest through the cycle." They invest a lot of money when oil prices were low and they could invest good returns, and their returns on capital went down enough that they just didn't have much extra cash flow. If you can look in the late 90s, Exxon oil prices were really low, and Exxon was killing it. So, they had all this leftover money, and they could just invest at the bottom of cycle, and get all these good projects and good returns.
But this time, their underlying profitability wasn't high enough to do that. So, I was just like, the thesis is wrong. But oh, by the way, I really like these-- there're a few companies, but Magellan Midstream, they're the best operators in the space, their management is legitimately very good, most of their assets are really high quality and still are, they're refined products assets, which were over half the company. So, I switched my stake into that and maybe a couple other Energy infrastructure names. The assets that weren't very good, the 30 or 40 other percent of the company were a lot worse than I thought. So, I transitioned my money in there, and the management is still great, and most of our assets are still good. But now they're making a couple 100 million less dollars than I thought they would at this point. The degradation of value come straight off the equity. It didn't do very well on that either.
In both of those cases, if I would have invested in something with a lot more leverage or where the business was worse, I could have lost all my money. So, luckily, I was smart enough not to do that. But if this was a 5% position that would be one thing. If it's 15%, then losing a little bit of money over five years while everything else you own, well, not everything, but the other companies you own are doing really well, it really impacts your performance. So, I think that was the big mistake. I shouldn't have owned too, too much confidence. Realistically, I didn't know those businesses as well as other ones. So, that's probably the biggest behavioral bias I have. I'm trying to solve like we talked about. There're others that probably matter less, but that's a big one.
Bill: I like that. People asked me or people have said that talking about names creates confirmation bias, or consistency bias, or whatever. That doesn't really get to me. I do think to your point, I think overconfidence is probably one of my biggest areas. I know that my biggest personal, my weakness is that I pull the trigger a little quick, which is why I will flip sometimes. But I need to figure out the best way to determine whether or not the cost of that decision is worth the risk. My sense is that it's not worth the risk and I used to be so into the idea of, "Well, if you buy something cheap enough, that's your margin of safety." And I'm morphing a lot to the idea that execution is your margin of safety. If I look at Altice, where I think that if I was going to pick apart the decision, I think that you and I both agreed that the stock was too inexpensive or cheap, if we had waited for some of the results that we were expecting to actually come through, does the stock double overnight? Probably not. So, could I have waited for execution for a better entry point.
It's something that as I talked to more pros, they say, "You can buy things higher with less risk." And I have a natural aversion to that statement because I have such a perception of price being the margin of safety, but I'm starting to understand that statement a little bit better if that makes any sense. Because I do think that if Altice specifically proves the theory that Suddenlink is there for not the taking, but they can execute in Suddenlink and they can start sub growth again. I don't know what's the stock rip from here, maybe, more but from where we bought. It just seems to me like one of those things that maybe I'm a little quick. I'm rambling here but I'm just going to continue. The idea of being long term I think sometimes I have bought something and I've said, "Well I'm long term, so it'll work out." Where the real thought that would have been more accurate is I have time to wait because I'm long term.
Kyler: Right. Yeah, exactly, right.
Bill: I think the price has almost always driven that decision and that's where I think I get screwed on value traps.
Kyler: Yeah, honestly, the places I've made almost all my money, and honestly thinking back, if I was to do some return attribution and subtract some things that don't fit this, it might be more than all the money I've made is just is realistically high-quality companies that we know are executing that just sold off a lot for a non-core reason. That's I made all my money like that. There's no real question. Charter a few years ago, people were worried about video. It was easy enough to go in and see video wasn't that profitable, if profitable at all. So, that was an awkward reason and they were executing plenty well on the internet side and they were growing, and Andrew Walker did a bunch of good write ups just showing how cheap that was. That was an obvious situation. They're executing really well. Businesses doing well.
Most of the time-- in that one, the market wasn't cheap, but most of the times, I've done well as the market really sells off. Something that everybody knows is good and executes well, gets too cheap, plenty of examples there. But I think you're right. Businesses are made up of people. They're not in a spreadsheet. If you're going to do the strategy that I'm and I would say we are trying to do, you need to own the ones that are executing well. Altice, if it doesn't work out, it will be because they don't execute well.
Bill: Yeah.
Kyler: I'm more than happy to make the bet that they will and that they can figure it out, and that might be wrong. It's a higher risk thing than I usually do, and I was luckily sized as such from the beginning. But you're right, it is execution. I own this is--, I mean, one we know well in the fall of 2019, I bought Wells Fargo, and the thesis there was look their deposits are growing a little less than JPMorgan or Bank of America, but they're roughly in line even though they have all these operational problems and they have so much cost. So, if they can just execute well, they're not losing the franchise in the interim, and the cost will come out down the line and if you assume costs get back to normal levels, then your IRR and it was going to be like 15 or 20 years or something high.
COVID happened, and rates plummeted, and all the bank sold off, and you're worried about loan losses, all those things. So, I think I bought at 45 and it went to 20 or something in there. But in the meantime, and I remember you sent me-- I don't remember exactly the date, but you sent me the document there in front of Congress, and Congress was like, "Hey, you guys, we said you need to do all those things." [crosstalk]
Bill: You've done none of the things. None of the things.
