March 4, 2025 • 30 mins
With the number of mergers and acquisitions being positively linked to small-cap performance, this year will be one to watch after a particularly weak 2024. In this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, along with co-host Michael Casper, US small cap and sector strategist at BI, spoke with Bryan Wong, vice president at Osterweis and a portfolio manager for the Osterweis Opportunity Fund (OSTGX), about innovation and growth driving full-cycle returns and why his team focuses on companies with 100% upside. They also discussed why evaluating innovation in small companies requires looking at forward quality metrics and long-term intrinsic value and earnings power. This episode was recorded on Jan. 21.
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Speaker 1 (00:13):
Welcome to Inside Active, a podcast about active managers that
goes beyond soundbites and headlines and looks deeper into their processes,
challenges and philosophies and security selection. I'm David Cohne, i
lead mutual fund and active research at Bloomberg Intelligence. Today
my co host is Michael casper Us, small cap and
sector strategist at Bloomberg Intelligence. Mike, thanks for joining me today.
Speaker 2 (00:35):
Thank you, David.
Speaker 1 (00:36):
So you wrote an interesting note last week on the
connection between small cap stocks and M and A. So
how to merge his and acquisitions affect Russell two thousand performance?
Speaker 2 (00:45):
Yeah, Well, first a recap of what happened in twenty
twenty four, and it was the weakest year we had
on record going back to about two thousand, with the
last quarter of twenty twenty four being particularly bad, just
two deals worth a paltry four point four billion in
the fourth quarter, But that caped a year where there
was only about fifty two deals that was worse than
two thousand and eight sixty one deals and making it
(01:07):
the worst going back to two thousand. Now you might
be wondering where did that dip come from. It was
definitely in financials, they made up just nine point three
percent of last year's fifty four deals. Typically they average
around eighteen point three percent or so of deals annually
going back to again two thousand, So really the big
(01:27):
departure was in financials only. Energy, though saw more deals
than its pre pandemic and X Great Financial Crisis average.
But why does this really matter for small cap stocks?
At the end of the day, small cap performance and
the amount of M and A, so the amount of
targets in the small cap index are pretty closely linked.
So if you look at calendar year performance of the
(01:48):
rest of two thousand and deal count and value in
the correlation between the two Russell two thousand annual performance,
calendar year performance is point five two correlated with count
and it's point four correlated to deal value. So a
pretty significant positive correlation there. Obviously is takeouts to accumulate.
It drives a premium for some of these small cap
(02:10):
stocks in some of these sectors. And one of the
cool things just before I give up on this, one
of the cool things we did that I want to
mention is that we tried to look for commonality across
these takeout targets in the Russell two thousand, going back
to again two thousand or two thousand and one, and
what we found the commonality amongst them was most of
(02:33):
them had positive EBADA for the year prior to the
deal's announcement. Over sixty percent of all those deals going
back to two thousand had positive EBADA seventy two percent
or so. We're cheaper than the index median ev to
EBADA and about seventy percent had lower net debt to ebadas,
a lower leverage leverage than the median stock in the
Russell two thousand. So we did a nice little takeover
(02:55):
target screen looking at companies in the Russell two thousand today.
Speaker 1 (02:59):
That's great. So if we are talking about small caps,
I think it's a great time to welcome our guest.
I'd like to welcome Brian Wong to the podcast. Brian
is vice president and small cap growth portfolio manager at
Ostrowis and a manager for the Austrowis Opportunity Fund ticker OSTGX. Brian,
thanks for joining us today.
Speaker 3 (03:18):
Thanks for having me.
Speaker 1 (03:19):
David, So I'd like to begin by asking you how
you got your start in the investment business.
Speaker 4 (03:24):
Sure, well, I went to college at Yale. I was
a political science major, so a great great training for investments,
of course, and really what I was focused on studying
in college was the Grand Strategy of Countries. So I
wrote my senior essay on the Grand Strategy of Dung Dungshaoping,
who's really China sort of modern leader following Mount Malzaedong
(03:45):
really opened up the economy there, but still preserved capitalism
with Chinese characteristics. And when I was graduating from college,
I got a great opportunity to join a long short
hedge fund run by Yale history major Dan, who really
saw how my skill set might translate, and so the
first book he gave me was Competitive Strategy by Michael Porter.
(04:09):
So really I went from studying the Grand strategy of
countries and leaders to companies. That was just a tremendous
opportunity to learn the craft of investing. The senior analyst
that the firm was a fellow by the name of
Sal Khon, who went on to found the con Academy.
And so I remember just sitting with Sal after work
many days, seeing him watch him record these videos of
(04:32):
him tutoring his cousin in math, and really sort of
grew to appreciate the power of technology, obviously leveraging a
new model of distribution YouTube to reach a much broader
audience of millions of people. And the idea of using
technology as this efficiency driver. You can record something once,
but obviously the content is forever. And then additionally, I
(04:53):
think just this idea of scaling by creating value for others.
You know, dominant companies don't start out that way. Every
entrepreneur has humble, humble beginnings. UH an idea. You know,
it requires very hard work.
Speaker 3 (05:06):
So that was a neat experience to see very early
on in my career.
Speaker 4 (05:10):
And so when Sal left to start kN Academy and
and Dan retired, I joined the Packard Foundation, which is
now run by Kim Sargent, a disciple formerly of the
Yale Endowment, and and there I learned the value of
long term investing uh and and for the past decade
I've been at Osterweiss applying sort of what I've learned
(05:31):
through those three to two former stages of my career.
First the idea of strategy and competitive advantage, second the
long term focus, and third this idea of you know,
how how do these companies start out from from something
small and scale to become something very significant. So I'm
very I'm very fascinated by that, and that's what I've
been applying for the past decade.
Speaker 1 (05:53):
So let's let's kind of dig into the opportunity fund.
You know, it sounds like you started getting into the philosophy,
you know, behind the fund strategy. Can you, I guess,
give us a little bit more about that philosophy that
you're using, I guess for the investment process of this.
Speaker 4 (06:08):
Yeah, I guess just to take a step back even
before we kind of talk about the philosophy. I mean,
why being sort of small caps at all? I think
it has to do with this, you know, defining characteristic
of capitalism, right, which is this this what makes America exceptional?
Speaker 3 (06:22):
Right?
Speaker 4 (06:22):
It's innovation and sort of this process of creative destruction
whereby smaller companies and entrepreneurs come up with newer, more
innovative ways of doing things, they offer superior value to
customers and improve lives. So I think, you know, I
very much believe in that fundamental process. And then if
we kind of move to active management, right, we firmly
(06:42):
believe there's there's a value of active in small cap
And you start with the idea that small cap is inefficient.
