Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Does it ever feel like the market is moving all together as a herd? Seifel Capital Management founder Chris Seifel describes how investors can look at alternative metrics and take a contrarian approach to outperform the S&P.
January 5, 2021 – By Simon Erickson
As individual investors, we are blessed with a unique gift that most traditional fund managers don’t have: We can invest anywhere we want to.
That means not being bound to specific types of companies in particular industries or with specific market capitalizations. It means no limitations related to P/E multiples, revenue growth rates, or dividend yields that we’re allowed to choose from.
It means the sky is our limit in terms of investment opportunities.
So how can we take advantage of that to significantly outperform the rest of “the market?”
In an exclusive interview, 7investing founder Simon Erickson chats with Seifel Capital Management founder Chris Seifel about his unique approach to investing. Chris starts with a higher-level framework of mental models, he drills down into industry and company-specific metrics to find hidden gems worth pursuing. From there, he builds a valuation model to compare to Wall Street’s expectations. And finally, he pulls the trigger and invests in the best-of-the-best companies, who are driven by industry tailwinds and yet underappreciated by the rest of the market.[su_button url="/subscribe/" style="flat" background="#84c136" color="#ffffff" size="6" center="yes" radius="0" icon="" icon_color="#ffffff" desc="Get full access to our 7 best ideas in the stock market for only $49 a month."]Sign Up Today! [/su_button]
Simon and Chris also discuss the types of metrics that Wall Street is often overlooking in their financial models, which are what highly influence their popular Price Target determinations. They also discuss this year’s historically-low interest rate environment, where investors should expect to see acquisitions in 2021, and one company that’s on his investing radar
00:00 – Introduction to Chris and his background
05:03 – Chris’ investing process: taking a different view from the consensus
14:57 – Identifying the critical factors that will most impact a company’s returns
18:09 – Comparing bottoms-up valuation models to consensus estimates
34:17 – Thoughts about today’s zero-interest rate environment
42:51 – Mergers & Acquisitions to watch for in 2021
45:22 – One company on Chris’ investing radar
52:14 – Chris’ advice for individual investors
Hello, everyone and welcome to today’s episode of our 7investing podcast! I’m 7investing founder and CEO Simon Erickson.
Does it ever feel like in the market, we’re all looking at the exact same things? Like we’re all looking at the same types of companies? Looking at the same price to earnings metrics and the same data points over and over, as a herd mentality?
Well, I’m very excited today to welcome Chris Seifel to our 7investing program. He’s going to give us some alternative ways to outperform the market. Chris is calling me from Boston, Massachusetts this afternoon. Chris, thanks for joining the 7investing podcast!
Simon, great to be here! I love what you guys are doing at 7investing. And it’s an honor. I’m really excited to talk to you today.
I’m really excited to talk to you too. You’re a really thorough analyst, Chris. I’ve really enjoyed following you on Twitter, on your page there.
But let’s let’s dive a little bit back into your background. Before we get started with this — and I do want to talk about valuation, I want to talk about some of those different metrics you’re looking at in the market — but to get started, it looks like your resume has some background in private equity and investment banking in your past.
That’s right, I have a very non traditional path to the public markets, if you will. To take a quick step back. It all started back when I had three elbow surgeries my senior year of high school and ended my baseball career. And because of that I had a freshman year internship when I was in college that introduced me to the stock market. And it was love at first sight. You know, it immediately replaced that passion I had for baseball. And ever since then I was hooked. You know, I did a finance and economics double major; did pretty well in school and I went down the path of I would say most comfort. You know, I didn’t have the the cognitive abilities I have today. And so, you know, Nassim Taleb and a lot of others say that, you know, a salary is most comfortable thing. So that’s kind of what I went after, I did a good job at Citibank. And I was doing investment banking for an oil and gas focused firm. And that was in 2014, when oil went from over $100 a barrel down to about $30. So needless to say, deal flow dried up.
And I ended up having a unique opportunity actually leading a restructuring for a company out in California. And so that was a really formative experience for me, because and I think you see in today’s markets, where, when stocks are going up and companies are performing well, everything’s really easy. And you can get somewhat lazy and get away with a lot of things. But when you’re in either a down round, or if a company is under significant financial duress, that’s when you really learn a lot.
So I was able to learn a lot. I think I was only 25 when that happened. So it was a really unique experience, which led me to the private equity background and family office I worked for, for about four, three or four years when I got to New York. And once again, talking about formative experiences, that is the lens through which I tried to view the public markets, and the analytical rigor that I bring to my process in my background when I researched companies. So we were doing deep dive operating models that were, I think it was like 17,000 lines long in Excel, something just absolutely crazy. When you know, you really understand how accurate forecasting is. But we were really understanding every single operating lever of the business. And that’s what I do with my modeling now, but a much more simplified version.
So fast forward a few years, you know, I always had that passion and love for the public markets. I was enjoying a nice salary, but I decided it was time to stop being comfortable, and start being uncomfortable and do what I love, and do what I want to do for the rest of my career. So in April of this year, I left the private markets and decided to pursue my goal and my dream of working in the public markets. It just so happened that was at a time of a worldwide pandemic. So you know, everyone kind of stopped hiring. So my plans were almost on hold a little bit. But it gave me this really unique opportunity to get involved with Twitter, which I started doing the middle of this year. I started my own newsletter, which I think a lot of people have enjoyed, and I’ve gotten a pretty good following there as well. So it’s almost the theme of you know, I think in everyone’s lives, everything happens for a reason.