Kyler: Yeah. [laughs] Like, "Stop stealing money from your customers." They're just like, "Nah, we're just going to keep stealing their money."
Bill: Dude, that document was crazy.
Kyler: Yeah, it was really bad.
Bill: The other thing that was nuts about that document is, they were hiring consultants to tell them what to do, and then they were sending the consultants' plans to Congress as if it was their plan, but they had hired no one that was capable of implementing the plan, and they hadn't actually even discussed it internally. It was basically, just like, blowing money on consultants to do nothing with the information.
Kyler: Right.
Bill: Part of me reading that report said, "I don't even know if this is nefarious activity. They may just be incapable of doing it, because they just don't even have the organizational knowledge of how to do this."
Kyler: Yeah.
Bill: Because they only hired from within.
Kyler: Right.
Bill: It's wild.
Kyler: I think that's right. I think what I got wrong was I said, "Hey, how hard is it to turn around a bank?"
Bill: Yeah.
Kyler: Maybe I should have thought about that a little more because it's a huge organization with all sorts of crazy incentive structures, and we knew that their culture was wrong. So, who knows? Again, long term that was only a couple years ago, maybe they'll figure it out. I don't really know. I was just kind of wrong like, they weren't executing. I think there's businesses that just continue to execute well, and ones that don't and you don't generally want to own the ones that don't. Luckily, when everything sold off in COVID, First Republic Bank which I love, it is great. It's sold off really hard too just with all the other banks, and I had to pay up a little bit to switch from Wells to the First Republic, but I did and since then, First Republic that they've just done a great job. They've really grown the business, great customer service and the whole thing.
I remember when I did this switch. I remember the math I did was, if Wells Fargo fixes itself, what's my return in 10 years? And then just what do I think I'm making First Republic, and the numbers were about the same. So, I was like, "Oh, hey, listen, the upside is pretty similar. Downside with Wells is infinitely higher, maybe?"
Bill: Yeah.
Kyler: [laughs] It was hard to pay up a little bit. That's one of my other biases is, I grew up a value investor and it's hard to pay up, but you just run the math on what you expect the returns to be and do what makes sense. So, I did that. Now, First Republic trades way higher than it should, but whatever, it's a compound or so.
[laughter]
Bill: So, never sell.
Kyler: [laughs] So, never sell.
Bill: Well, the thing about that is, the execution can bail you out. I think in the same way and I think this is one of these statements that all good ideas can get taken too far. But in the same way that returns compound, I think execution and culture compounds and there's a reason First Republic trades where it does relative to the rest of the group, whether or not the multiple turns out to be justified or whatever, I don't know. But I think that when I was younger, I didn't understand that there were reasons behind these things. Now, the devil's advocate in me says, "Well, why don't you just say the same thing about SaaS?" and the answer is, I'm perfectly fine admitting that I may be wrong that SaaS is too expensive here. But I don't have to have a view.
Kyler: Yeah. No, I don't. It's funny. We're talking about how I was looking at some really complex B2B SaaS name, and I don't understand most SaaS. But I was looking at it and it was like they provide database software and are used by the big cloud companies-- or through the big cloud companies. How am I going to know really what their competitive advantage is, and you have to be right on it for probably 20 or 30 years to make money, and do I really think that I'm going to be able to understand their competitive position for that long, and if Amazon or Microsoft build something that's better themselves, do I have any idea on this? If there's somebody else comes in and builds a new one? I know the switching costs are high, but that's not enough for that long and it's like I don't know. Happy to skip it and look at something else.
Bill: Yeah. I think, that's right.
Kyler: I think there's plenty of companies that you just watch them over time and there's a similar survivorship bias thing. "Well, hey, listen five years ago there were companies that everybody thought were great," and then they weren't true." So, I don't think this is an iron thing, but there's plenty of companies that you notice they have the right culture for their industry and they just keep doing well and probably they have some moat that helps. I think you can have good culture and a really hard business, and it won't matter or maybe you won't do super well just because the business is hard. But there's plenty that you just see what the people-- how the people that business behave themselves, and the results they generate, and they just sort of get it. I'm looking at Amazon right now, and future I don't really know.
But you look at the past and you look at Bezos just talking about like, "Hey, we're taking prices down, and we're going to spend all this money on free shipping, and the customers will really like it, and so, fuck it. We're just going to do it because we think it's the right thing to do." Not really sure, but just really customer focused, and obviously that worked out incredibly for them. I think it's the most important thing, maybe almost, but it's really hard to figure it out and obviously culture will change.
Bill: What is culture or when you say, it's the most important, I just want to make sure I understand what you're saying. Are you saying culture or--
Kyler: I would say culture blended with the ability to execute.
Bill: Execution. Yeah, okay.
Kyler: Yeah, I think so. There's just another example. My dad's a painting contractor. They paint big commercial jobs. Most of those other companies went bankrupt over the last maybe 15 years and a lot of them-- 2009 happened, and there was not that much work, and a lot of them just chased complex low-margin jobs, and something went wrong, and you're out of business.
