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VALUE: After Hours (S07 E21): Hidden gems in global small cap value $XPEL, $TRRVF and $JSCIF with Chris Waller

Published 1 week ago46 minute read

In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Chris Waller discuss:

You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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Tobias: I think we’re live. This is Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guest today is Chris Waller of Hidden Gems Investing. How are you, Chris?

Chris: I’m good. Thank you. Thanks for having me.

Jake: Welcome.

Tobias: Our pleasure. Tell us a little bit about you and Hidden Gems.

Chris: Yeah. So, I grew up in the UK and I moved to New York in 2016 to do an MBA at Columbia. I run Hidden Gems Investing, which is a Substack I launched in November last year. And Plural Investing, which is really my main job, which is running a small-cap value fund, Plural Partners Fund. I’ve been doing that for about five years now.

[crosstalk]

Chris: Oh, yeah.

[laughter]

Chris: It’s a global fund.

Jake: Oh, you’re okay then. Yeah.

===

Chris: It’s been a great period for US large cap and tech. Not so good for small-cap, international and value. But hopefully, that’s now changing. It’s been okay despite those headwinds. Basically, with that and the Substack, I’m looking at these niche small-cap businesses and trying to find companies that are less looked at and where there should be opportunities if you’re able to do the work.

Tobias: Global, small-cap value must be a great opportunity set right now.

Chris: There are definitely a lot of opportunities, a lot of companies, obviously. I tend to focus mostly on US, Canada and Europe. There have been and I think continue to be a lot of opportunities outside the US. I grew up in the UK, so I look at that market a little bit and there’s definitely been a lot of cheap things in the UK for the last decade. At some point, that will change. Maybe it’s starting to change now, but there’s a lot of attractive, I think, investments available.

===

Tobias: What do you think has driven that– I don’t want to say underperformance of small-cap, but just–

Jake: Valuation wedge?

Tobias: Yeah.

Chris: Yeah. It’s tricky to say. We’ve obviously gone through periods like this in history. And this particular period we’re in right now is by some measures the biggest period of underperformance, depending on which measures you want to take. If I had been asked that question a couple years ago, I would have said, low interest rates obviously and easy money. When that changes, maybe that reverses. But it has changed, hasn’t really reversed yet. [Jake chuckles]

We’ve had obviously a lot of development in AI, gained a lot of publicity come in just as interest rates started to normalize. And so, that became another leg. So, I think those have been some of the drivers. It’s difficult to know when that changes. I’m confident that at some point it will change. Historically, these divergences haven’t persisted forever, but it’s always difficult to know exactly what the catalyst or timing for that would be.

Tobias: How do you feel about that flows argument? Michael Green says, “The flows are the lion’s share goes to the larger, more liquid companies which are already the companies that are doing the best and the other side of that is small global value.”

Jake: Yeah. [chuckles]

Chris: Yeah. Like I mentioned on the UK, we’ve had outflows in the UK pretty much every year for a decade. Just changing this year. That’s definitely had an impact. When I speak to companies in the UK or small-cap companies in the US as well, that has definitely had an impact. The way I try and think about it, rather than necessarily predicting how those flows may change is to look for companies where the company itself can deliver a good return regardless of almost whether people pay attention to it.

Everyone cares about earnings growth, for example. So, if you have a company that’s able to redeploy capital well for many years it will grow earnings and even if the multiple doesn’t change, you probably earn a decent return just through that earnings growth or buybacks and so on. So, that’s how I’ve tried to, yeah, focus on that and negate the flows a little bit.

Tobias: Yeah. I’ve done the same thing. Try to look at the returns without any multiple mean reversion.

Chris: Yeah.

Jake: Yeah. You need those self-help stories.

Chris: Yeah. And ultimately, if the stock is cheap enough, and management is smart and they’re buying back the shares, then maybe it can actually work in your advantage that the multiple isn’t re rating. So, yeah, there are still definitely opportunities, but you have to be tactical about it.

Jake: I posed this question to a friend that Toby knows over the weekend. We were hanging out and I said, “Okay, imagine that you can divide the world of investors into two camps. Camp A are groups of people who when they buy something, they want to see the price go up that next day. And camp B are people who want to see the price go down the next day.” What percentage of the investment universe allocating, buying things, doing things in public markets are in Camp A versus Camp B? What do you think the breakdown is?

Chris: I think it would be almost entirely in Camp A, where they want the prices to go up. It’s a very interesting way to look at it. Almost a more exaggerated way to look at it would be to say how many investors want their companies to be acquired, because obviously you might get that initial premium, but then it takes away this investment from you forever. So, I’d like to think I’m in more in the second camp. It’s harder to be like that when it does actually go against you, but I’d like to think I’d certainly try to be in the second camp.