You have a universe of emerging companies with limited analyst coverage.
So it's certainly an area where active management can add value.
I think Morgan Stanley did a great study where they
found the cumulative media and alpha by active managers and
(07:03):
small cap was nearly sixty percent over the past thirty years. It's,
you know, very different versus sort of mid MidCap and
large cap. And then third, similar to private markets, the
best managers and I'm really talking about sort of the
top quartile, the top descl can add tremendous value. And
that's similar to kind of like an institutional investor looking
(07:24):
at private equity or venture capital. You don't want to
be in sort of venture capital just for the sake
of being in venture capital. You really want to be
in a top quartile type manager. And so those those
are the things we believe. And if you then layer
into kind of our strategy, you know, we think we
have a few key advantages. First, all we do is
small cap, at least my team of four, we focus
(07:48):
on this emerging company universe. We happen to be located
in San Francisco, which obviously gives us a backdoor seat
to a lot of the innovation, particularly in the tech,
technology and healthcare sector. Second, our team experience. Again I
mentioned the four of us as industry specific sector analysts.
Third and absolute valuation discipline, which I'm sure we'll get
(08:10):
into later, but every name has to have at least
one hundred percent upside at the time of our purchase
over a five year time horizon. We use no more
than a thirty times pee multiple and our five year
model estimates. And then finally, fourth, a high conviction portfolio.
So on average we have about forty names in our portfolios,
so fairly concentrated. And so what that gives us is
(08:33):
this portfolio of innovation and growth, but it's also tethered
to reality and valuations, and we think that's the secret
sauce to full cycle returns and the alpha that we've
been able to generate over time.
Speaker 1 (08:46):
So I know quality is an aspect that you're looking for.
Is there anything that you would you define quality as?
Any specific characteristics?
Speaker 4 (08:54):
Yeah, I think I think traditional managers would certainly look
on you know, wide modes, high an uninvested capital, that
sort of thing. And I think quality has a number
of different dimensions. As you said, you know, we like
high return on invested capital businesses just as much as
everyone else. But I think sometimes the opportunity in this
(09:15):
emerging company universe is to have a more forward definition
of quality and sort of, you know it s Gretzky said,
skating to where the puck is going to be. So
we're much more forward looking than sort of backward looking.
So in addition to kind of the playbook of being
able to buy high return on invested capital businesses when
they sell off, you know, we want to kind of
(09:36):
be diving into the mystery of the emerging company universe
and think about these future, forward looking quality metrics, and so,
you know, certainly we care about competitive advantage, but I
think frequently there's an innovation component which we're looking for.
There's a strong margin expansion component, so we're often focused
(09:56):
on incremental margin as opposed to just kind of current margin.
And then we're focused a lot on management, obviously, and
trying to invest with these entrepreneurial management teams that set
ambitious objectives but also have a clear plan and track
record upon which they can execute towards those objectives.
Speaker 2 (10:14):
And you mentioned PES as one of the metrics that
you use. How do you feel about equity valuations broadly
and are there any other metrics that you like to
use for valuing stocks.
Speaker 4 (10:27):
Yeah, our primary valuation metric is long term earnings power,
and so we have a process we call it this
anchor point, where we're focused on intrinsic value five years out.
So we're oftentimes looking, we're trying to understand the unit
economics of these companies. Everything we do is focused on
fundamental bottoms up research, and so if you break down
(10:48):
revenue of any company, right, there's often a volume component
and a price component. A company can sell a certain
amount of widgets and charge a certain price per widget,
and then you layer on the incremental margins. I've on
the earnings per share target and so upon which we
applied no more than a thirty times p multiple to
those five year estimates, and every company to enter the
(11:08):
portfolio has to have at least one hundred percent upset
on those on those metrics. So that is the primary
valuation metric we use. We do look at other relative
valuation metrics, you know EVD sales, EVD, EBITDA, things like that,
but the primary metric is really the five year earnings
power and the intrinsic value of these companies.
Speaker 1 (11:31):
I wanted to do a follow up on you know,
you were talking about management teams just a few moments ago.
You know, what are the exact qualities? I know you
mentioned you know, having ambition and you know having you know,
good products. Are there any other I guess qualities you
look for in management teams?
Speaker 3 (11:47):
Yeah?
Speaker 4 (11:48):
Management, I mean it is there's kind of the science
of investing, and I guess there's the art, right, and
I think management is much more of an art than
than a science, uh to to say there's one way
of managing a companyany Obviously, every company can be very different.
But I think the best entrepreneurs do tech. If you
look at just the Magnificent seven for incentra right, I mean,
(12:09):
the most successful companies were all sort of founder led.
These these folks who are driven to change the world
and and and and have been able to scale the
company's in remarkable ways. I don't I don't think every
founder has the capability to scale to those levels, obviously,
but those are the most successful outcomes. But we do,
(12:30):
we do analyze culture of companies, uh, you know, even
glassdoor reviews, things like that. We certainly like to take
advantage of our location, again being in the B area,
being able to access private companies, venture capitalists, competitors, suppliers,
kind of the traditional Fisher scuttle butt work, and and
then ultimately I think somebody once told me the best
(12:51):
managers do set low expectations.
Speaker 3 (12:54):
And constantly sort of surpass them.
Speaker 4 (12:55):
Right, Not not to say that they're unambitious expectations, but
if you can consistently kind of outperform relative to the
expectations you set, that's a very good thing.
Speaker 2 (13:07):
Are there any sectors you currently find particularly compelling? And
one of the things I've focused on in twenty twenty
five is the sector rotation that kind of moved away
from tech, especially in large caps. Do you think that
could last in twenty twenty five?
Speaker 3 (13:20):
I am hopeful.
Speaker 4 (13:21):
I personally spend a lot of time in the technology sector.
But you're absolutely correct that when you look at the
drivers of the s and P five hundred, obviously they're
very much concentrated in the magnificent seven or eight. One
of the interesting things about the small cap universes, to
some extent, we've seen that broadening. So if you look
at the drivers of the returns in the small cap space.
(13:42):
It is not solely technology, and certainly for our strategy,
we've seen great performance in consumer and healthcare and in
industrials and other sectors. So I think we're already starting
to see some of that broadening. We haven't seen it
to the extent in the S and P. Five hundred,
but I think some of that will depend on, obviously,
whether technology can maintain its leadership, particularly in AI, and
(14:05):
whether some of these other sectors can broaden out. Certainly
with the new administration, that that that there is some
reason to be supportive of the overall economy.