Bill: Yeah. It's different. But that's how my father's side of the family had a huge construction business and complexity plus, I think, a couple aggressive bids turned into bankruptcy.
Kyler: Yeah, and it's easy. So, what do you have to do to be successful? Okay, yes, you need to know a lot of things on your actual business. But I think having a culture, hey, even in that case, it's just like, "Hey, we're not going to do stupid things." That's what saved them. We're just going to be rational and do things that make sense. If insurance can be like that too, lot of cyclical things can be like that. But you have to have patience and not do anything for a couple years and hopefully have a strong balance sheet, all those things. But it's the culture that I think really makes a true difference over the long term, frustrating for investors, it's the hardest thing to figure out. So, if you can, then you can I think do pretty well.
Bill: It's funny, when you're saying you need the ability to not do stupid things, patience, and a good balance sheet, that's pretty much what I think it takes to be a good investor too, right?
Kyler: Yeah.
Bill: I struggle the most. I've said it now a couple different ways. But doing nothing is like not-- it's a hard skill to learn.
Kyler: I think where individuals have the biggest advantage, you don't have to report to anybody. Obviously, there's the Buffett saying about that, "There's no called strikes." But there's two ways to look at investing in my opinion, like two big ways. One, your dollar cost average. You have some money, you invested in your best idea, you try to blend together in a good portfolio, that's not taking too much risk or whatever. And that works really well. If you consistently do that over time, you're very likely to have a very good result.
The other way is, money comes in, you put in your brokerage account, and it sits in cash, and then when you see 25% IRR, you deploy it. I think what's really hard is a lot of the very best investors, that's how they operated. The very best ones with the best long-term returns, like Berkshire they made most of their money at market bottoms. Washington Post, GEICO was like that when they initially bought it. Wells Fargo, when they bought it in 1990, that was killed. [unintelligible [00:56:59] Santa Fe, most of their big ideas happened at the market bottoms because they had cash ground and they're some counter examples obviously. But I think what's really hard is, some of the very best investors, that's how they made all their money. But also, I know a bunch of people who have been in 50% cash since like 2012, because oh, it feels the Fed, and like all this stuff. So, again it's that sort of survivorship bias like, "What am I seeing with my eyes? Oh, yeah, I can just sit around and wait for all those huge IRRs, but there's plenty people that try to do that and do much worse than if they just dollar cost averaged." So, I don't think there's a right way. I think there's two separate ways. Both can be successful. It's higher variance if you try to wait around. And also, it's hard to predict when you get the opportunities right. We've gotten good opportunities every couple of years, but you can go long periods of time without anything, and then it makes it harder because you're like "Well, I've been waiting for three years," and then maybe you're more liable to take an opportunity that's not as good as you should have, because you're impatient. It's not a-- [crosstalk]
Bill: Yeah. You end up stretching on an idea to get something done.
Kyler: Yeah, and Buffett's on that, too. I've done that. Probably, Wells Fargo in 2019 was that. I had too much cash and said, "Ah, well, this just looks pretty good," and probably should have done that one. I think in the same way that there's you can avoid risk. Like I said, buying the best businesses compared to the worst, you can't avoid risk in this whole cash management thing either whichever way you decide to try to go, there's just risk everywhere, and you need to try to be aware of it, and make really rational decisions and it's not easy for anyone.
Bill: Yeah. No, I think that's right. It's funny because I was naturally attracted to the stay in cash and then swing. I think now where I'm closer to being attracted to is, have some core positions, and then be very, very honest about what the opportunity cost of selling those positions is. What do you not-- well, not everything, but every new idea that I like, by definition I like, and there's a good chance I don't understand what I don't like about it in the same way that I understand the stuff I don't like that I own? So, what's the appropriate spread to incur all those risks, and I think that historically, I probably have underappreciated what that spread should be. It should be a very high bar, I think.
Kyler: Yeah, again, I feel like people sometimes come on these and they just like, "Well, hey, here's the right answer." It's like, "No, listen. There's no right answer." Your spread should be positive, if I think I'm going to make 10% on constellation software from here, and 10% on some new thing, but just say like the new thing doesn't have leverage either and it's really high quality assuming buying more constellation software wouldn't make me too concentrated in it, I should go with the thing that I know better.
Bill: Yeah.
Kyler: That should be perfectly clear and is the spread two points of IRR for the new thing or four? I don't know. But it's more than zero and you need to adjust for it. When I first bought Altice, what I was trying to do is say, "Hey, I think I'm going to make X percent IRR on charter." So to own Altice, I need to think I'm going to make about 5% a year or more. It's only been a few months. We'll see how things play down the line and hasn't worked out so far yet. But I think the idea is right and Altice operationally is not as good and so I think you need to try to make adjustment for that as well. But I think you need to try to take into account.
Bill: Yeah, I have tax loss, sold Altice. We'll see whether or not that is a mistake. Historically, it has been a great contraindicator. So, that's your inside tip.