Jake: Toby, what do you think the breakdown is? Like, give me a number.

Tobias: Oh. 99%. I’d almost put myself in that. Just for something different, I want to see some of the stock prices go up.

[laughter]

Jake: Just to see what it feels like.

===

Tobias: Chris, you want to take us through XPEL? Because I think XPEL is a name that’s reasonably well known. In fintwit, certainly, it’s a name that’s been bandied for years and years now.

Chris: Yes.

Jake: It’s the poster child of a micro-cap homerun.

Tobias: Yeah.

Chris: Yeah. It’s interesting, actually. If you look at Twitter, the number of tweets about the company and how that changes with the share price,-

[laughter]

Chris: -it’s contrary.

Jake: Direct correlation.

Chris: Yeah.

Jake: Yeah.

Chris: Exactly. If anyone doesn’t know, XPEL, it’s a supplier of paint protection film and other types of films. So, these are clear plastic films that get wrapped on your car, typically the front, and protects it from rock chips and scratches and so on, and generally keeps your car looking new. They sell some other products like window film for the car. They’re increasingly moving into films for boats and for your home and so on. But essentially, it’s protection film for your car.

Jake: You can wrap a house? I never thought about that before.

Chris: You can wrap windows. [crosstalk] So, any type office window. That is definitely a smaller business for them, and I don’t think it’s a natural cross sell.

Jake: Yeah.

Chris: The person who’s wrapping your car probably isn’t someone you naturally think to wrap some of your windows. This company has done very well. It’s been run by someone called Ryan Pape. He’s the CEO. He’s not the founder, but he was one of the– I think, maybe the fourth or fifth employee and he owns a lot of stock. He’s done an–

Jake: He went all in really personally on that.

Chris: Yes. So, he really came back to the company, I think, in 2008 or 2009 when the company was really on the verge of bankruptcy. He totally turned that business around. So, he’s done an extraordinary job. He’s not just a great capital allocator, but someone of high integrity.

Tobias: What was wrong with the business when he came back, and what did he do to turn it around?

Chris: Well, at the time, they only really sold software. So, they would sell software where an installer would cut out the exact shape of the film that was needed to wrap on the vehicle. But they didn’t sell the actual film itself. They didn’t particularly have a brand or anything around it. Obviously, it was a small company at the time with very weak balance sheet. And 2008 happened, and that essentially was going to be fatal for the company.

His big strategic change has been to offer a whole suite of products and really build what I call more of a franchise-franchisee relationship, where they’re not just supplying you software, they’re also supplying you the film, they’re supplying you the brand, the lead generation, the training, the aftermarket service. So, they’re supplying a full package.

===

If you’re an installer and you want to open a shop and you’re trying to think about which brand do I go with, if you go with XPEL, you’re going to get the full package and you’re probably going to get significantly more customers than if you go with any other brand, because XPEL is by far the most recognized brand in this space. And so, that’s really the key for the company.

It’s interesting, because a lot of investors, I think, although this is a quite well covered stock, still view it as a supplier. So, they supply film. Of course, they supply film, but what they really are is a franchiser. So, someone going to Domino’s is not necessarily going to Domino’s, because it has the absolute best pizza. They’re probably going there, because–

Jake: It’s pretty good though, honestly. For the price, it’s pretty damn good.

Chris: But they’re probably going to Domino’s, because they think they’re going to generate good returns if they open a store. That’s why installers go to XPEL. If they open an XPEL store, more people come than if they open a store under a different brand. That’s really the key and that’s what my research was focused on.

Tobias: You’re measuring Domino’s by your sophisticated Manhattan [Chris laughs] pallet rather than a seven-year-old– [laughs]

Jake: Yeah.

[laughter]

Tobias: A seven-year-old insists it’s the best.

Chris: Yeah.

Jake: He’s right.

Tobias: So, XPEL has captured the imagination of Fintwit at least and had a pretty good run.

Jake: For a while it did, right?

Tobias: Yeah. And then has backed off, but continues to be a great business. Perhaps, the valuation got ahead of it, but do you want to talk us through-

Jake: Yeah. Where are we now?

Tobias: -what happened– Yeah, where are we now?

Chris: Yeah. So, if you go back to 2020, middle of 2020 after COVID initially hit, the stock was around $10, $12. And over the course of the next 18-months, it went all the way to $100. And since then, it’s come all the way back down to high $20s. And today, it’s in the mid to high $30s. So, it’s been quite a journey. I think what really drove that whole journey is initially coming out of COVID– Even beforehand, but particularly coming out of COVID, they had very, very strong revenue growth and operating leverage as people essentially didn’t have a lot of things to spend their money on. This was one of the things they would buy.