So you know, I’m here today now. I have developed this amazing Twitter following that, you know, I always love interacting with I have this great email subscriber base for my newsletter. And I’m just in the process now of trying to find a job to work for: a great fund a great public markets investment manager and really trying to find you know, a great mentor that can teach me really the public side of things because there is a difference between public and private valuations. And then from there in the long run, you know, manage money one day, you know, become a become my own manager of money and do what I love to do.
Chris, there are so many parts of that story that I really love, especially the part about getting uncomfortable and following your passion. That is fantastic. I’m a huge fan of your work as well, everything that you posted in your newsletter.
And I want to double click on that as the first part of the interview here, which is your approach to investing the process that you go through. And I’d like to put this in your own words of what you posted to the newsletter, that you’re saying that “you’re bringing a differentiated view to the public markets and alternative investments, specializing in developing alpha generating ideas through detailed, bottom up fundamental analysis coupled with a macro economic top down view. The ultimate goal is to find stocks that are mispriced in the market and have a high probability of appreciating towards your personal view.”
That is perfect prose! That is exactly refreshing to me. Because it’s not running with the herd and looking at things the same way that everybody else is. Can you unpack for me a little bit about your approach that I just described, in your own words? But maybe a little bit deeper into how it is you’re finding those kinds of companies?
Definitely. So I think that I did also start out by maybe not going with the herd, but looking at ideas and opportunities and companies that I think were obvious, if you will. And I think the goal is to find things that are not obvious things that people are not doing. And it’s the very traditional, you know, just knowledge set that, you know, money flows to where the returns are, which brings down forward returns.
So I think when I started out, if you look at my older newsletters, I think I was trying to find the exciting ideas at the very beginning of the S curve. But maybe were more obvious than I think I’d want in an investment. And that was fine, I think, you know, I was getting my feet wet. And it was helpful for me to start that transition from the private to the public markets. But the overall goal, I think, is to find those names that are either underappreciated or unknown in the market. And it just goes back to the concept of, you know, money flows to where the returns are, which brings down forward returns. So if everybody’s in the idea already, then you’re starting from almost somewhat of a disadvantage, where you don’t have as big of a runway of returns to gain from your investments.
If we take a step back, and I start kind of higher level, and almost meta, if you will, in terms of my approach, I start with trying to develop this, you know, what Shane Parrish calls a latticework of mental models. It’s what Charlie Munger always talks about. And it doesn’t drive my investment ideas, per se, but it makes my investment ideas, I think, a little bit more, a little bit less susceptible, if you will, to a lot of the cognitive biases that a lot of investors I think suffer from. And it also helps me to analyze companies a lot quicker.
And so what do I mean by that? If I understand how a certain business model works, let’s talk about maybe an aggregator business model, then any aggregator business, I can analyze a lot quicker, because I understand what those dynamics are and what the unit economics should look like, what the TAM penetration should look like, and what that can grow to. So I’m starting off from a position of operating leverage, right? And then if I talk about the actual mental models that I can use, whether it be you know, first principles thinking or circle of competence, you know, second order thinking and probabilistic thinking, you know, all of these things go into developing a very, I think, simple, but also complex, the same time investment thesis that will then allow me to generate alpha in the long run.
And the reason why I do that is because this comes back to maximizing the ROI on my time. And I think, you know, as someone that’s operating by myself, without a lot of resources, it’s really important. So that’s why I start there. And then if I talk about or think about what James Clear says, which is, you know, every thought that you have, is really just downstream from what you consume. I make sure that I’m reading only very high quality information from sources that I think are very credible. So I’m reading things like for Stratechery, Tech Crunch, you know, a lot of different sites that are well established and have over time produced a lot of really insightful analyses and insights into companies. So I’m consuming high quality information.
And that allows me to then understand very clearly what is happening in the present. What is the current state of play in the world, in certain industries, etc. And that then allows me to have some sort of view of where I think alpha could be. And the key is, that’s right, and it kind of goes off of what I said originally, which is, and I think this was Andre Perold say this on the capital allocators podcast, you want to skate to where the puck is going not to wear the puck is, right? And so by having that very clear understanding of the present, you can skate in the right direction.
So that’s what I try to do. And then so now we want to talk about consensus, right? Because the whole idea of generating alpha is twofold. One is you have to have a differentiated perspective. But you also have to be right. So let’s talk about the first part, right? Having a differentiated perspective. What does that mean? It means just having a view that’s different from the consensus, you know. Bruce Kovner says the consensus that is not confirmed by price action is what you want to look for. So it’s almost like there the ability and that outperformance is capable in the company currently, but the market has hasn’t realized it yet. That’s what you want to find. You don’t want to find highly speculative plays that, you know, in this market especially can go up 30 – 50% in a day. You want to find those companies that have shown established fundamental growth that the market is hasn’t recognized yet. And so that’s what I’m really trying to do.
So I go through this process of just doing thematic industry research, I’m doing a lot of reading, I’m trying to really understand the industry holistically. And the biggest part of that is actually really understanding the technology. So I don’t know if you saw my thread a couple weeks ago, on ASML and their photolithography technology. It’s that level of understanding I’m really trying to gain, because that helps me understand not only one, why does the customer need this product, but also to what is do they have a durable and sustainable competitive advantage. Because at the end of the day, that’s what we need as investors to make sure that we’re having a high ROI or not getting diluted in terms of returns.