Kyler: [laughs]
Bill: So, we'll see. I don't know. But the crappy part of getting involved in a situation like that is the decision on charter is it a little stretched? The decision there is like, "Oh, well, do I want to live through this, should I tax loss, sell something?" I actually do get a real benefit from short-term losses. Liviam capital has asked me this a couple of times, and I think it's the right question to ask. He likes to go up my beloved Qurate about this, which I will not accept because that is the greatest thing ever.
Kyler: [laughs]
Bill: But even if the idea is right, are you introducing the possibility to mismanage the idea or the position? I do think some of that question underestimates what can go wrong in other investments, that's easy to say now about Altice. This isn't a game of 100% hits. So, I don't know where I fall on that answer, but I think it's one worth pondering a little bit.
Kyler: Wait, what's his question? Can you just rephrase that one-- [crosstalk]
Bill: He basically said, why don't you just own some stuff that you think are executing a little bit better, and I mean specifically his take is big tech, right?
Kyler: Right.
Bill: My answer was, I think these have a reasonable probability of outperforming big tech. I don't think you're going to fight multiple fade, I think you're going to benefit from multiple expansion over time, which is real. I think it is objectively a lot easier to own Google, which I've now owned for four years or so.
Kyler: Congratulations.
Bill: Oh, thank you. Thank you. But it's just easier to own, right? It's arguably the best business that's ever been created, and it's maybe never been the best performing stock in the market, but always you can see intrinsic value building over time, you can see what they're doing, other bets is a pain in the ass, but they've got a little bit of religion on that, and it's just you can sleep at night owning it. Now is that a toppy thing to say? I don't know, maybe but I think people have been saying that for a long time and Google has proven people wrong. We'll see if it continues to do so in the future. So, is it easier to just close your eyes and buy something or hold something like that? I don't know.
Terry Smith, I think is a great example of a guy who is very, very good at holding, and very, very good at being very dogmatic in what his definition of quality is and only getting in a pond where he thinks he can own these businesses for a very long time. And there's some merit to that. Look no further than his record. [unintelligible [01:03:48] too.
Kyler: Yeah. I think, it's a hard question and like you said, maybe it's a toppy thought. I was talking to your good friend and my new friend, Jake Taylor, a couple weeks ago, and he's talking about, "Well, hey, let's try to make some predictions and see how often you're right." Like me in that class, like 95% sure, but for some reason that answer is only right 80% of the time. That's weird. [chuckles] Longer term predictions, I think about this a lot. There's not really good feedback loops in investing.
Bill: Yeah.
Kyler: The good ones are you get zeroed. That's a feedback loop. Like I invested in this and I got zeroed and bummer. But as far as even start three years ago and say Google's done well, but let's say-
Bill: People didn't like Google back when I was buying it at all.
Kyler: Yeah.
Bill: They didn't hate it necessarily. But it was like, "What are they doing with other bets, they've got no capital return program, what's going on here? They're not focused," and now, story is changed.
Kyler: Yeah. Story is changed. I don't think you can just say, "Well, hey, listen over the past five years, AMT--" There's a good one. "Over the past five years, AMT has done so well. Why don't you just buy more of that?" It's like, "Well, listen, their revenues have mostly fixed escalators and the ground leases underneath the towers have inflation-based escalators, and right now, nominal real interest rates are super low." So, if rates are up instead of down, you could have gotten killed on that. That's just one example. But there's a million examples out there of people, you can't just say, "Oh, it's been three or five years and I made the decision to buy this stock and not on that one, and it's worked out for me. So, that was the right thing to do." There's plenty of alternative histories out there where that didn't work out. I think in this case if you're trying to be first decile all the time in performance, that way of thinking can be really dangerous. You can say, "Well, hey, what did best off the March 2020 lows?" You can go like, "Oh, I should have bought a bunch of leverage shit."
Yeah, you would have made a lot of money. But imagine-- it's going to be hard, but imagine like the Fed didn't save the world or things got worse like, you could have lost all your money like that. I really try not to even let a few years of performance tell me, "Oh, this was a good decision or not." I mean, honestly, let's say you started investing in 1982. Interest rates have gone down the whole time you've been investing, arguably, I think that would be bad experience to have. I don't think it's, "Oh, well, you've got 40 years of experience." It's like every year pretty much that you've been an investor rates have gone down and so all the things you think you've learned, not all of them, but a lot of them are just a function of the most important macro variable going one way. Maybe we shouldn't try to draw all these hard conclusions. I think about it for myself like the last five or six or seven, or how many years, anybody who's bought dips has done pretty damn well.
Bill: Yeah.
Kyler: So, anytime there's a dip, I'm conditioned to be like, "Oh, I need to find something to buy." So, the market rips up 100%, and then it goes down 5%, and I'm like, "Oh, I need to buy something." It's like, "Well, maybe not."
Bill: Yeah.
Kyler: If real rates really start moving up, there's a lot of things that are very expensive. I think you need to have a lot of humility and not overfit lessons, because again, you don't get those hard feedback loops. You don't know what would have worked if the environment was slightly different. That's another argument for not being too concentrated. You learn all the wrong lessons, and you concentrate and do what you think are good ideas, and then the environment changes, and then you are dead.