Jake: We’re not going anywhere, but let’s get that car wrapped. [laughs]

Chris: Exactly. People were very enthusiastic about their cars. This was a company generating 30%, 40% incremental returns on capital, 30% growth. And in the last 12-to-18 months, that has changed very quickly. Revenue growth has been more in the single digits. And in fact, profits last year declined, because they invested ahead of growth that never really materialized. So, their cost base overshot what their revenue growth was.

And so, obviously, I’m trying to figure out, has something fundamentally changed there? And my answer is I still think this company can grow at 15% on average. But I think what changed is they introduced window film, which is now about 30% of their revenues. They rolled that out across their entire installer base.

So, because they have such a strong relationship with all the installers, they were able to say, “We think this is a great product that you can offer your customers. And if you’re currently doing window film with someone else, we think you should switch to XPEL.” And that was a big revenue boost for a few years as that rolled out. That’s now complete.

I think the other thing that changed is just the US auto market hasn’t been that strong for a number of years. But in particular in the last 12-to-18 months, you did see some of that effect of people spending on film reverse. And so, there’s been a cyclical downturn at the same time. And so, that’s why there was this overnight change and the stock reacted to that.

There were also a couple short seller reports, I should probably mention that. Talking about different things, one was around cyclicality and I think there was definitely some truth to that as we’ve seen. The other one was more about Tesla. Is Tesla 35% of sales and is Tesla about to insource and do this themselves? I would just point out now that we’ve had 18 months– In fact, Tesla has now partnered with XPEL, so reversed that decision and partnered with XPEL. So, I think that’s a great indicator.

The other thing around that was there’s a paint company called PPG and the short seller was saying, “There’s going to be some new paint getting developed that means we don’t need this film anymore.” Again, it’s been 18 months now and the actual product that PPG were talking about has been released. It isn’t in my view what really the short seller was talking about. So, yeah, that’s the journey.

Jake: [crosstalk] Does an aging fleet, which the US seems to have matter– Like, do people wrap old cars or new cars?

Chris: It’s generally new cars

Jake: I can see the argument for both.

Chris: Yeah. You could in theory wrap an old car to make it last longer. But I think generally speaking, people are basically enthusiastic about their car. They want it to look really nice. And so, it’s usually someone who’s just bought a new car enthusiastic about it.

Jake: Okay. So, then, an aging fleet would probably not be very helpful for XPEL then.

Chris: Not unless the aging fleet means people start renewing that.

Jake: Well, they will eventually, but they may be waiting.

Chris: Yeah, eventually. Yes. Yes.

Tobias: Do you have any idea about the pricing and what XPEL takes on a wrap?

Jake: Yeah. What the unit economics look like?

Chris: Yeah. So, for most people who are going to wrap just the front of their vehicle because that’s where the rock chips and so on hit, it’s about $2,000 for that job. So, that’s you going into an installation shop, you pay $2,000. It usually takes 24 hours. So, you’ll leave your car there overnight.

XPEL is only about $300 to $400 of that $2000. So, that’s quite an important factor because XPEL is only about 15% to 20% of the job. But they’re probably bringing on average, something like 10%, 20% more customers to that store. So, it makes a lot of sense for the installer to go with XPEL, because financially, it’s almost like they’re getting the film for free if they’re getting the extra customers. They won’t quantify it in that way, but that’s how the economics work.

Jake: So, it’s a pretty heavy labor component then really?

Chris: Yeah. So, that’s really the biggest cost is is the labor.

Jake: And the giant hair dryer, is that how they put it on there?

Chris: Yeah. Well, it’s all by hand. So, XPEL software, which, when they got started, was really the big advantage ahead of the brand and so on. The reason the software was so important is because it gave you really accurate cuts of the film, and so you didn’t have to reapply it. So, if you imagine your phone, if you put screen protector on it and it had a bubble, that would be very annoying and you’d have to redo it.

A car is obviously much more complex than a phone. There’s a lot of curved surfaces and so on. And so, by XPEL providing better cuts, they’re able to ensure that this film is wrapped more accurately. It saves the installer a lot of time. And because time’s the biggest cost, that’s why, at least initially, XPEL was the number one in the industry.

Tobias: And is your expectation that you save $2,000 worth of deterioration, depreciation on the front of the car by doing that?

Chris: It does have an effect on the resale value of the car. But to be honest, I don’t think this decision can be justified purely financially. I think a lot of it is people who want their cars to look good.

Jake: Toby, you want to get girls. Come on.

Chris: Yeah. People pay $2,000 for the car to be red instead of black, and for the wheels to be different and for other parts. So, people do pay for these components.