So that’s a lot of what I’m looking for. And then of course, there are other things like what are the typical go to the go to market models and business models of this industry? And then what are the typical financial metrics that I should see out of a company, right. And that helps me then frame kind of normalize or stabilize state for this company.
So after doing all its industry research, I find those disruptive stocks, right, that I mentioned are kind of earlier on the S curve. And once I find the stock, then I’m doing a quick scan on, you know, like Tipranks, which has a lot of analysts, expectations, and price estimates to understand what is the consensus, you know, where the target price is, you know, what is currently being priced. And I try to understand that, then I go through and do my own homework. And I’m really trying to understand the company through my own lens. And that just requires a lot of I think typical things. A lot of analysts do do, you know, ripping through filings, doing some news, filters, etc. But then also trying to channel checks, and trying to get in touch with people that I think are very knowledgeable about the space and give me certain insights that I might not be able to gain otherwise. And that’s really after that is where I can actually develop a pretty good thesis.
Now, unfortunately, a lot of the time, you know, my analysis and my homework. My view is the same as the consensus. So I don’t end up investing. So a lot of the time, I’m doing a lot of work. And really, there’s nothing that really comes out of it very much, you know, going back to my investment banking days, where you do a lot of work and nothing happens. But it’s the nature of the beast. But what it allows you to do is a few things, one allows you to better learn the industry, which helps you to then maybe find another stock, another name that doesn’t have this consensus view that you know, you may have on the company itself. But then it also gives you that kind of more operating leverage, right.
It’s like a research graveyard that Patrick o Shaughnessy talks about so just because you do an analysis on a company and you’re not ready to invest in that time, doesn’t mean that you never will. You kind of store it away. And if there’s ever a time where that stock is under loved, you can just revisit that analysis and research that you did. So it’s through that process that I’m able to find those, I guess you could say, under loved or underlooked areas of the market and companies that I believe have future earnings power that can really drive, you know, greater than 30% returns over a certain time period.
Yeah. Fantastic, Chris very methodical. You know, starting out at the higher level, with the mental models that you’re looking for. Secondly, finding those critical factors that you mentioned, which are important technologies or company specific. And then looking at the price.
Let’s unpack each of those a little bit more. Do you use a detailed checklist in this process? And if so, what are some of the mental models that you find to be the most appealing that you start with?
It’s funny, I actually have my checklist right next to me. I think it’s a little bit scattered about. But, you know, the very detailed one is about seven pages long, which I don’t necessarily need too much because a lot of it has notes for myself. Because, you know, it’s not a static exercise, right? It is something that’s constantly evolving by, you know, learnings that I that I generate through doing the process for other companies, if I make a mistake, I’ll add that into my process, you know, what is something to look for. So I do have this checklist right here written out, and I have it starts even at sourcing random life experiences, reading newspapers, blogs, etc, read through 13 apps. And so I’m starting at the very top, and I’m making sure that I don’t miss anything. And then so yeah, of course, then I dive into the industry research here. And it has everything from collecting the actual macro data. Like I think, my page on the site. Everything for the industry, right? And a lot of the time, what I’m doing is I’m not, you know, you can use the the the jics/gics, however you want to call it, you know, industry label, and you can use that to try to find those industry metrics. But what I do is really, I create my own, I guess, peer groups, or watch those myself, based off of my understanding of the business models of the actual area of the economy that they’re in. And that’s what I then collate all of the financial metrics for. Which I then use by juxtaposing all of that data to price action I can find. What are the real main drivers from a very basic financial metrics standpoint, for the industry? And it’s a very similar process I take for individual stocks itself. So you know, to answer the question, yes, I have a very detailed checklist. I think it’s Atul Gawande wrote the Checklist Manifesto, which I haven’t read yet. But you know, it all those back to the fact that I think it was like a Boeing airplane that crashed, it was after that, that led to the the pilot checklist. And you know, after then the number of crashes, you know, it’s basically zero, right? It’s negligible.
And it’s kind of that same framework. Where the biggest and most important part of investing is minimizing risk, right? If you have capital preservation, if you’re minimizing your risk, that allows you to generate returns. But if you’re focusing only on the returns, the risk is always what comes back to bite you. And I think about it, that same framework, towards my research, if I add my checklist, and I’m structured, I’m really minimizing risk and holes that it may have otherwise, if I’m just trying to go off the top my head.
That’s fantastic. And let’s look, let’s look a little bit more at valuation, perhaps. Because now that you’ve got kind of the mental models, you’ve got a checklist that you follow. You kind of are looking for some industry specific metrics, you’ve then got to make a decision on whether or not this is sane or insane pricing, or if it seems like it’s pretty fair pricing, based on the estimates that are consensus from other analysts out there.
You have a background in this. You worked up on Wall Street in in New York City. So how do you make a determination on what a fair consensus estimate is? Or, how are you able to find something consensus that looks like it’s completely unreasonable for a company?