Speaker 2 (14:16):
Yeah, and it's it's good that you bring up the
new administration.
Speaker 4 (14:20):
Uh.
Speaker 2 (14:20):
Do you think that any of the election results changed
any of your investment theses?
Speaker 3 (14:26):
Yeah, yes, and no.
Speaker 4 (14:27):
I mean I think we are much more focused on
these secular growth themes of technology, healthcare. Uh, you know,
just just more innovation throughout the economy. Consumer businesses have
are offering, you know, always offering better value to customers.
New companies like sweet greens and restaurants along healthier living
trends or elf and beauty and cosmetics offering sort of
(14:50):
you know, value at at a good price point. And
so those those don't tend to be correlated as much,
uh with sort of administration changes, where you might have
more cyclical factors of you know, industrials being more in
or out of favor. But I do think on the margin,
obviously we're paying attention to tariffs, we're paying attention to
(15:10):
the drive towards government efficiency. But I think the most
positive factor with the administration is there does seem to
be a renewed focus on innovation and technology in general.
So obviously you have JD. Vance who is formerly a
venture capitalist. There's reasons to think he might be better
for little tech as opposed to just big tech, which
would benefit the small cap space as well as venture capital.
(15:34):
And you have Elon and and other folks are who
are driving efficiency and innovation, which I think is good
good for America and good good for a small cap.
Speaker 2 (15:42):
And I've been really focused on rates, and obviously the
rate pictures increasingly more up in the air as we
get into twenty twenty five, but I've been really focused
on rates as a catalyst for small cap stucks to
kind of inherrow the gap with the S and P
five hundred, What do you think the catalysts are for
you know, maybe a small cap resurgence this year.
Speaker 3 (16:01):
Yeah, I think.
Speaker 4 (16:03):
I think a stabilization in rates is really the key.
We've never wanted to make explicit bets on rate cuts
and things like that, although we understand the market does
that for us and and may have gotten a little
bit ahead of itself maybe let's say six six months ago,
But now I think the general consensus will see maybe
one or zero rate cuts. Again, I think putting putting
(16:28):
sort of the past five years in context. You know,
rates on the ten year went from close to zero,
maybe fifty basis points to four and a half percent,
and so that was a big headwind for small caps.
And now I think there's a debate of you know,
do rates stick down a bit or take up a bit? Again,
putting putting this all in the context of the past
five years, I think the most important takeaway is we're
(16:50):
not nobody's expecting a four or five hundred basis point
increase in rates, right. We seem to be entering a
more stabilized period of interest rates broadly, and I think
along combined with the strong economy, that's going to be
a very positive thing for small caps.
Speaker 2 (17:06):
And since I talked about it at the beginning of
the segment, What do you see as the outlook for
IPO and M and A D see a comeback after
this really week two year stretch that we've had.
Speaker 4 (17:16):
Certainly so, I think we're already starting to see it.
We've seen a trickle of technology IPOs, but you're correct
that following a ro us twenty twenty and twenty twenty one,
twenty two, twenty three, and twenty four were fairly meager.
Speaker 3 (17:33):
That window is beginning to lift.
Speaker 4 (17:35):
I follow the private technology ecosystem very closely. Supposedly there
are fifteen hundred private unicorns with valuations of a billion
or higher, and I think there's been a strike by
the private markets to really underwrite the lower valuations that
are necessary in some cases to take those companies public. Obviously,
(17:59):
many of these companies were funded during a period of
very low interest rates, and so there's been a disparity
in terms of private versus public market valuations. I think
certainly the lower regulatory environment going forward, the certainty of
the new administration will be positive catalysts for that, and
I think that's necessary. I think there's been this trend
(18:20):
of companies staying private for longer. I'm not sure that's
such such.
Speaker 3 (18:25):
A good thing.
Speaker 4 (18:26):
Uh, And I think I think we'll want to see
smaller companies come come come public sooner.
Speaker 1 (18:35):
You had mentioned you know the portfolio is pretty concentrated.
Do you have any I guess things in place to
manage portfolio risk?
Speaker 3 (18:47):
Yes, I think.
Speaker 4 (18:47):
I think when we look at portfolio risk first and foremost,
we are we are looking at the the risk of
losing capital as opposed to to solely volatility. Although you know,
you can screen our portfolio on sharp ratios and downside
capture ratios and we happen to look pretty attractive on
(19:07):
those metrics. I think part of that is due to
our absolute valuation discipline and our general each company has
to have at least one hundred percent upside. Again, at
the time of purchase, we use no more than a
thirty times pe on those price starting's estimates, and then
we're generally trimming when the upside falls to fifty percent
(19:28):
or lower. As opposed to a pure buy and hold manager,
We're not willing to hold an exceptional company at an
infinite price, and so we're quite disciplined about that. The
best companies that stay in the portfolio over multiple years
have to continuously prove themselves in terms of the upside.
Otherwise we'll trim and sell the lesser companies as they
become more fully valued. So our best defense is really
(19:50):
our knowledge I think of the individual portfolio companies. We
certainly want to know the key drivers of these companies
as well or better than anyone else to mitigate the
constant intration. Though again, we have a five percent max
position limit, so we're not going to hold companies above
a five percent weight because we recognize there can be
additional volatility and risk associated with that. But really it
(20:13):
is it is our knowledge of these companies and our
absolute valuation discipline.
Speaker 1 (20:18):
I had one follow up question to that. You mentioned
trimming companies, and so I'm curious, are there any other
things you look at? You know, I guess we trigger
selling the portfolio, not just you know, trimming a company gets.
Speaker 4 (20:31):
Yeah, we sell for one of three reasons, typically one
the position becomes fully valued, to upgrade to better opportunities,
or three. I mentioned this anchor points concept we have
whereby we're really looking out five years into the future
and trying to anchor it to these estimates of intrinsic.
Speaker 3 (20:52):
Value if those.
Speaker 4 (20:56):
If those companies are failing to meet those objectives over time,
which does and that's a third reason we sell.
Speaker 2 (21:02):
So I've been following fundamentals for for small caps for
for some time, and it looks like consensus is very
weak for the fourth quarter earning season. Are there any
macro factors you're you're watching that might help turn the
tide on fundamentals?
Speaker 4 (21:15):
I think interest rates and valuations would be the main
thing we're focused on, in addition to just company earnings.
I think, you know, the biggest debate in the market
right now is technology and AI. I was just at
a conference the other week, and so I think the
biggest question in the market right now is you know,
(21:40):
perhaps AI probably has the most promise of any technology
we've seen right because it's it's tam unconstrained in terms
of being able to address labor, labor and services, not
just tools and software spend. But because of that, it
can be prone to overhype. And so I think, you know,
a lot of Fortune one thousand type companies want to
(22:00):
bet on a technology that's well understood and minimize risk.