Tobias: Yeah. So, that was my next question. Is it aesthetics rather than protection? So, there’s a protection element to it, but a big part of it is aesthetics.

Chris: Yeah. Yeah. Most of their customer base today or the end customer is an enthusiast. They’re increasingly trying to move out that core enthusiast base and into more general customers, because most people have never heard of paint protection film.

Tobias: So, you can’t just wrap the front of your car though if it’s for aesthetics. You need to wrap the whole car?

Chris: Well, if you wrap the front, you’ll protect it from those rock chips, because those are all generally coming from the front of the car. There are certain other parts of the fenders and so on, bits near the wheels where you might wrap around the back. But if you wrap the front, you’ll get most of the chips. Some people do wrap the whole car. It’s just more expensive. It’s a transparent film. So, it’s not going to change the color.

Tobias: So, it does not color actually.

Jake: Toby, you’re not going to be able to turn your Corolla into the General Lee or anything.

[laughter]

Chris: They are actually just pretty much any day now going to release colored films. So, it’s funny you bring that up, because that will be a new product suite that’s coming out. If you look on Fintwit, a lot of people think that’s a big opportunity and some people have looked at it as a risk as well. I just think that most people buy the car in the color they want. So, then the market for people who want to change the color of their car is just naturally smaller.

Tobias: You just pay a small premium for some of the colors. So, I thought I’ll just get the base level, Communist Gray.

Jake: Don’t even paint it and we’ll just– [laughs]

Tobias: Get it wrapped in my favorite colors. Get it wrapped in my logo, make it a company car.

Jake: There you go. So, Chris, as far as investment process goes and digging in, what scuttlebutt things would you do for XPEL, for instance?

Chris: Yeah. I always find with any company– It’s interesting talking to people in an industry. If you were going to buy a house, you’d probably want to go visit. If it was your job to understand the value of homes, you’d probably speak to some former owners and the people who live next door and check the neighborhood out and all that thing. So, my approach with investing in any business is to try and do the same thing.

===

So, with XPEL, for example, one of the things I did is I spoke to a lot of the installers. That’s where I discovered that the reason they are going with XPEL is not necessarily just because the film is the best or the software is the best. It’s actually that they just get more business because of the brand of the company. That’s something that would be quite difficult to figure out. If you were just reading the annual report, you’d probably look at this as a supplier of a product rather than more of a franchise. So, I always find it helpful talking to people in an industry.

I think going to trade shows and industry events is really helpful. I just came back from this thing called the Eastern Energy Expo. It doesn’t sound like the most exciting thing, but one of the companies that I’d invest in was TerraVest. They make storage tanks of different types. You can go to this expo and there’s about a hundred booths there of different people in this industry and you can just talk to all of them. So, I think it’s really helpful to just understand what’s really happening in an industry and why people go with one company or another.

Tobias: So, just before we move on from XPEL, talk us through the valuation proposition. What you expect there?

Chris: Yeah. So, I think at face value, this looks like a reasonably expensive stock. Certainly, for someone like me who’s used to cheap value things. So, I think earnings per share is about $1.70 and the stocks in $35 to $40 depending on which day you’re looking at it. So, it’s trading on 20 to 25 times earnings.

Just bear in mind. Last year, like I said, they invested in a lot of cost because they anticipated their revenue growth to continue at that 20% plus mark. And it didn’t. So, they’re really running a bloated cost base right now. They’ve talked about reducing some of that and talked about growing into some of that.

So, I think if you were to look on a normal margin basis, it’s probably trading on a high teens or 20 times multiple. This is a company that can still grow in my view, 15% per annum organically for quite a runway. And then, they’ve got a very strong balance sheet right now actually with net cash. So, I think they’re going to start deploying that either in acquisitions, where they’ve been quite successful in the past or they’ve just started a buyback authorization. So, I still think if you look on a three plus year basis, you can still generate a very nice return even if the multiple doesn’t go up from here.

Tobias: Let me just give a shoutout to the folks who are at home. First in the house. Toronto. Bixby, Oklahoma. Gothenburg, Sweden. Lausanne, Switzerland. Filthydelphia. Cromwell, New Zealand. Early stuff for you. Valparaiso. What’s up Mac? Dubai. Las Vegas. Tallahassee. Petah Tikva. Breckenridge. Bremerton. Tampa. Jupiter. Portsmouth. Brandon, Mississippi. Salzburg, Austria. Ballynamullan, Ireland. Milton Keynes. Prague. Dead Cat Gully, New South Wales. Me too, brother. Cincinnati. Jamaica. [Jake laughs] Rochester. Thanks, folks. Good to have you here. Let’s talk a little bit about TerraVest.