So let me start with kind of how I approach maybe modeling, right? So modeling is a part of my process for every company that I analyze. And it’s not the typical kind of investment banking modeling, or the modeling that you learn in school as an undergrad, right? Like, I remember doing DCF through my nose when I was an undergrad. It was great training, in terms of the fundamentals of finance, but not really helpful in practicality when you’re analyzing high growth stocks. Now, it works for, you know, you’re mature businesses that have a lot of tangible capital on the balance sheet, and they’re not really going to be growing more than let’s call it 5% a year. And they’re already kind of at their stabilized nature, right? Then a DCF works great. But if you’re analyzing a company that’s growing at 5%, top line, then your DCF is not going to make any sense. And if anything, you’re either going to have a value that is an error, because you’re dividing by a denominator that’s negative, or you’re going to just come up with a value that is way too small to make any sense. So how do I use modeling? I use my models to really understand the operating leverage drivers of the business. So I am building out a pretty detailed model as I go. But the the the core of it, the the true heart of the matter is certain revenue and gross margin drivers that I can easily track either through just the quarterly earnings reports, or just a little bit more detailed research. And it’s those drivers that really formed the heart of my critical factors, which is kind of my milestones my benchmarks for if my thesis is playing out or not.
So that’s really the core of it, you know, I’ll build up this operating model that will allow me to understand those factors. I mentioned all the revenue gross margin drivers, but also what stabilized unit economics look like. And the reason why that’s important is because a stabilized earnings model is a part of my valuation framework. And so what am I doing there, right? I’m looking out into the future, and understanding what their stabilized margins on a let’s call it EBIT basis will be what is a stabilized operating margin. And I look at other things like their cash return on invested capital. I’m looking at also some EBITDA margins, if it makes sense, and operating cash flow, free cash flow, etc. But the the numerator is going to be based off of my EBIT, right? So I’m looking at the company and how it’s been performing, and what scale has enabled it to generate in terms of operating leverage. I’m looking at other competitors in the business and the same exact analysis, you know, what do their margins look like, and their unit economics look like? And then also for the stabilize the older companies, even if not in the exact industry, at least with a similar business model? To see, okay, you know, where is this company? Where could it be in, say, 20 years when it’s not growing at 80% anymore, right. And so I come up with some sort of framework around those margins. And based off of the revenue estimates that I come up with, in my operating model, I can say, okay, in five years, if my EBIT margin is 40%, and I expect revenue to grow at, let’s say, a 30% CAGR from where it is right now, at 80%, that gets me to a five year revenue estimate at these margins, I can then calculate your net operating profit after taxes. Which is going to be basically my numerator of of my of my enterprise value, right. And then I divide by a WACC, which I always use just 10%. You know, I think it’s Terry Smith was going on about this, how, you know, a lot of analysts try to really nail down your discount rate. But what I tell people when I get asked at the same time is, if you’re, if your discount rate is the determining factor in if you should invest or not, you shouldn’t be investing, because your discount rate should not be that driver.
So I come up with my enterprise value. I do the crosswalk the equity value, and I come up with a per share price projection, right? And so over whatever time period, that is, I can compare it to the current price. And that then allows me to understand, well, what’s that implied CAGR? What’s that implied forward return? And like I said, if that doesn’t yield a 30% plus, which is what I target, then it’s a pass just on that part of the Mosaic, righ? You know, there’s a lot of things that go into the analysis. But on that part, and then I do also do a very basic DCF on the existing business. Sometimes I do it, you know, multistage, just to get to some sort of some sort of valuation in place, cash flows. And then the way that I think about it is this, and I’m still working on building up this framework, is I can look at what the current market cap is.
I can look at my DCF value, that spread is what I call an options value, right? A real options value. And Aswath Damadoran and Michael Mauboussin and a lot of these guys talk about real options pricing. And I personally haven’t come up with a good enough framework to implement it holistically yet. But essentially, you can think about it this way. And it uses the same math, as, you know, financial options derivatives in the financial markets. But you can look at the r&d spend of these companies. And what that’s doing is is creating future options for the company in terms of areas to invest in, right. So you can think about Unity, for instance, right there. The big value for Unity is not in gaming. It’s in industries outside of gaming. And a lot of their r&d spend since John Ricotello took over in 2014. I think it was, has been dedicated to those industries outside of gaming. So it’s creating option value for the company. And so that delta between their DCF value and their current market cap, there’s going to be the option value.
And so what I’m going to be able to finally, finalize is, does that option value make sense? Is it over or undervalued compared to what I believe the company’s true option value is? And I can go on to a diatribe about how the current rate environment effects that how the Fed put effects.
That was my next question for you, by the way, Chris!
Sure. Sure, bring it bring the diatribe. Those are really the I think valuation frameworks I look at now. I also use, you know, these very high level enterprise value to sales, multiples and a lot of other like free cash flow multiples, gross margin multiples, which I really like, because anyone can, you know, make sales, if you invest, you know, 100% of your of your sales into sales, then, you know, you can grow your top line pretty well. But can you retain that on gross margin that on an EBIT basis, that’s really the thing that you need to figure out. So I look at those as well.
But more on the back end, as kind of like a double check to make sure that things are making sense. And then I can also what I can do is using those, EV/sales multiples, because a lot of these companies aren’t generating cash flow yet. I can kind of imply what the what the forward returns have to be for that multiple to make sense. And so there’s a lot of different kind of valuation methodologies that go into the mosaic. But those are kind of the core ones that I do.
Okay, perfect. Now, we’re gonna go back to the diatribe in a minute, because I want to talk about interest rates, because it seems like things are a little crazy out there right now. But just to kind of put all of those pieces together of what you just described, it sounds like you’re kind of unpacking a company’s financials, you’re using the mental model understand what’s what they’re capable of, you’re looking at what a reasonable expectation based on the business model based on the industry that they’re in, for kind of a forward estimate of revenue, earnings, operating cash flow, whatever it might be. To kind of unpack that into a discounted cash flow model, a DCF model, like you said, compare that to the current valuation, and then maybe make a determination of whether or not that seems reasonable. Is that a fair recap of how you’re looking at things, Chris?