I think with Cloud there was much more, much more
consensus over the value of cloud, and even then I
think you saw some companies be resistant for some time.
So with the risks of hallucinating, you know, I think
it's hard to see widespread enterprise adoption right now. Certainly
(22:23):
from a consumer standpoint, it's easier to see adoption there.
I think another area that folks are wondering about is
the scaling laws. Right we're quickly exhausting all the data
upon which we're training these models, and we're using increasingly
synthetic data and reasoning and trying to see sort of
how that progresses, as well as well as the return
(22:44):
on invested capital versus the capex. So these hyperscalers are
all extremely well funded, the Microsoft's Amazon schools of the world,
and they can support this capex I think for some time,
but at a certain point it starts diminishing your free
cash flow. And so it's striking to me that a
company like Microsoft is reporting a decline in its free
(23:06):
cash flow for share this year. I think investors might
overlook that for a period, but over time, you obviously
want to see the growth in the free cash flow,
and so Sequoya put out a good paper I think
last year on AI's six hundred billion dollar question asking
whether whether the return on this two hundred billion of Nvidia,
(23:26):
you know, data data center spend is supported by the
six hundred billion in revenue software and application revenue, which
we've yet to seen. So I think that's the biggest
debate in the market right now. I know that's less
of a macro factor, but in terms of thinking about
something I'm watching in terms of secular growth trends, Yeah.
Speaker 2 (23:43):
That's definitely interesting. And did you have any major takeaways
from the third quarter earning season and is there anything
you're watching as fourth quarter results start to roll in
for small cap companies.
Speaker 4 (23:53):
No, I mean, I think it's it's mostly a function
of what what I just described. I think I think
we're try to think about the broadening I guess, first
and foremost what's happening in the technology sector, but second
also the broadening of the economy, certainly with industrial industrial economy, ism,
(24:14):
data like that as well. But again, our focus is
more on secular growth and whether these companies are tracking
towards these long term anchor points. I think during the
dot com bubble, Jeff Bezos said it best. I think
his stock Amazon was down something like eighty ninety percent
at one point. But he was talking about how by
(24:35):
any measure, Amazon was stronger than a year ago. Its
customer account had increased from fourteen million to twenty million,
its sales had climbed over sixty eight percent, its operating
loss had narrowed. And so we're trying to think about
these fundamental metrics in terms of the drivers of unit
expansion and incremental margins that are creating heavier and heavier
(24:56):
businesses over time, because in the short term market is
a voting machine, but in the long term it's a
weighing machine, and we're trying to invest in these heavier
companies over time.
Speaker 2 (25:07):
And you mentioned the AI investment maybe not justified by
the payoff as a risk. Are there any other big
risks you see the stocks this year?
Speaker 4 (25:18):
Well, certainly, as we touched on that, I think interest
rates and valuation metrics would be the concern, so that
those are factors we will be falling. I think the
market is relatively expensive by traditional metrics. One of the
encouraging factors on small cap is relative to large cap
we are undervalued on a relative basis, and certainly small
(25:43):
caps have underperformed large caps over the past decade. I
think it's the longest stretch in history. Traditionally, obviously, there's
been this small cap premium. I think over the past
ninety seven years, if you invested a dollar in small
cap versus large cap, you would have ended up with
over four times your money in small So that hasn't
been the case for the past decade. There's good reasons
(26:04):
why that is the case, with the rise of these
Magnificent seven companies and so forth. But markets trends don't
tend to last in one direction forever, and we think
there's a real opportunity for me and reversion here. As
a small cap has underperformed and the evaluations are relatively cheaper.
That should bode well as the economy broadens and we
(26:26):
could see some momentum and small cap and then again, additionally,
an active manager doesn't have to invest in the whole
asset class, but we can really invest in the most
exceptionally well positioned companies within the asset class.
Speaker 1 (26:39):
It would be something to definitely look forward to. But
before we let you go, we'd love to hear what
some of your favorite reads are. You know, any financial
favorite financial books you like?
Speaker 4 (26:48):
Yeah, I began talking a little bit about the Phil
Fisher scuttle, but type work, you know, attending conferences, industry events,
expert networks. We mentioned kind of our location here in
the Bay. I remember one investment we made in a
software company called Avalara for sales tax collection. Obviously, there's
only two certain days in life, death and taxes, and
(27:11):
so I remember going to one of these some of
these tax tax conferences and hearing from the California Department
of Tax and Fees that they were expecting additional you know,
one a half to two billion revenue back in I
think the twenty eighteen or twenty nineteen time frame, because
there was a Supreme Court decision called South Dakota versus Wayfair,
(27:32):
which ruled that it overturned the physical presence requirement where
if you bought something on Amazon, let's say, from California,
but it chipped from Texas, Texas couldn't collect state tax
on that unless the seller had a presence in Texas.
Speaker 3 (27:47):
And so when the Supreme Court court overturned.
Speaker 4 (27:49):
That ruling, there was a huge rush to sort of
tax a broader jurisdiction. So Avolara was well positioned for
that trend and so the scuttle butt I mentioned in
terms of that primary due diligence really is the craft
of small cap investing, and Phil Fisher very much pioneered
that with his book Common Stocks and Uncommon Profits. I
(28:09):
think one of the questions he always asks management teams
is what are you doing that your competitors aren't doing right,
because you really have to sustain innovation to drive future
appreciation in your business. And then the second book, I
think is a book called Seven Powers by Hamilton Helmer,
and it's a little bit an extension of Clay Christensen's
(28:32):
work on the innovator's dilemma, but he has a concept
called counter positioning which is very very powerful in small
cap and a classic example I think is Netflix versus Blockbuster.
So when you look at Blockbuster's business, they were challenged
in a couple different ways, not only with sort of
the internet distribution model changing that from brick and mortar,
(28:54):
but also if you looked back at their business, I
think a substantial chunk of their income was derived from
late ease, and so when you had a newer incumbent
like Netflix rise, they were able to compete in a
way that Blockbuster was really powerless to sort of respond
to because to compete they had to not only change
their business model in terms of the generation from late fees,
(29:18):
but also the brick and mortar model to Internet. And
so we like this idea. But whereby new companies can
counterposition against legacy incumbents.
Speaker 1 (29:27):
That's an interesting point. I guess I never really thought about,
you know, all those nights, you know, going to Blockbuster
years ago, the late fees drove so much of their revenue,
but definitely makes sense. This is great, Brian, thank you
so much for joining us today. Thank you, Mike, thanks
again for being my co host today.