===

Chris: Yeah. Oh, I should have probably said at the beginning actually. I obviously own shares in XPEL and TerraVest. So, just full disclosure on that. TerraVest is a really interesting company. They are Canadian listed. Their business is in the US and Canada. They operate in a series of industrial niches. So, industries that seem very boring. Different types of storage tanks, propane tanks, fuel tanks and so on. The trailers and trucks that carry these different tanks.

I think a lot of investors for many years dismissed it, because those industries frankly aren’t very exciting. Many of them are very low growth. A few of them even declining industries. But the stock has actually performed really well. It’s compounded at about 35% per annum for a decade. The reason is because they have an excellent management team of four or five guys at the top who are all really competent, all have most of their net worth in the stock and have done a great job taking the cash from those businesses and acquiring other mom-and-pops.

And so, they’ve not tried to chase growth in some of these industries. They’ve been very clear that they’re going to take the cash out and they’re able to buy these mom-and-pops, because in a lot of these industries, there are only four or five companies in a specific niche. These are small industries where there’s only really a small number of acquirers, with TerraVest being the obvious one.

If you’re a mom-and-pop maker of propane tanks, you pay a lot more for steel than TerraVest does. So, TerraVest can acquire that company, use its scale to get a 10% to 20% discount on steel by cutting out the distributor and so on, and basically transform that business from a company they acquired at probably 10 times free cash flow to now 6 times free cash flow. And so, they’re able to generate a very good return through those acquisitions. They’ve just been doing that again and again, and been very return focused. That’s why they’ve generated such strong returns in an industry that doesn’t seem very exciting.

Tobias: So, talk us through the management team there. How long have they been there? They seem to be central to the story here.

Chris: Yeah. So, Dustin Haw, who is the CEO, I think only 45 still. He’s quite young. The whole team have basically been there for just over a decade now. So, Charles Pellerin, who’s the chairman, and then they’ve got Mitch Gilbert who’s the chief investment officer who leads a lot of the M&A initially. And then, they’ve got some division heads, some of whom have joined through these acquisitions.

They’re all very, very accomplished. I think Dustin, in particular, the CEO is the key. He’s someone who is both very knowledgeable as an operator. He really understands the engineering of these products. I think he has a PhD in physics or astrophysics. I think maybe Physics. Yeah. So, he really understands the engineering of this stuff. He really understands how to actually run the businesses, but he also understands how to deploy capital. I think it’s so rare to find someone who can do all of that.

Jake: Is that what’s wrong with the US right now, is our PhDs in astrophysics are doing M&A roll ups?

[laughter]

Chris: Yeah.

Jake: Oh, man.

Tobias: I think there should be more of you doing it.

Chris: Yeah. Yeah. So, he’s just so impressive. Every time I speak to him, I leave thinking I don’t own enough shares. He’s very impressive and someone with high integrity as well. If you look at the way he communicates and the way this company in general communicates, it’s not promotional at all. They don’t really have targets. In fact, they don’t do earnings calls. They don’t really have an investor relations website if you go on it. There’s not really anything there. So, they just have been really focused on executing for the last decade and just done a great job.

Jake: How do they finance the acquisitions?

Chris: So, they do use debt. They usually go up to about two times EBITDA. One thing I will say just to counter some of my points, is that in the last couple years or so as the stock has increased, well, really from $30 to now $160 in a couple of years, it’s been the first time it’s gone from a 10 times free cash flow stock to now 25 times, which is maybe still fair for a company, these qualities, but obviously different. So, they have started financing some of the acquisitions through equity.

Personally, I would probably prefer they didn’t do that. They would probably say they’re acquiring at multiples much cheaper than where their stock trades at, which is fair. But yeah, traditionally, they finance through debt and occasionally they issue equity to pay off some of that debt afterwards.

Tobias: If the stock’s done 35% a year for a decade now, how can it be undervalued? Talk to us about the valuation.

Chris: Yeah. So, I own a few shares still. I think at this point, it is close to fair value. I think that they can generate incremental returns on invested capital of about in the 15% to 18% range. And they typically reinvest basically all of their earnings. So, they can still, through acquisitions, probably grow in that 15% to 18% range. They’ve got an excellent record.

And so, what should a business of these qualities trade at, which still has a long runway to keep doing that? Obviously, some really successful serial acquirers traded a much higher multiple. I would say going back to our early conversation, I probably wouldn’t bank on any multiple increase at this price point.

25 times multiple is probably a reasonably fair multiple for this business. If it can still grow at 15% to 18%, then you still get that return going forward. But yeah, I definitely think it is obviously a lot more fairly valued now than it used to be. And the interesting thing will be as they get bigger and they have to move into more adjacent markets, can they still deliver these types of returns?