On the DCF side, yes. And then also, just keeping in mind the stabilized earnings model, which I think is the better way. And the primary…I weight everything, right? I make decisions and do all my analysis from a probability standpoint, like I mentioned before. That mental model, probabilistic thinking, and so I’ll assign probabilities or weights to my different valuation frameworks. And so I think for the most part, the stabilized earnings model is really the key. And so Fred Lu, from Hayden capital, I was listening to a podcast he was on and he explained what I do better than I did, which is if you think about a triangle, almost, and the bottom of the triangle is the current value. And then if you draw your hypotenuse out to the right, five years, whatever it may be, but then with the slope of whatever your CAGR is on that earnings power. You then compare that slope to what the slope is of where the price point is today. And that’s your real CAGR.
So that’s what I’m doing is almost like a little bit of geometry at the end of the day, which is, which is just applying what the earnings power CAGR is, to what the implied CAGR is from the current price.
Love it, love it. And then back to the 17,000 line financial models that used to be building or maybe still are building. That is very detailed. That’s a lot of tabs open in Excel you’ve got to switch between.
You know, it’s interesting, though, comparing that to consensus, you know, and I’ve seen consensus estimates that are based on very, very simple financial models, and some that are very, very complex. Do you think that wall street is missing certain inputs that are more important that are not represented in a lot of those price targets and expectations of what a stock is worth? Just in general?
Are there a couple things that you look at that you think that wall street should be paying more attention to?
That’s a great question, Simon. So let me start with this. The 17,000 line models are overkill, in my opinion. The reason why we build those out is because, you know, the two partners are really the main capital providers for the fund. So they wanted to be able to see and know and understand every single nuance and granular detail of the business. Right. And so we were buying seniors, seniors housing facilities, right? They were skilled nursing, assisted living, independent living, but it wasn’t just the operating company we were buying it was also the property companies. So it was a the whole entire shooting match, right. And so when I say 17,000 lines, we were modeling everything down to the FTE, their individual salaries, you know, by payroll code. We were crosswalking ADP data to our actual staffing models, and then we were also modeling everything down to the individual codes of the Medicare rate, you know, getting as detailed as possible, right. And so that project alone will forever I’ll be, I’ll be able to build that model in my sleep one day, right.
But when you crosswalk that to the public markets, and I was mentioning, you know, the difference between private and public, you know, analysis and analysts, you know, one of the thing, one of the things are that in the private markets, it’s simply about, you know, what is the value of this asset? And what is the value that you can get it at its price versus value, right? In the public markets is very different. And we’ve been talking about it, which is, you can have an idea of what value is of an asset of a stock, and you can compare that to the price. And you could be showing a 30% CAGR. Right. But if the market doesn’t agree with you, or if they don’t figure it out, within your investment horizon, then you’re wrong. Right? It doesn’t matter if at the if, in five years, you’re right, if your investment horizon was two years, you’re wrong for that investment. So the big difference is really finding that differentiated perspective, and then making sure that your critical factors have catalysts, which occur within your investment horizon.
So now going to your question on Wall Street. And their models? You know, I haven’t I haven’t seen or had anyone send me, you know, any buyside models? I know that it depends on the shop that you’re at. So some shops, they build very detailed operating models. I mean, they’re going almost as deep as I did, you know, in the private markets, which is fine, in and of itself, right. Some firms, they are just trying to get like I was talking about them doing currently, which is more, what are the main drivers? You know, what are the critical factors of the business? And what is your view of them? And how can you track them with quarterly earnings, whatever it may be, right? And so I think that what it comes down to, to answer your question is this, it doesn’t matter how detailed your model is, what matters is, is that you find out and you determine correctly, what the critical factors are of the stock, meaning, what are the two to three or 123, things that truly drive the stock price. And if you can figure that out, and just model that out correctly. And, and the street then comes to agree with your view, that’s all you really need. Right?
And so, you know, like, there’s some pm that you don’t even show them a model, they don’t care, right. But for you, it’s, you know, once again, maximizing that ROI on your time, if you are spending so much time in a model that you’re never out there, you know, doing your channel checks, talking to people in the industry, learning about new companies, in your head, just buried in the computer, you’re not going to succeed. It’s not possible, right. So that’s why my approach and I think the better approach is focusing on just the 123 things that truly matter. building that operating model to understand the levers not getting too crazy with it. And then making sure that you’re once again, going back to process and a checklist, making sure that on a quarterly basis, you can readily update that model pretty quickly, and spend more time analyzing and less time with the mechanics. And this is why with a 17,000 line models and private equity, I built through VBA macros to update on a monthly basis the financials, because for us to do that before it took us over a day and a half to do that for all 50 assets that we had, by using a macro was three hours done. And so it’s figuring out ways to maximize and create operating leverage for yourself that can then allow you to build good enough models to understand the business and then be a better analyst down the road.
Chris, I have been having some problems sleeping lately. So please send me that 17,000 lines of your model that details every single thing of every Medicare code out there, I’d love to see it. So put me to sleep like a baby after reading some of that.
Best thing that you’ll be able to get.