Speaker 2 (29:43):
Thank you both.
Speaker 1 (29:44):
Until our next episode, this is David Cohne with Inside
Out
Speaker 4 (30:00):
Four No.
Welcome to Inside Active, a podcast about active managers that
goes beyond soundbites and headlines and looks deeper into their processes,
challenges and philosophies and security selection. I'm David Cohne, i
lead mutual fund and active research at Bloomberg Intelligence. Today
my co host is Michael casper Us, small cap and
sector strategist at Bloomberg Intelligence. Mike, thanks for joining me today.
Speaker 2 (00:35):
Thank you, David.
Speaker 1 (00:36):
So you wrote an interesting note last week on the
connection between small cap stocks and M and A. So
how to merge his and acquisitions affect Russell two thousand performance?
Speaker 2 (00:45):
Yeah, Well, first a recap of what happened in twenty
twenty four, and it was the weakest year we had
on record going back to about two thousand, with the
last quarter of twenty twenty four being particularly bad, just
two deals worth a paltry four point four billion in
the fourth quarter, But that caped a year where there
was only about fifty two deals that was worse than
two thousand and eight sixty one deals and making it
(01:07):
the worst going back to two thousand. Now you might
be wondering where did that dip come from. It was
definitely in financials, they made up just nine point three
percent of last year's fifty four deals. Typically they average
around eighteen point three percent or so of deals annually
going back to again two thousand, So really the big
(01:27):
departure was in financials only. Energy, though saw more deals
than its pre pandemic and X Great Financial Crisis average.
But why does this really matter for small cap stocks?
At the end of the day, small cap performance and
the amount of M and A, so the amount of
targets in the small cap index are pretty closely linked.
So if you look at calendar year performance of the
(01:48):
rest of two thousand and deal count and value in
the correlation between the two Russell two thousand annual performance,
calendar year performance is point five two correlated with count
and it's point four correlated to deal value. So a
pretty significant positive correlation there. Obviously is takeouts to accumulate.
It drives a premium for some of these small cap
(02:10):
stocks in some of these sectors. And one of the
cool things just before I give up on this, one
of the cool things we did that I want to
mention is that we tried to look for commonality across
these takeout targets in the Russell two thousand, going back
to again two thousand or two thousand and one, and
what we found the commonality amongst them was most of
(02:33):
them had positive EBADA for the year prior to the
deal's announcement. Over sixty percent of all those deals going
back to two thousand had positive EBADA seventy two percent
or so. We're cheaper than the index median ev to
EBADA and about seventy percent had lower net debt to ebadas,
a lower leverage leverage than the median stock in the
Russell two thousand. So we did a nice little takeover
(02:55):
target screen looking at companies in the Russell two thousand today.
Speaker 1 (02:59):
That's great. So if we are talking about small caps,
I think it's a great time to welcome our guest.
I'd like to welcome Brian Wong to the podcast. Brian
is vice president and small cap growth portfolio manager at
Ostrowis and a manager for the Austrowis Opportunity Fund ticker OSTGX. Brian,
thanks for joining us today.
Speaker 3 (03:18):
Thanks for having me.
Speaker 1 (03:19):
David, So I'd like to begin by asking you how
you got your start in the investment business.
Speaker 4 (03:24):
Sure, well, I went to college at Yale. I was
a political science major, so a great great training for investments,
of course, and really what I was focused on studying
in college was the Grand Strategy of Countries. So I
wrote my senior essay on the Grand Strategy of Dung Dungshaoping,
who's really China sort of modern leader following Mount Malzaedong
(03:45):
really opened up the economy there, but still preserved capitalism
with Chinese characteristics. And when I was graduating from college,
I got a great opportunity to join a long short
hedge fund run by Yale history major Dan, who really
saw how my skill set might translate, and so the
first book he gave me was Competitive Strategy by Michael Porter.
(04:09):
So really I went from studying the Grand strategy of
countries and leaders to companies. That was just a tremendous
opportunity to learn the craft of investing. The senior analyst
that the firm was a fellow by the name of
Sal Khon, who went on to found the con Academy.
And so I remember just sitting with Sal after work
many days, seeing him watch him record these videos of
(04:32):
him tutoring his cousin in math, and really sort of
grew to appreciate the power of technology, obviously leveraging a
new model of distribution YouTube to reach a much broader
audience of millions of people. And the idea of using
technology as this efficiency driver. You can record something once,
but obviously the content is forever. And then additionally, I
(04:53):
think just this idea of scaling by creating value for others.
You know, dominant companies don't start out that way. Every
entrepreneur has humble, humble beginnings. UH an idea. You know,
it requires very hard work.
Speaker 3 (05:06):
So that was a neat experience to see very early
on in my career.
Speaker 4 (05:10):
And so when Sal left to start kN Academy and
and Dan retired, I joined the Packard Foundation, which is
now run by Kim Sargent, a disciple formerly of the
Yale Endowment, and and there I learned the value of
long term investing uh and and for the past decade
I've been at Osterweiss applying sort of what I've learned
(05:31):
through those three to two former stages of my career.
First the idea of strategy and competitive advantage, second the
long term focus, and third this idea of you know,
how how do these companies start out from from something
small and scale to become something very significant. So I'm
very I'm very fascinated by that, and that's what I've
been applying for the past decade.
Speaker 1 (05:53):
So let's let's kind of dig into the opportunity fund.
You know, it sounds like you started getting into the philosophy,
you know, behind the fund strategy. Can you, I guess,
give us a little bit more about that philosophy that
you're using, I guess for the investment process of this.
Speaker 4 (06:08):
Yeah, I guess just to take a step back even
before we kind of talk about the philosophy. I mean,
why being sort of small caps at all? I think
it has to do with this, you know, defining characteristic
of capitalism, right, which is this this what makes America exceptional?
Speaker 3 (06:22):
Right?
Speaker 4 (06:22):
It's innovation and sort of this process of creative destruction
whereby smaller companies and entrepreneurs come up with newer, more
innovative ways of doing things, they offer superior value to
customers and improve lives. So I think, you know, I
very much believe in that fundamental process. And then if
we kind of move to active management, right, we firmly
(06:42):
believe there's there's a value of active in small cap
And you start with the idea that small cap is inefficient.
You have a universe of emerging companies with limited analyst coverage.
So it's certainly an area where active management can add value.