Tobias: That seems to be a problem for many of the serial acquirers. I just think about [chuckles] Constellation.

Jake: Constellation.

Tobias: Yeah.

Jake: Heico, TransDigm. Yeah.

Tobias: Constellation going outside VMS software. I think it’s not even software, right? It’s just anything at this point.

Chris: Yeah. They’ve done an amazing job obviously for many years. Obviously, I wouldn’t anchor on that, because that’s the exception. But it is possible. TerraVest management team are so strong and they’ve acquired essentially platforms now. So, they’ve brought in some bigger companies that are have some overlap with their existing industries, but are also in some more interesting ones. Those platforms are now acting as acquisition vehicles, a little bit like some of these serial acquirers. So, you can see they’re being very thoughtful about how they build it out.

But I do think it’s fair to say that they used to generate over 20% returns on capital, just getting discounts on steel and quite basic things. That is not going to continue forever. They still do those types of acquisitions. But by their nature of being small, mom-and-pops, they’re just less meaningful. So, we shouldn’t expect that level of return to just continue.

Jake: Is there may be an onshoring thesis that could be helpful there too? This might be a tailwind.

Chris: Possibly. All their manufacturing is in the US and Canada. So, they’ve reasonably insulated from that point of view. But to some extent, they’ve always been quite insulated because steel tanks are just heavy. So, the transportation cost is high. And so, they haven’t traditionally faced huge competition from China.

Tobias: Heavy and bulky.

Chris: Yeah. Yeah. So, a lot of those markets actually very local. So, even in just specific parts of Canada– Western Canada doesn’t always supply Eastern Canada and so on.

Jake: It’s like a gravel pit.

Chris: Yeah. Yeah, exactly.

Tobias: JT, we’ve just gone past the top of the hour. Do you want to give us your vegetables? Make benefit, glorious nation of Value: After Hours.

===

Jake: Yes. All right. So, imagine you’re looking at Earth from space and from that vantage, it’s all these majestic swirls of blue and green and white. The mess of human life, traffic jams and laundry piles and overdue bills vanishes into this abstraction of this beautiful glowing globe that we all live on. If you pull back far enough, of course, everything looks orderly, but if you zoom in, suddenly you’re navigating chaos and signals turning into noise. And so, how we see changes with the distance from what we’re looking at? It’s also true that how we think also changes with distance.

So, there’s this concept that I learned about recently called construal level theory, which we will use CLT for the rest of this segment just to keep because it’s quite a mouthful. So, the further away something is the more abstractly that we process it. The closer it is, the more detailed and emotionally reactive our thinking becomes. So, according to CLT, there are four kinds of psychological distance that shape our perceptions. So, there’s temporal distance. That’s how far away something is in time. The further away it is, the more abstract we tend to think about it.

Spatial distance. So, physical proximity or remoteness. Social distance, like the gap between groups versus individuals. And then, hypothetical distance, which is the likelihood that we assign to an event. So, we didn’t just zoom in and out with our eyes, we also zoom in and out with our minds. And Buffett is, I think maybe the best at this, or he’s so good at it. At that abstract 30,000-foot level, you find most of his quotes, which are almost cliches at this point.

The ideal holding period is forever. That speaks to the time value of compounding over really long term. Buy businesses with a moat. Now, we’re talking about this abstract metaphor of sustainable competitive advantage. Be fearful when others are greedy. Now you have a mental model rooted in behavioral finance and market cycles. All of these are like looking at the earth from outer space.

But then, he’ll pivot on a dime and then he’ll be dissecting a depreciation schedule of a brick plant in Alabama, or loan loss reserves and collection practices at Clayton Homes, or unit economics of See’s Candies and how much they pay for sugar. So, it’s abstract principles one minute and then forensic accounting the next minute. And that construal level theory in action is what’s really happening.

He’s doing it never without really naming it. So, the trick and I think the edge sometimes is knowing which zoom level serves the decision that you’re trying to make. So, of course, Michael Mauboussin urges us to lean on base rates. Statistical realities that emerge only at a distance. Those are that outside view. But it’s hard to think abstractly when the market is screaming these price changes in your face every day.

So, to use it effectively, I think you need to regulate your cognitive altitude. Like, how far away are you from something? And so, here’s a list of some potential things to keep in mind for your cognitive altitude.

Tobias: That’s a banger, by the way. Cognitive altitude. I’m just writing that down right now.

Jake: Yeah, write that down. Okay. Identify the distance. So, is this a decision near term or long term, high stakes or hypothetical? Match your mindset. So, zoom out for vision, you know maybe strategy and thesis and then zoom in for tactics, execution, establishing kill criteria, for instance, something a little more concrete.