I certainly agree with you that time is important when you’re doing research. And, you know, it seems from my perspective that we really are in kind of a new era, where technology and software specifically cloud based software, even more specifically has kind of changed the game on so many businesses, especially those legacy software providers that used to have to go spend a lot of sales cost to send people out to close deals. It’s super easy to do that now. And I know a lot of the companies that you follow to our cloud based companies as well tend to in my research, look for things like lifetime value divided by the acquisition cost of getting a new customer or retention rates, and revenue growth and things like that. But all this brings me to my next question for you.
Which is that you said that you, you typically just slap on a 10% discount rate for your conservative model and say, okay, you know, if I just say this, what does my valuation look like compared to the rest of the market? That’s interesting, because in today’s day and age, as crazy as 2020 might have been, I think we’re going to be looking at another historically low interest rate environment in 2021. And some people might say, a 10% discount rate, crazy as this might sound when we’re talking about it is being too conservative. Because even small businesses can borrow money at six to 8% right now. What do you think? And you know, I know you’re not the expert on following macroeconomic trends out there, Chris. None of us is. But what do you think about this environment we’re in right now? Has it propelled the valuation of software companies that don’t have to take a whole lot of debt on to unsustainable levels?
So I’m glad I saved my diatribe for this. And you’re right, I’m not an expert. You know, I certainly am interested by macro economics. I really am. I follow global markets, I’m looking at foreign exchange crosses, you know, I find it interesting. But I’m not an expert. And I think that at least most the majority of, you know, equity analysts or managers that have tried to be macro experts, they’ve kind of missed the boat. And you know, they’re either calling 1 or 2 of the past three recessions, or they’re, you know, trying to market time and they’re missing huge moves forward. Right. So I don’t try to be a macro expert.
But you know, your question’s a little bit, I think, more simple than that. It’s not asking about that. So, you know, what do we know? Right? It always goes back to that, like, what what do we know? The Fed has stated that they’re keeping these low interest rates, right? ZIRP is going to be occurring through 2023. And if you follow the fed back in…
Zero interest rates. Zero interest rate premium.
Yep. zero interest rate policy. Right. Their target is 0%. Right. And that’s on a nominal basis. So we can get into the real rates as well. Right? So we’re at negative real rates. And there’s a whole lot of discussion on what the real inflation rate is, that’s, that’s maybe a different podcast that we can do. Right. But when you look at what the Fed had stated back in 2008, and 2000, and you just listen to the Fed, and follow their direction, you would have been, right, they what they said, and that’s it goes back to the integrity of the Fed, what they said they did. And so right now, they’re saying we’re gonna have low rates through 2023. Okay, so what does that mean? To your point, you know, you can think about it that way, where these companies, even though they don’t, a lot of these companies are debt free, actually, they don’t even need that, to to grow. And that goes back to the asset light nature of their business models, which is something I like about them.
But also, it’s harder to get a competitive advantage that way, etc. But what it does do is that it’s right, if you think about the valuation models that anyone on the street does not me, but anyone on the street, that is actually building their own discount rate, you’re right, those asset values are going to be inflated relative to a quote unquote, normal rate environment, if we ever get back there, who knows, but they’re going to be higher than your steady state. So comparing a enterprise value to sales multiple today, versus 2000, doesn’t make any sense, we’re in a different rate environment period, right. And so the opportunity cost of capital is a lot lower today than it was back then. So your equity values are gonna be higher, you’re gonna see dollars flowing into risk assets.
So that’s one just from a pure valuation model standpoint, assets will be higher on that same lens, right of lower interest rates, you have the phenomenon of the Fed put. Now what is the Fed put do right? The Fed put is saying that they’re just not going to allow businesses to fail. Now, if you think about, well, what are the businesses that are most likely to fail, those are going to be your younger, faster growing companies. So if you think about then a returns distribution for a company, right, your younger higher growth companies are going to have a wider distribution, then a possible range of outcomes, then your mature company, right, you’re going to have a higher what you would call kurtosis of a mature company versus a high growing company. So you have this wide distribution of outcomes both to the negative and to the positive, right. And of course, you know, stock returns are not normally distributed, but for ease of this conversation. Let’s just say they are right. So what is the Fed put do the Fed put is cutting off the left tale of those negative outcomes for a high growth company, which is more valuable for the growth companies than the mature companies. Because if you have kurtosis, the left tail is negligible, right? But for the high growth companies, it’s meaningful, you have this absolutely this pretty good probability they could fail. But the feds not allowing it. So what does it do? It increases your probability weighted future returns or your probability weighted value.
And so from that standpoint, also, you can see that the high growth companies should command the premium to your mature companies, right. And I can go further down that path as well. But I want to touch on one last thing on this phenomenon. And this is if you look at, you know, dollars are always being competed for, right, you know, the market, just like anything else, is, you know, people, individual actors, trying to allocate scarce resources, dollars investment dollars is, is a scarce resource, right. And so if you think about where the dollars are going to flow, it’s going to go to those factors or areas of the market that are more probable to grow in the long run, right. And so really quickly, if you look at, quote, unquote, value versus growth, your value managers historically have been able to capitalize on the simple compound nature of earnings over 30-40 years. And due to the very convex nature of compounding, the majority of that value comes at the very end, right? So if you had, you know, a company back in the 60s at a 40 year lifespan, Warren Buffett can invest in that company, and over 40 years, the overwhelming majority of the value he gets from that investment is going to be from earnings compounding, not the price or multiple he paid for Terry Smith talks about as well. It’s simple math, right. But if today, the average lifespan of an s&p 500 company is I think it’s like 12 years. If you have that compression and timespans, you don’t have as long anymore, for those earnings to compound. Value managers don’t have as much runway anymore, it’s a lot harder for them to find those opportunities.