Bill: Yeah.
Kyler: So, again, it's hard. [chuckles] That's really hard.
Bill: Yeah, I agree with that. I think the really, really good investors, when it's all said and done, are the people that could get through different environments and survive.
Kyler: Right.
Bill: I don't know how much of that requires changing strategy or how much of it just requires discipline? I'm not really sure on that answer. It definitely requires ever evolving, I think.
Kyler: Yeah, I think we've watched some value investors that have done really well in the early 2000s, be a little dogmatic, and again I'm pretty hesitant to draw conclusions. It's a little easier if somebody ran long short, and it was long value and short growth. I think they're just maybe completely impaired. But let's say you're long only and you own a bunch of value stocks, and maybe you've underperformed the last 10 years, I think that's okay, and I think if the environment looks different, they could have maybe done a little better, and maybe worse in some cases, but probably in most of the alternative histories done a little bit better. But that being said, I follow a lot of high-quality businesses and I can tell you without reservation almost every single one was very cheap at some point over the last six or seven or eight years. I don't care what you're looking at, Visa was maybe 15 times earnings in 2011.
Constellation software has been pretty cheap even in the last four or five years a few times even in a higher rate environment. You can just go down the list and you can see really high-quality stuff that wasn't expensive. It's fun. That's another one of my biases was on the Google thing, I had a friend almost to the day of the COVID low. We own a lot of similar things. He said, "Hey, do you own Google?" I was like, "Ah, no, I don't." He's like, "Why not?"
Bill: [laughs]
Kyler: I'm like, "I don't know." Good question. My wife works there, personally, we own a lot. Is it really that good? He was like, "Have you actually looked at it?" I'm not really kidding. I'd looked at it for two hours and I was like, "Huh." I thought it was maybe 18 times trailing earnings turns out with some [unintelligible [01:10:17] losses, it was less. I remember thinking, "Well, hey, it's 18 times earnings, it's really durable, I really like it, I'm just going to buy it." So, then after I did that, I was thinking, "You know what? Google's minus whatever it was, 25% or 30% from before COVID, and there's a lot of things that I look at that are minus 50, and I'm buying Google." I'm buying the one that is relatively less attractive than a lot of the stuff that's lower quality and with leverage and everything. Why is that? Why was I buying other things instead of Google when they were less attractive relatively? I realized I just had a mental block of buying anything over 20 times earnings. When you say it out loud, it's like, that's the dumbest thing I've ever heard.
Bill: It's not unique, man. I think a lot of people suffer from it. I have suffered from it.
Kyler: Yeah, it's not unique, but it is dumb.
Bill: Yeah, that's right.
Kyler: What we're trying to do here is discount the cash flows and if it's above or below 20 times earnings, is that a hard rule on what the discounted cash flows are, what's net present value? No, it isn't.
Bill: Yeah. Especially, in a business with that kind of potential for growth reinvestment.
Kyler: Yeah. There's not a lot of businesses I pay that much for, but there are a few.
Bill: Yeah.
Kyler: It's hard headed to ignore them. Obviously, you can, listen, the right business at 100 times sales, you can make money on. I don't know any of it. Hypothetically, you could.
Bill: Yeah.
Kyler: I think you're trying to remove those blocks-- You notice you have a block and you try to remove it. Do I remember what the question was when we started?
Bill: It doesn't matter.
Kyler: But remember that being important.
Bill: This is where we're going.
Kyler: Yeah, I also in late 2018, market sold off pretty hard, and I had a similar sort of idea. I owned Brookfield at the time and it had sold off, and constellation software also sold off, and look like real rates were going higher, and that would really hurt Brookfield's business. Don't tell me but I said that, but it's true.
[laughter]
Kyler: There's a lot of leverage in-- Whatever, anyways, we would've hurt their business. There's a lot of leverage there and constellation didn't have a lot, and Brookfield was down more, and I bought constellation. It was the same sort of thing. I was like, I think my returns are going to be very adequate, and there's very little risk. So like, "Why am I going to do the riskier thing to make a little bit more money when I can make plenty here?" Then again, I'm thinking, "Well, shoot, if I'm not buying all the levered really beaten-down stuff when the markets down a lot. Then it's more attractive, hypothetically. I shouldn't be buying it when the market's at a normal level. I shouldn't really be buying it at all if I don't want to buy it when it is most attractive." I think ever since then I used to own a lot of things with a lot of leverage. Now, I own a few, but much less just realizing that those mistakes I made mentally.
Bill: Yeah, I'm thinking through. Obviously, hard to talk about Qurate and see you don't own stuff with leverage. But I think, generally, I try to partner with people that I think know how to manage leverage, which is why a lot of the leverage in the portfolio is at liberty. I think those guys get it.
Kyler: Right.