Preload your clarity by writing down your thesis and what would change your mind. Use time to test conviction. So, as your reasoning, does it degrade under proximity or maybe it wasn’t all that durable to begin with. And balance that abstract and the concrete by pairing narrative with numbers. So, maybe dream big, but model small.

So, let’s try to just land this plane. Clarity lives at altitude, but action happens down on the ground. If you only zoom out, you risk becoming a philosopher with no skin in the game and you’re just wandering around and it’s just all bromides. But if you zoom in too much, then you’re this like lab rat that’s only reacting to the shocks. So, the real craft and the real like Buffett level mastery is knowing when to fly high and then when to get your hands dirty. So, before your next big decision, ask yourself, “Am I seeing this from the right distance?”

Tobias: Good stuff, JT.

Jake: Thank you.

===

Tobias: You use any ideas like that? Chris, would you say that you’re more– The traditional value guy would say, “I’m very much bottoms up. I never take a look from altitude.” How do you feel?

Chris: Well, I think there’s a couple things. One way that I would probably apply that is which ponds to fish in. So, at a high level, you can just be looking in the wrong areas. There are certain ponds that are better to fish in. When you do look at a company, I think one of the dangers of my approach is that you get so stuck in the detail and the weeds, you can actually miss the bigger picture.

So, I think one thing that’s important for an approach focused on scuttlebutt and primary research is to just first figure out, okay? you don’t have to necessarily scuttle butt everything about this company. Just what are the one or two key things that will really matter? And then you can go really deep on that, but channel it into the right areas.

Jake: Chris, do you think that there’s a point of diminishing returns on scuttlebutt and effort where you probably start to increase your confidence in your understanding faster than the actual competence of the understanding?

Chris: Yeah. Yeah, that definitely is. Hard to say exactly when you reach that point.

Jake: Yeah. Where is it?

Tobias: Yeah, the confidence thing, you have to be careful about that, for sure. You can convince yourself, because you’ve done so much work on something that.

Jake: I know the CEO’s shoe size. How can I possibly lose money here, right?

Chris: Right. Exactly. So, that’s definitely, yeah, something to watch out for.

Tobias: What do you think generally for the US versus the rest of the world, Europe, Canada, Japan? Is the US heavily picked over or is it just that the bifurcation just means there’s a lot lying around as well?

Chris: It is picked over, but I think there’s these very strong forces going on like we touched a little bit on in terms of flows and so on that mean there are still significant opportunities. I’ll give you a extreme example. Just fairly recently, a company I was looking at was delisted from the NASDAQ. It started trading OTC, and the stock was down 25% on that day and obviously nothing had changed about the company. It was available for a 25% discount. And within five days, it regained all of that. So, these sorts of things, you could almost say that because there’s such strong flows into passive funds that can actually create different types of opportunities.

I would still say that more broadly speaking, obviously, things outside the US tend to be less picked over. I focus more on Canada and the UK and continental Europe. UK in particular has been very cheap for a long time and a lot of these countries have been. So, I still think there’s a lot of opportunities there.

Tobias: Just blanked on what I was going to ask.

Jake: It’s going to be incredibly insightful penetrating. [laughs]

Tobias: Carry on. Watch me in a moment.

Chris: One thing about the flows is the flows are coming from somewhere. So, very strong inflows into all sorts of US assets for a long period of time. But for example, very strong outflows in the UK. So, it can pop up somewhere else and create opportunities in a place like the UK, for example. I’m not just saying that, because I grew up in the UK. It just happens to be one of the weakest markets for quite a while.

Tobias: [crosstalk]

Jake: [crosstalk] running a large current account deficit, those dollars go out and then can come back as people buying equity in companies or bonds or whatever. Interesting thought experiment of what does it go the other direction at some point and now it’s all just sell signals that are the flows.

Chris: Yeah. Possibly that’s what has been happening here today. Obviously, it is a goal of the current administration to reduce that current account deficit. The flip side of that is it should also reduce the capital account surplus. So, that also leads to some effects. You may be seeing that now with flows into some of these European equities that have for the first time in a long time really significantly outperformed and then caught up a bit.

Tobias: So, my question that I blanked on before was there’s this phenomenon in the US which you could call it adverse selection or something like that, but it’s from two ends. There’s IPOs tend to come onto the market bigger probably since Sarbanes-Oxley, which is quite a long time now, early 2000s. Facebook might have listed earlier, but Facebook when it lists as a large cap. SpaceX is private. OpenAI is private and these are $100 billion plus businesses.