So then what does that mean? You want to find the companies that are going to accelerate their earnings, the fastest over a shorter time period, which are your high growth companies. So I think that the low rate environment, coupled with the just structural nature of the markets today really makes for a more healthy or I think more high demand investment case for high growth companies. And I did a thread about it, which basically talked about I just said, so I think that’s one really important takeaway for the investment markets related to the feds interest rate policy.
Chris, we could we could go on for four or five more beers talking about this one. But just to wrap it all together, back to the geometry, if we’re increasing the angle of those earnings growth in the short term, where we’re not looking at Terminal values 30 years out, we’re looking at 12 years lifespan on the s&p 500.
I’ll ask you the same question that I asked my other 7investing advisors on one of our recent podcasts, what sector of the market is ripe for m&a in 2021? Now that money is cheap, and earnings are growing quickly, where are you going to start seeing some more acquisitions and mergers out there?
That’s a great question. You know, I’ve to put on my banking hat. So I think one place that you could see it, like think about this, right? Think about areas in the market in 2020, that specifically had really rapid price appreciation. So you so these companies essentially have free capital, right, relative to any other time period where you would have let’s say, a 10%, normal increase in equity prices for a year. So these companies have a lot of free capital, right? And so where are there sectors or pockets of the market, where there was an industry that had that high price appreciation, but there was a dispersion within the industry? So there were select winners and some select losers? I think one area you can see this is in the semiconductor space. You know, think about, you know, Micron Technology. Well, first of all, you’re seeing a lot of it, right with Xilinx?
So you’re seeing a lot of it already. I think you’re gonna see more of it, you know, and what I’m really interested to see is what happens and what plays out with Intel. And Dan Loeb currently released that letter and trying to get more active with Intel, which is a really sad story, if you think about it, because Intel is one of the great technology companies of all time. But I think that the semiconductor space given the dispersion in returns, but also given the fact that I think we’re in more of a structural bull market for semiconductors, and I can go into the bull case there. You know why i think that i think that those two phenomenons really lead to a very healthy m&a environment for that space.
Just as an aside for anybody listening, I did put Chris on the spot with that question. That wasn’t something we prepped in advance. But I personally would have chosen semiconductors as the industry as well. So I guess great minds think alike. Or at least I think like your great mind, Chris. Actually, on the spot with that one.
You know, let’s, I can’t we could we could take this in several different directions. But I do want to take a chance to kind of pull all this together. And maybe could you present one company that is on your radar right now, when you combine the mental models, when you look at those companies specific metrics are industry specific metrics, we look at the price today versus the price consensus estimates is our expecting. What’s one that’s on your radar, that’s really standing out for you right now?
Yeah, another great question. Because, you know, I think if you look at the market overall, I wouldn’t say the market’s in a bubble. I think that that’s a very lazy argument to make. I think that there are definitely areas where there are actually great opportunities, and you haven’t really seen this, this crazy price appreciation in names. You know, I’ll leave aside the SPACs and the recent new issues right. But, you know, one stock I’ve been looking at and I haven’t really dug in and didn’t tell my full research on is nCino. So nCino came public in I think it was July of 2020. And my visceral or just first kind of thought there is, you know, for starting high level again, right?
I want to think about what industries are ripe for disruption, what industries have kind of been lagging behind in terms of this digital transformation, technological transformation, similar, you know, similar thesis right, that Chamath has with open door and disrupting real estate. Well, another industry that really is ripe for disruption is, you know, our financial institutions and banking. Right and you’re seeing, I think, a slow and gradual push by, you know, your Squares of the world, your PayPals to be almost somewhat of a digital, a digital bank, if you will, but there are certain, you know, regulatory factors which will impede that long run, right. So I think the banks will always be here to stay. Given that the banking technology and infrastructure is incredibly outdated from my understanding of talking with some people and is really there is a need to bring this cloud based software asset light infrastructure and really operating leverage through that to these financial institutions.
nCino, I think is the name that’s going to be able to do that. And so if you know what nCino is, is essentially if you think about a Veeva Systems, you know, on the healthcare side, or even you know, Salesforce in general, right? nCino is a CRM for financial institutions, you know, they do when they also do everything from customer onboarding, account opening loan origination, etc. So almost, you know, a full stop, you know, suite for any single financial institution. And their goal, and I think the bull case is is that they become the main operating system for the institutions now. Kind of going back to high level, you know, what’s the industry bull case there? Well, financial institutions, and I didn’t know this until I did some research. They actually spend the most in IT spend every single year out of any industry. It’s like 350 billion or something like that. Now, nCino states that they’re, you know, total addressable market is only 10 billion. I think they’re being conservative. They’re given just a total IP spend annually by these banks and these other financial institutions. So I think there’s a large TAM, I think that nCino has the ability as somewhat of a first mover to really penetrate there, especially kind of what you can think about in terms of maybe AI when it comes to the loan origination.
And so just the the high level industry, macro view, I think, is really bullish for them. Then you look into their current relationships with other financial systems they already have, as customers, they already have, I think it’s somewhat like close to 1000 relationships already with different banks. And that includes things like Bank of America, Barclays, TD, like some really big names, they’ve already gotten on board, and they’re using the institutional product. So they already have some pretty solid customer penetration, if you will. And so what I see them doing similar to if you think about it, CrowdStrike or a lot of these other software names that are really asset light, and they have a single lightweight agent that they’re able to then deploy and roll out new features and updates. You would see there’s going to be creating new features or modules, if you will, for their platform that will make it a better product for their customers, which will make it more sticky for their customers.