I think Morgan Stanley did a great study where they
found the cumulative media and alpha by active managers and
(07:03):
small cap was nearly sixty percent over the past thirty years. It's,
you know, very different versus sort of mid MidCap and
large cap. And then third, similar to private markets, the
best managers and I'm really talking about sort of the
top quartile, the top descl can add tremendous value. And
that's similar to kind of like an institutional investor looking
(07:24):
at private equity or venture capital. You don't want to
be in sort of venture capital just for the sake
of being in venture capital. You really want to be
in a top quartile type manager. And so those those
are the things we believe. And if you then layer
into kind of our strategy, you know, we think we
have a few key advantages. First, all we do is
small cap, at least my team of four, we focus
(07:48):
on this emerging company universe. We happen to be located
in San Francisco, which obviously gives us a backdoor seat
to a lot of the innovation, particularly in the tech,
technology and healthcare sector. Second, our team experience. Again I
mentioned the four of us as industry specific sector analysts.
Third and absolute valuation discipline, which I'm sure we'll get
(08:10):
into later, but every name has to have at least
one hundred percent upside at the time of our purchase
over a five year time horizon. We use no more
than a thirty times pee multiple and our five year
model estimates. And then finally, fourth, a high conviction portfolio.
So on average we have about forty names in our portfolios,
so fairly concentrated. And so what that gives us is
(08:33):
this portfolio of innovation and growth, but it's also tethered
to reality and valuations, and we think that's the secret
sauce to full cycle returns and the alpha that we've
been able to generate over time.
Speaker 1 (08:46):
So I know quality is an aspect that you're looking for.
Is there anything that you would you define quality as?
Any specific characteristics?
Speaker 4 (08:54):
Yeah, I think I think traditional managers would certainly look
on you know, wide modes, high an uninvested capital, that
sort of thing. And I think quality has a number
of different dimensions. As you said, you know, we like
high return on invested capital businesses just as much as
everyone else. But I think sometimes the opportunity in this
(09:15):
emerging company universe is to have a more forward definition
of quality and sort of, you know it s Gretzky said,
skating to where the puck is going to be. So
we're much more forward looking than sort of backward looking.
So in addition to kind of the playbook of being
able to buy high return on invested capital businesses when
they sell off, you know, we want to kind of
(09:36):
be diving into the mystery of the emerging company universe
and think about these future, forward looking quality metrics, and so,
you know, certainly we care about competitive advantage, but I
think frequently there's an innovation component which we're looking for.
There's a strong margin expansion component, so we're often focused
(09:56):
on incremental margin as opposed to just kind of current margin.
And then we're focused a lot on management, obviously, and
trying to invest with these entrepreneurial management teams that set
ambitious objectives but also have a clear plan and track
record upon which they can execute towards those objectives.
Speaker 2 (10:14):
And you mentioned PES as one of the metrics that
you use. How do you feel about equity valuations broadly
and are there any other metrics that you like to
use for valuing stocks.
Speaker 4 (10:27):
Yeah, our primary valuation metric is long term earnings power,
and so we have a process we call it this
anchor point, where we're focused on intrinsic value five years out.
So we're oftentimes looking, we're trying to understand the unit
economics of these companies. Everything we do is focused on
fundamental bottoms up research, and so if you break down
(10:48):
revenue of any company, right, there's often a volume component
and a price component. A company can sell a certain
amount of widgets and charge a certain price per widget,
and then you layer on the incremental margins. I've on
the earnings per share target and so upon which we
applied no more than a thirty times p multiple to
those five year estimates, and every company to enter the
(11:08):
portfolio has to have at least one hundred percent upset
on those on those metrics. So that is the primary
valuation metric we use. We do look at other relative
valuation metrics, you know EVD sales, EVD, EBITDA, things like that,
but the primary metric is really the five year earnings
power and the intrinsic value of these companies.
Speaker 1 (11:31):
I wanted to do a follow up on you know,
you were talking about management teams just a few moments ago.
You know, what are the exact qualities? I know you
mentioned you know, having ambition and you know having you know,
good products. Are there any other I guess qualities you
look for in management teams?
Speaker 3 (11:47):
Yeah?
Speaker 4 (11:48):
Management, I mean it is there's kind of the science
of investing, and I guess there's the art, right, and
I think management is much more of an art than
than a science, uh to to say there's one way
of managing a companyany Obviously, every company can be very different.
But I think the best entrepreneurs do tech. If you
look at just the Magnificent seven for incentra right, I mean,
(12:09):
the most successful companies were all sort of founder led.
These these folks who are driven to change the world
and and and and have been able to scale the
company's in remarkable ways. I don't I don't think every
founder has the capability to scale to those levels, obviously,
but those are the most successful outcomes. But we do,
(12:30):
we do analyze culture of companies, uh, you know, even
glassdoor reviews, things like that. We certainly like to take
advantage of our location, again being in the B area,
being able to access private companies, venture capitalists, competitors, suppliers,
kind of the traditional Fisher scuttle butt work, and and
then ultimately I think somebody once told me the best
(12:51):
managers do set low expectations.
Speaker 3 (12:54):
And constantly sort of surpass them.
Speaker 4 (12:55):
Right, Not not to say that they're unambitious expectations, but
if you can consistently kind of outperform relative to the
expectations you set, that's a very good thing.
Speaker 2 (13:07):
Are there any sectors you currently find particularly compelling? And
one of the things I've focused on in twenty twenty
five is the sector rotation that kind of moved away
from tech, especially in large caps. Do you think that
could last in twenty twenty five?
Speaker 3 (13:20):
I am hopeful.
Speaker 4 (13:21):
I personally spend a lot of time in the technology sector.
But you're absolutely correct that when you look at the
drivers of the s and P five hundred, obviously they're
very much concentrated in the magnificent seven or eight. One
of the interesting things about the small cap universes, to
some extent, we've seen that broadening. So if you look
at the drivers of the returns in the small cap space.
(13:42):
It is not solely technology, and certainly for our strategy,
we've seen great performance in consumer and healthcare and in
industrials and other sectors. So I think we're already starting
to see some of that broadening. We haven't seen it
to the extent in the S and P. Five hundred,
but I think some of that will depend on, obviously,
whether technology can maintain its leadership, particularly in AI, and
(14:05):
whether some of these other sectors can broaden out. Certainly
with the new administration, that that that there is some
reason to be supportive of the overall economy.
Speaker 2 (14:16):
Yeah, and it's it's good that you bring up the
new administration.
Speaker 4 (14:20):
Uh.
Speaker 2 (14:20):
Do you think that any of the election results changed
any of your investment theses?
Speaker 3 (14:26):
Yeah, yes, and no.