Bill: And to be fair, a lot of women over there, those people get it is what I should say. Yeah, I don't know it's interesting. I think that Pythia had commented that every time he has thought that something is priced in, that has been a dangerous thought. I do agree that I've gotten in trouble by thinking-- I think maybe the most accurate way to interpret his comment and my experience is, when I say something is priced in, I probably need to dig deeper into what I'm missing so that I can actually have an informed view of what priced in means. Because I think I was fortunate enough to go out to Peter Coffin's day, and I don't know that I 100% agree with what anybody says, but his concept of win-win-win I think makes a lot of sense and I think that if I look at business decisions that I have made that have been justified by its priced in are usually businesses that are not win-win-win. They're usually undergoing some sort of problem and I'm usually overlooking the problem because of the odds. I think that that's like going to the track and seeing a horse that has a cut on its foot, and walking gingerly, and then saying, "Well, I'm getting good odds."
Kyler: [laughs]
Bill: It's like, "All right, their horse isn't going to win bro." There's a reason those odds are the way they are.
Kyler: [laughs] Yeah, no, it's true. I think a thought exercise is really good here like, what IRR do I need on this to own it? I base everything on opportunity costs. I have a sort of a minimum, but I say, "Listen, I can go buy Berkshire, there's no leverage, there's a lot of cash on the balance sheet. It's really diversified, it's really high quality, it's run almost annoyingly conservatively." I think I can make 10% on that a year and never pay any tax. So, it's not going to do much if I don't think I can even make 10. The way I do it is like, "Well, okay. If I really like the business, really, really like the business and I'm okay with some leverage on it," but if I going to buy something to leverage, I need to make more. So, say 12, or 13, or 14, or whatever.
If there's some operational risk to your point, I need to make more. I think you just need to ladder all these risks and increase the IRR you need to be interested. So, I remember looking at Altice, and "Okay like what do I actually need to make here for me to want to own it?" My answer was 20% a year, and that's maybe comically high to some people. But also, the way I underwrote it wasn't, "Oh, it's going to go from I don't remember what the multiple was, but 8x EBITDA at 10x." So, I'm going to underwrite the multiple expansion. It's like, "No, no. If I was going to buy this whole business and own it, I need my cash on cash returns when I take the growth into account, and I need to make 20% a year." I think what's interesting is the price you pay in most circumstances is very low. Obviously, it doesn't mean it can go lower, and if there's a lot of leverage like there's of Altice, sometimes it does and that has, but I think going through the exercise sometimes can be a little surprising if you're really thinking through all the incremental risks you're taking, and you try to pay yourself for them. Sometimes, you barely pay anything for something.
Then on top of that, I would say, you understand it's a higher risk situation like Altice and my sizing is going to be a lot different. There's no world in which Altice is 10% of my money or cost. It would be for something really high quality like a constellation software that I like. So, I think you just put in all those safeguards, and hopefully your analysis is right, and hopefully it works out, and maybe it's not, but there's plenty of businesses that I like and I look at them, and I say, "What would I pay for them?" It's like, "Half of what they trade at." That's just like I'll probably never own it, but that's okay. There's other ones you can own. But it's important exercise to go through, and obviously it doesn't mean you never lose, but you should be I think doing those things in the first place.
Bill: Yeah, I agree with that. On Constellation, I have some questions for you, if you don't mind.
Kyler: [laughs] Yeah.
Bill: So, something that I've been thinking about is, why at in its terminal state would Constellation not look a little bit like Altria? What I mean about that is if you have a segment where your organic growth is negative. I know that, Mark in the past has said, "Well, that's sort of a function of how they run the business." So, I think that maybe my underlying assumption is not fair, maybe, that's a choice. How do you think through-- So, for people that don't know, Constellation is a software company that is a serial acquirer. They're very, very good at acquisitions, they're very, very focused on returns on capital, and the guy that runs it is, the closest thing to Buffett meets software I think that I've ever encountered, not that I'm a savant, but I think he is right. But a function of their strategy results in some negative organic growth. So, how do you think through what that business looks like in a terminal state and how many acquisitions they can make going forward? Does that make sense?
Kyler: Yeah. Let me just start off by saying, I'm not sure how well Constellation will work from these levels. I own it. It's between that and Topicus, which has recently spun off on one of their six business units. It's my biggest position. Not sure how it's going to work. It's more expensive than it has historically. On that question, specifically, I would say that when you're looking at the organic revenue, what you really care about the maintenance revenue, they have some other hardware which usually shrinks. The most important thing is the constant currency, organic maintenance revenue. That's usually a little positive. Don't quote me exactly on this. I think the last five years, their total organic revenue growth has been zero or 1% per year, and the maintenance has been like 3%. So, they grow a little, which is a lot better than shrinking a little.
One other thing is like you've mentioned, they buy some things and run off. They buy some businesses where they say, "Well, hey, listen, revenue is going to go down, but we're going to be able to make what we think is an adequate return on money even with that. So, I would guess if they stopped doing acquisitions tomorrow, which they won't, but if they did, their organic revenue growth would look a little better. There's also an argument you made that their margins would go up, which I don't assume, and I don't assume their organic revenue growth gets better either. But the way I think of the base businesses is just I think they're low organic growers, in my head I think 0 to 2% sort of thing over time, and maybe that's a little conservative if not, but that's how I view it.