Now, the only thing that I’m not a huge fan of from my research so far is that they’re a per seat based pricing model, which I think kind of limits that upside that I just talked about in terms of having new features. But you know, I do kind of like where nCino is positioned. And so I am gonna be working on building out some more research there. What else? Yeah, I like the founder lead as well. So nCino is one name I’ve been looking at.
And if you look at and this kind of goes back to your question. Also, if you look at the chart itself, it’s been trading in a range for quite a few months now. You know, it hasn’t been one of those high growth. So on one side, you can say, Well, you know, that’s not healthy, because you want to see, you know, your leading stocks lead in these markets. On the other hand, you know, what you see in bull markets is that, you know, you change leadership, right? It’s not the same leaders every single time there’s a bull market. So is nCino maybe poised to be a leader in the next bull market? We’ll see. Right now the stock is trading, I think it’s around. Is it 60 bucks now? Or maybe in the high 60s? I think when I was looking at.
$69 a share?
Yep. 70 bucks. Sure, sure. So we’re looking at Tipranks, I think I was seeing a lot of analysts estimates of 95-90 bucks a share. So there’s just word when it comes to the consensus estimates, if you will, versus the current price, there is a dislocation. So based off of my research, I’m going to figure out do I agree with these analysts? Right? And do I see that there are catalysts in the near term within my investment horizon, that will make the market you know, the buy side and the institution’s agree with that thesis? And if so, then I’m going to think about putting some capital to work there. Because I think that you know, at a six and a half billion dollar market cap, and only a 38 you know, million float, you know, there’s some opportunity there to really have some nice upside and you know, I’ve been seeing a lot of you know, fund ownership increasing over the past couple quarters. So and see you know, the name to watch.
NCNO is the ticker for that one. For nCino what Chris is talking about, definitely an industry that’s ripe for disruption and everything that you just said, a lot of optionality maybe deserving of a premium for a company like that.
Chris, my last question for you is an open ended one, our audience at 7investing is individual investors. What’s something you would pass along as a piece of advice for people that want to learn more about investing in the stock market?
I think the most important thing is to follow me on Twitter and subscribe to my newsletter.
[laughs] Seifel capital! @SeifelCapital to follow Chris.
That’s right. And so what do I’d say to investors? I’ll try to keep it short. Because you know, you’ve been very generous with your time. A few things, I think, one is, is that and you know, I’m also newer to the markets in terms of managing my own pa managing money, right. But I am aware of this, it is not always this easy to generate returns, you know, and I don’t want I would be concerned for people think that this is always the case where you’re almost, you know, throwing darts at a dartboard and stocks are going up. Right? I would recommend that people develop their own rigorous process if they can, if they have the time to have their own checklist, you know, what do you want to look for in a company? And how are you gonna value a company and determine if it’s a good investment, and follow that process for every investment that you make, have that level of discipline and rigor, and consistently do it? You know, don’t, don’t take any days off, you want to make sure that you’re practicing how you play, right.
And the reason why I kind of thought about this is because Gavin Baker had a great thread over the weekend. And he talked about it was something along the lines of an intellectual versus like a visceral understanding, or lack of an experience, right. And so the example he said was like, whew, the tech analyst back in 1999, right before the Bubble Pop in 2000. So that that experience for him was formative where, you know, stocks don’t just go up. And, you know, even though it seemed like it back in 99. And in the very beginning of 2000, it may seem that way. He realized he learned early on from an actual experience. That’s not right. But for me, I never had that experience. So it’s hard for me to really understand what it’s like. But so I would be very cautious if you’re an individual investor, that you know, socks just go up all the time that you can just throw money wherever you want. I would also say you know, for any aspiring investor out there, you know, it’s easy for me to say because I did it, but you know, if you want to be an investor, just go go out and go after it. Right. You know, I think you know, Tom Bilyeu from I think it’s Quest. You know, he was I read a quote from him one time if something like if you believe in, you know, human’s ability to achieve whatever they want and what’s stopping you right that there should be nothing right?
So if you want to be an investor, go out and make it happen, do what I do create your own process, create your own checklist, manage your own money, you know, develop your investing reports, and through that you’re going to learn a lot. And it’s going to be hard at first and you’re going to experience a lot of trials and tribulations. But if you learn from each of those instances, you’re just going to get better.
And you know, one last thing for me is the reason why I love the markets is because my my passion, the one thing that drives me every single day is learning. I just want to be constantly learning and when I’m not, I have almost borderline anxiety. I kid you not like when you know when I’m relaxing in bed at night. I’m watching curiosity stream because I’m learning something even though I’m kind of being lazy, right? So, for me, you know, the markets is the perfect place to learn every day. And I know that in 50 years when I’m still, you know, going out and I’m managing money, I’m still gonna be learning something new every day because if you’re not, then you’re doing something wrong and you’re probably not gonna be generating good returns.
Once again, Chris Seifel, the founder of Seifel Capital Management. A person I have a ton of respect for. Thank you, you do incredible research; very thorough in your approach. Chris, thanks very much for joining us here at 7investing for our podcast today!
Thanks, Simon! I really appreciate it. The same to you guys as well.
And thanks for tuning in for this edition of our 7investing podcast. We are here to empower you to invest in your future. We are 7investing!
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