Speaker 4 (14:27):
I mean I think we are much more focused on
these secular growth themes of technology, healthcare. Uh, you know,
just just more innovation throughout the economy. Consumer businesses have
are offering, you know, always offering better value to customers.
New companies like sweet greens and restaurants along healthier living
trends or elf and beauty and cosmetics offering sort of
(14:50):
you know, value at at a good price point. And
so those those don't tend to be correlated as much,
uh with sort of administration changes, where you might have
more cyclical factors of you know, industrials being more in
or out of favor. But I do think on the margin,
obviously we're paying attention to tariffs, we're paying attention to
(15:10):
the drive towards government efficiency. But I think the most
positive factor with the administration is there does seem to
be a renewed focus on innovation and technology in general.
So obviously you have JD. Vance who is formerly a
venture capitalist. There's reasons to think he might be better
for little tech as opposed to just big tech, which
would benefit the small cap space as well as venture capital.
(15:34):
And you have Elon and and other folks are who
are driving efficiency and innovation, which I think is good
good for America and good good for a small cap.
Speaker 2 (15:42):
And I've been really focused on rates, and obviously the
rate pictures increasingly more up in the air as we
get into twenty twenty five, but I've been really focused
on rates as a catalyst for small cap stucks to
kind of inherrow the gap with the S and P
five hundred, What do you think the catalysts are for
you know, maybe a small cap resurgence this year.
Speaker 3 (16:01):
Yeah, I think.
Speaker 4 (16:03):
I think a stabilization in rates is really the key.
We've never wanted to make explicit bets on rate cuts
and things like that, although we understand the market does
that for us and and may have gotten a little
bit ahead of itself maybe let's say six six months ago,
But now I think the general consensus will see maybe
one or zero rate cuts. Again, I think putting putting
(16:28):
sort of the past five years in context. You know,
rates on the ten year went from close to zero,
maybe fifty basis points to four and a half percent,
and so that was a big headwind for small caps.
And now I think there's a debate of you know,
do rates stick down a bit or take up a bit? Again,
putting putting this all in the context of the past
five years, I think the most important takeaway is we're
(16:50):
not nobody's expecting a four or five hundred basis point
increase in rates, right. We seem to be entering a
more stabilized period of interest rates broadly, and I think
along combined with the strong economy, that's going to be
a very positive thing for small caps.
Speaker 2 (17:06):
And since I talked about it at the beginning of
the segment, What do you see as the outlook for
IPO and M and A D see a comeback after
this really week two year stretch that we've had.
Speaker 4 (17:16):
Certainly so, I think we're already starting to see it.
We've seen a trickle of technology IPOs, but you're correct
that following a ro us twenty twenty and twenty twenty one,
twenty two, twenty three, and twenty four were fairly meager.
Speaker 3 (17:33):
That window is beginning to lift.
Speaker 4 (17:35):
I follow the private technology ecosystem very closely. Supposedly there
are fifteen hundred private unicorns with valuations of a billion
or higher, and I think there's been a strike by
the private markets to really underwrite the lower valuations that
are necessary in some cases to take those companies public. Obviously,
(17:59):
many of these companies were funded during a period of
very low interest rates, and so there's been a disparity
in terms of private versus public market valuations. I think
certainly the lower regulatory environment going forward, the certainty of
the new administration will be positive catalysts for that, and
I think that's necessary. I think there's been this trend
(18:20):
of companies staying private for longer. I'm not sure that's
such such.
Speaker 3 (18:25):
A good thing.
Speaker 4 (18:26):
Uh, And I think I think we'll want to see
smaller companies come come come public sooner.
Speaker 1 (18:35):
You had mentioned you know the portfolio is pretty concentrated.
Do you have any I guess things in place to
manage portfolio risk?
Speaker 3 (18:47):
Yes, I think.
Speaker 4 (18:47):
I think when we look at portfolio risk first and foremost,
we are we are looking at the the risk of
losing capital as opposed to to solely volatility. Although you know,
you can screen our portfolio on sharp ratios and downside
capture ratios and we happen to look pretty attractive on
(19:07):
those metrics. I think part of that is due to
our absolute valuation discipline and our general each company has
to have at least one hundred percent upside. Again, at
the time of purchase, we use no more than a
thirty times pe on those price starting's estimates, and then
we're generally trimming when the upside falls to fifty percent
(19:28):
or lower. As opposed to a pure buy and hold manager,
We're not willing to hold an exceptional company at an
infinite price, and so we're quite disciplined about that. The
best companies that stay in the portfolio over multiple years
have to continuously prove themselves in terms of the upside.
Otherwise we'll trim and sell the lesser companies as they
become more fully valued. So our best defense is really
(19:50):
our knowledge I think of the individual portfolio companies. We
certainly want to know the key drivers of these companies
as well or better than anyone else to mitigate the
constant intration. Though again, we have a five percent max
position limit, so we're not going to hold companies above
a five percent weight because we recognize there can be
additional volatility and risk associated with that. But really it
(20:13):
is it is our knowledge of these companies and our
absolute valuation discipline.
Speaker 1 (20:18):
I had one follow up question to that. You mentioned
trimming companies, and so I'm curious, are there any other
things you look at? You know, I guess we trigger
selling the portfolio, not just you know, trimming a company gets.
Speaker 4 (20:31):
Yeah, we sell for one of three reasons, typically one
the position becomes fully valued, to upgrade to better opportunities,
or three. I mentioned this anchor points concept we have
whereby we're really looking out five years into the future
and trying to anchor it to these estimates of intrinsic.
Speaker 3 (20:52):
Value if those.
Speaker 4 (20:56):
If those companies are failing to meet those objectives over time,
which does and that's a third reason we sell.
Speaker 2 (21:02):
So I've been following fundamentals for for small caps for
for some time, and it looks like consensus is very
weak for the fourth quarter earning season. Are there any
macro factors you're you're watching that might help turn the
tide on fundamentals?
Speaker 4 (21:15):
I think interest rates and valuations would be the main
thing we're focused on, in addition to just company earnings.
I think, you know, the biggest debate in the market
right now is technology and AI. I was just at
a conference the other week, and so I think the
biggest question in the market right now is you know,
(21:40):
perhaps AI probably has the most promise of any technology
we've seen right because it's it's tam unconstrained in terms
of being able to address labor, labor and services, not
just tools and software spend. But because of that, it
can be prone to overhype. And so I think, you know,
a lot of Fortune one thousand type companies want to
(22:00):
bet on a technology that's well understood and minimize risk.
I think with Cloud there was much more, much more
consensus over the value of cloud, and even then I
think you saw some companies be resistant for some time.