I think the good question is, the run rate free cash flow of the Constellation when you take out the non-controlling interest, it's like a billion dollars a year, the market cap is $35 billion right now or right around there. So, what is a collection of really moaty businesses that barely grow worth, I don't know. I would say depends on the discount rate. But if your discount rates 10 and you assume they grow 2%, then you're going to pay $12.5 billion for him. If you assume they go to zero, you're going to pay 10%. So, it's like, hmm, market caps 35, and the base businesses maybe you say whatever your discount rate is eight, maybe say I'll pay 15 times free cash whatever. The base businesses are worth between $10 and $15 billion and the whole business is worth $35 billion. So, there's a bit of a gap slightly.
[laughter]
Bill: Yeah. This is been part of my issue because I'm trying to figure this out.
Kyler: Yeah.
Bill: Because I don't know. Because I've thought something similar where I've been like, "Okay, even if say it's software, so maybe I don't require 10. Maybe I'll only require seven."
Kyler: Right.
Bill: If you think it grows too, you still not that much higher than a 20 times free cash flow multiple, right? So, just like--
Kyler: You're still $14 billion short.
Bill: Yeah. So, what am I missing is, is what I'm trying to figure out more than-- and I don't even mean it from a stock perspective as much as I mean it from a business perspective, because there's obviously that $15 billion, the market is saying that's their acquisition ability. That's what we believe they're going to create via acquisitions in today's dollars.
Kyler: Right. Yeah. So, Mark Leonard asked their AGM a few years ago, they had an analyst come and Mark Leonard asked him this question. It's like, "Why the hell is our stock so expensive?" I think at that point, it was 25 times earnings or a little higher free cash flow, there are about the same here. Yeah, I was like, "Well, the Fed, and this, and that." He started off circuitously got the answer. But the real answer is the 10 years 1.5, these businesses, it's almost a misnomer to be like, "Oh, they're software businesses. They're just very moaty B2B businesses. They are oligopolistic. The total addressable markets are very, very small. I think they own one that it gives you your software to book a tea time. You know, just like really low-- [crosstalk]
Bill: I like it. That one I pay a lot for and no one else would be able to book their tea time, and I'd have all the tea times.
Kyler: [laughs] Yeah.
Bill: As long as you're talking about golf and not actually sipping tea.
Kyler: Yeah, right, exactly. They're very moaty. They're the [unintelligible [01:24:06] businesses, I really like these, and there's high switching costs. Because if you rip out your mission critical software, it's hard to operate your business. So, I really like these businesses because they're just like, "If you run them, well, you will succeed. If you can't operate them, well, like we talked about, you can lose customers, and your turn is going to go up, and your results are going to be very good." But if you operate them well in Constellation is, I would say, are good operators, you take the prices up a little over a year, and they're going to grow a little bit, and they're very, very durable. So, what kind of return should you earn on a portfolio like that, say 7%, its low risk, they're unlevered mostly, you shouldn't need to make a lot. That's how you evaluate the base businesses. So, whatever, say $15 or $20 billion if you want to use a low discount rate.
But then the second thing is, the acquisition machine is really interesting. I don't know of another company like it. Most companies or funds, maybe you start out with not that much money, you do some acquisitions. If you do well you raise more money or you just get bigger, and then you do bigger acquisitions at lower rates of return, and the cycle keeps going, and you use more leverage, and basically, you go from doing small acquisitions to really big ones. The returns on those are just not going to be as high. Constellation, they have tons of people all across the organization looking for a really, really small deals, and the capital markets are really inefficient at the size like we're talking a million dollars of EBITDA, and they'll buy them for $4 or $5 million, maybe I want maybe even less. But really small deals.
There's tons and tons and tons of these software companies out there, and so they've shown ability to do $500 million a year, maybe $400 or $500 million a year of really high IRR acquisitions that are really small. They earn something like 25% returns on these. So, just say they deploy $400 million, they get $100 million of free cash flow. We just talked about what's the cash flow worth? Call it 15 to whatever. 15x, 20x is too much I think but call 15x. So, they put out $400 million, they get off $100 million dollars free cash flow, they get $1,000,000,005 in value. So, if they just do this every year without growing, they're adding $100 million of value every year, the net present value of that without growing discounted at 8% is that's like $12 billion. So, I think what happened over the past few years is the market realized, "Hey, wait a second. They've scaled this organization. They can do a lot of this M&A really consistently because there's a lot of targets." We think the net present value of that M&A abilities, like maybe somewhere in that range $10 or $15 billion dollars and I think that's why the valuation has come up.
Now, they're starting to try to do some bigger stuff on top of the small things that will come in and lower returns, and I hope they're successful and I think they will be like if Mark Leonard is really, really sharp, if you can listen to him talk ever you should. I had the opportunity to stand with 15 people and ask them a bunch of questions a few years ago of the AGM, and he's, I don't know he might be just as smart as Buffett, honestly. I came away really, really impressed. But they're going to look to do some bigger stuff, and I'm sure that'll add some value. But when you can consistently put a lot of money to work at 25% IRRs, it's worth a lot. And they've shown the ability to be able to do that and probably they'll do it for a long time. I think that's why the valuations expanded and given where rates are and everything. So, it'll be interesting to watch. Hopefully, I hope they can keep growing at a good rate. Obviously, it won't happen forever, but I wouldn't be shocked if they just kept being in the lab value for a long time.