So with the risks of hallucinating, you know, I think
it's hard to see widespread enterprise adoption right now. Certainly
(22:23):
from a consumer standpoint, it's easier to see adoption there.
I think another area that folks are wondering about is
the scaling laws. Right we're quickly exhausting all the data
upon which we're training these models, and we're using increasingly
synthetic data and reasoning and trying to see sort of
how that progresses, as well as well as the return
(22:44):
on invested capital versus the capex. So these hyperscalers are
all extremely well funded, the Microsoft's Amazon schools of the world,
and they can support this capex I think for some time,
but at a certain point it starts diminishing your free
cash flow. And so it's striking to me that a
company like Microsoft is reporting a decline in its free
(23:06):
cash flow for share this year. I think investors might
overlook that for a period, but over time, you obviously
want to see the growth in the free cash flow,
and so Sequoya put out a good paper I think
last year on AI's six hundred billion dollar question asking
whether whether the return on this two hundred billion of Nvidia,
(23:26):
you know, data data center spend is supported by the
six hundred billion in revenue software and application revenue, which
we've yet to seen. So I think that's the biggest
debate in the market right now. I know that's less
of a macro factor, but in terms of thinking about
something I'm watching in terms of secular growth trends, Yeah.
Speaker 2 (23:43):
That's definitely interesting. And did you have any major takeaways
from the third quarter earning season and is there anything
you're watching as fourth quarter results start to roll in
for small cap companies.
Speaker 4 (23:53):
No, I mean, I think it's it's mostly a function
of what what I just described. I think I think
we're try to think about the broadening I guess, first
and foremost what's happening in the technology sector, but second
also the broadening of the economy, certainly with industrial industrial economy, ism,
(24:14):
data like that as well. But again, our focus is
more on secular growth and whether these companies are tracking
towards these long term anchor points. I think during the
dot com bubble, Jeff Bezos said it best. I think
his stock Amazon was down something like eighty ninety percent
at one point. But he was talking about how by
(24:35):
any measure, Amazon was stronger than a year ago. Its
customer account had increased from fourteen million to twenty million,
its sales had climbed over sixty eight percent, its operating
loss had narrowed. And so we're trying to think about
these fundamental metrics in terms of the drivers of unit
expansion and incremental margins that are creating heavier and heavier
(24:56):
businesses over time, because in the short term market is
a voting machine, but in the long term it's a
weighing machine, and we're trying to invest in these heavier
companies over time.
Speaker 2 (25:07):
And you mentioned the AI investment maybe not justified by
the payoff as a risk. Are there any other big
risks you see the stocks this year?
Speaker 4 (25:18):
Well, certainly, as we touched on that, I think interest
rates and valuation metrics would be the concern, so that
those are factors we will be falling. I think the
market is relatively expensive by traditional metrics. One of the
encouraging factors on small cap is relative to large cap
we are undervalued on a relative basis, and certainly small
(25:43):
caps have underperformed large caps over the past decade. I
think it's the longest stretch in history. Traditionally, obviously, there's
been this small cap premium. I think over the past
ninety seven years, if you invested a dollar in small
cap versus large cap, you would have ended up with
over four times your money in small So that hasn't
been the case for the past decade. There's good reasons
(26:04):
why that is the case, with the rise of these
Magnificent seven companies and so forth. But markets trends don't
tend to last in one direction forever, and we think
there's a real opportunity for me and reversion here. As
a small cap has underperformed and the evaluations are relatively cheaper.
That should bode well as the economy broadens and we
(26:26):
could see some momentum and small cap and then again, additionally,
an active manager doesn't have to invest in the whole
asset class, but we can really invest in the most
exceptionally well positioned companies within the asset class.
Speaker 1 (26:39):
It would be something to definitely look forward to. But
before we let you go, we'd love to hear what
some of your favorite reads are. You know, any financial
favorite financial books you like?
Speaker 4 (26:48):
Yeah, I began talking a little bit about the Phil
Fisher scuttle, but type work, you know, attending conferences, industry events,
expert networks. We mentioned kind of our location here in
the Bay. I remember one investment we made in a
software company called Avalara for sales tax collection. Obviously, there's
only two certain days in life, death and taxes, and
(27:11):
so I remember going to one of these some of
these tax tax conferences and hearing from the California Department
of Tax and Fees that they were expecting additional you know,
one a half to two billion revenue back in I
think the twenty eighteen or twenty nineteen time frame, because
there was a Supreme Court decision called South Dakota versus Wayfair,
(27:32):
which ruled that it overturned the physical presence requirement where
if you bought something on Amazon, let's say, from California,
but it chipped from Texas, Texas couldn't collect state tax
on that unless the seller had a presence in Texas.
Speaker 3 (27:47):
And so when the Supreme Court court overturned.
Speaker 4 (27:49):
That ruling, there was a huge rush to sort of
tax a broader jurisdiction. So Avolara was well positioned for
that trend and so the scuttle butt I mentioned in
terms of that primary due diligence really is the craft
of small cap investing, and Phil Fisher very much pioneered
that with his book Common Stocks and Uncommon Profits. I
(28:09):
think one of the questions he always asks management teams
is what are you doing that your competitors aren't doing right,
because you really have to sustain innovation to drive future
appreciation in your business. And then the second book, I
think is a book called Seven Powers by Hamilton Helmer,
and it's a little bit an extension of Clay Christensen's
(28:32):
work on the innovator's dilemma, but he has a concept
called counter positioning which is very very powerful in small
cap and a classic example I think is Netflix versus Blockbuster.
So when you look at Blockbuster's business, they were challenged
in a couple different ways, not only with sort of
the internet distribution model changing that from brick and mortar,
(28:54):
but also if you looked back at their business, I
think a substantial chunk of their income was derived from
late ease, and so when you had a newer incumbent
like Netflix rise, they were able to compete in a
way that Blockbuster was really powerless to sort of respond
to because to compete they had to not only change
their business model in terms of the generation from late fees,
(29:18):
but also the brick and mortar model to Internet. And
so we like this idea. But whereby new companies can
counterposition against legacy incumbents.
Speaker 1 (29:27):
That's an interesting point. I guess I never really thought about,
you know, all those nights, you know, going to Blockbuster
years ago, the late fees drove so much of their revenue,
but definitely makes sense. This is great, Brian, thank you
so much for joining us today. Thank you, Mike, thanks
again for being my co host today.
Speaker 2 (29:43):
Thank you both.
Speaker 1 (29:44):
Until our next episode, this is David Cohne with Inside
Out
Speaker 4 (30:00):
Four No.
Host
Gina Martin Adams
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