Bill: Yeah, that makes sense. I got to have you do one more thing and then I'll let you get out of here. Can you explain the difference between what TransDigm does when they acquire a company and then sell off units versus the difference between when Comcast acquires a company and then pays down debt?
Kyler: [laughs] Yeah. Brian Roberts couldn't stop this interview.
Bill: [laughs] He tried. My Comcast-- [crosstalk]
Kyler: [crosstalk] early today, but we fixed it.
Bill: He did. He [crosstalk] Now, it's time to take a shot back at him.
Kyler: Yeah. We can't be silenced.
Bill: [laughs]
Kyler: Yeah. It's really important to understand how companies fund M&A. I don't think everybody gets this right. So, TransDigm whatever, I don't want to talk about the whole business. But the numbers are pretty clear. They tend to acquire stuff around three to four times revenue, and then get the EBITDA margins up to 50% a few years after. If you know anything about TransDigm at a consolidated level, they use six turns of leverage on their EBITDA. So, if you're just really quickly trying to figure out how creative these are, you'd say, "Well, okay. If I buy something for three times revenue $300 million, and it's got $100 million of revenue, then TransDigm's going to get $50 million of EBITDA out of that." So, they acquired it at six times EBITDA, and they use six times of EBITDA leverage.
Once they get the margins up, they're going to take all the equity that they put into the acquisition, they're going to take it out. So, in that case, those cash flow streams are worth something like 15 times EBITDA. So, it's like I spent $300 I ended up getting $50 million of EBITDA, and I'm going to have $300 million of debt on it, and my equity is going to be worth $450 million. So, they just created $450 million value at 15 times multiple, and they pulled all their equity out. That is not many places can do that. No, I'm not really aware of any other ones. But then there're many companies that will acquire something with debt, and then they're going to pay the debt off. I think people will say, "Well, hey, listen--" That's one example of like, this guy acquisition that operationally it didn't work out or hasn't worked out very well so far. There're plenty of companies that acquire something good and they use all debt and people like, "Oh, wow, they bought it. It's a 5% free cash flow yield and it's growing 5%, and they bought it with all debt. So, they're making 10% a year, and they use 2% money. How obvious is that?" I think what people miss is, if you pay the debt off, then you just use equity.
Bill: Yeah, or at a minimum, you deferred your free cash flow to common equity by paying down debt, right?
Kyler: Yeah.
Bill: Your opportunity cost is very real because you are then paying down debt. So, it's different.
Kyler: Yeah. If anybody doesn't follow this, go do a discounted cash flow model, and assume, I buy something for $100 today using all debt, and then in year one, I pay down all my debt with the other cash flow from my company, I have $100 of cash outflow in year one, which I could have used to buy back stock or pay dividend or whatever, and then I get all the cash flow from the company over those years. You can still make a good return, but you should not be fooled by-- [unintelligible [01:31:50] done this, they bought this company [unintelligible [01:31:52], and they're like, "Oh, it was all debt." Like you run the math and if you thought that it was going to be 10% IRR with all the debt they use up front, and then when they paid it off really quick. It was like it'd be like 11 or maybe it was 12. But not, "Oh, it was free money." There are differences.
Bill: Yeah.
Kyler: Some people they acquire stuff and it's about how much leverage you have on it at the end, and that's all important. But I think, that's the most important thing. So, it's a good model to have in your head to actually map out when the cash is going in and out.
Bill: Yeah. It's a difference between free cash flow to the firm and free cash flow that's available to common equity. I think there's a lot of people that miss that those two things are quite a bit different, and free cash flow to the firm can be used to pay down debt, and if you're using it to pay down debt, it's not coming to the equity, and you got to discount that back in order to figure out the true value. It requires some thinking and I think you're one of the people that spends a lot of time on serial acquirers and M&A generally, and I like how you look at it. I think you got a good handle on it. So, I thank you for giving people a little bit of a lesson.
Kyler: [laughs] Yeah. I try and I'm some somehow probably wrong. The math says what the math says, but in this one case, the mathematics just doesn't work or there's something like that.
Bill: Well, we'll say that you're 65% sure you're right, and I'm 100% sure people should do their own damn work.
Kyler: [laughs] Yeah.
Bill: So, there's that.
Kyler: Yeah. I'm 100% true I'm right, and then I just failed my investing class.
[laughter]
Bill: Well, that's alright. I'll fail it with you.
Kyler: Yeah.
Bill: So, Kyler, thank you for joining me today. I appreciate it, sir.
Kyler: Thanks again for having me on. I really appreciate it, and thanks for having all the famous people on before me, so that you'd have a big audience by now.
Bill: Well, that's my goal. I'm basically, and then I'm going to continue that, and then you're going to come back on.
Kyler: Okay. Sounds good.