And then, on the other end, you have private equity supposedly is very cashed up. They should be intervening in that lower mid-market to buy stuff, but really, I don’t see a lot of activity from private equity on the public markets. It seems to me like if anything they’re just trading private companies back and forth or from one fund to the next. So, do you think that there’s a–

Jake: With a markup.

Tobias: With a markup. Do you think that there’s some adverse selection? I’m sure they are. Why wouldn’t they? There’s some adverse selection in the US. I don’t know about the rest of the world so much, but in the US, do you think in that small micro mid cap?

Chris: Yeah. There’s definitely the need to go public has reduced because of these private opportunities.

Tobias: So much capital.

Chris: Yeah. So, I think that has had an effect. But I would also say though a lot of, I think, the private capital is chasing more interesting and exciting opportunities. So, for example, if you’re a VC right now, if you’re a startup, even in– I was speaking to a startup in renewable energy, which you would think more growth industry. But they were telling me that they speak to a lot of VCs and if you’re not an AI, it’s very difficult to raise money right now. So, I think that there is obviously a lot more private market capital these days. But it is chasing quite a narrow group of industries. And so, if you’re in propane tanks or paint protection film, you’re not really–

Jake: Yeah. How is the fund-raising environment there?

[laughter]

Chris: Yeah. You’re not really getting any capital from these private markets.

===

Tobias: What about buyout capital? There’s a lot of buyout capital around, and those seem like if it’s a roll up– That’s what private equity firms do. They love that stuff.

Chris: Yeah, it’s an interesting. So, with TerraVest, for example, why hasn’t a private equity firm gone and done this? One of the big propane tank manufacturers was bought out by a private equity firm a few years ago. But I think part of the reason for these serial acquirers that have been successful– Sometimes they’re successful, because they don’t make a lot of big changes at these companies. So, if you’re going to get 15% cheaper pricing on steel, that’s great. No, no founder is going to complain about that.

But if you are a more traditional private equity firm and you’re going to make staff reductions and so on, that is something that a lot of founders won’t like. And so, a lot of these serial acquirers can create the opportunity by not making big changes afterwards. And so, that’s why they’re still able to get these companies at a cheaper price than what a private equity firm might pay.

Jake: Do you have a sense, Chris, of how much of the market share they have?

Chris: So, in the niches that they’re in–

Jake: How fragmented it is?

Chris: Yeah. Well, they’re in a lot of different markets. But in the markets they’re in, they’re usually the biggest. Quite often, they’re actually something like 30%, 40%, even 50% of the market. But every market is different. So, if you’re making a truck for a type of propane tank, every type of tank needs a different type of truck. It has different regulations for different weights and so on. Quite often, the manufacturers are different in each of those markets. And so, although TerraVest has a very high market share in each of its markets, there are still a lot of these niche markets that exist where it’s not in at all, and that’s how it works.

Tobias: Can you walk us through your scuttlebutt process? How do you decide who you’re going to talk to, how to get access to them? What do you talk about when you meet with them?

Chris: Yeah. It’s different for different companies, but of course, I’m speaking to former employees, of course, I’m speaking to the competitors in that industry. Depending on what really matters for that company, I’ll focus on a different group. So, in the case of TerraVest or another serial acquirer, the group that really mattered were the people who sold their companies to TerraVest. “Why did you sell to TerraVest? Why did you sell at this price when there are other competing bids and so on?” And so, that was really the key focus.

With XPEL, there’s a lot of people, installers basically, who run their own shops, their own businesses in this industry. They’re probably the most knowledgeable people you could speak to. So, that’s who I really focused on.

I wrote a report on Seaport Entertainment, which owns properties in New York that it’s turning around. And so, in that industry, it was people who have run successful turnarounds or similar operations in New York. So, it does depend.

In terms of getting access to them, it takes a lot of work is the short answer. There’s no magic formula. If you just email people and ask them to be nice and speak to you, maybe 10% will respond. But generally speaking, people aren’t really going to talk to you. It also differs by industry and by country, by the way. Some industries are more receptive to talking. But what I found really helped was write–

The reason I started writing these reports on companies is it gave me something to trade back. So, I could say, “You know if you talk to me, I’m going to speak to 20 people in this industry and I’ll share the research anonymously with you.” Because I’m looking at these niche industries and small-caps, there’s often no real research, certainly no research focus on the financials and the economics of the industry. And so, someone might find it worth half an hour of their time to get something like that in return. And so, that really was, yeah, a breakthrough. It just requires you to actually write a report which is a lot of work.

Jake: How do you set your research agenda? Is it just do you follow your own personal interests or is it something more to it than that?

Chris: So, I have two areas of focus. So, one is I read a lot of write ups. There’s no necessarily right way to do it, but I’ve just found reading a lot of write ups from places like Value Investors Club quite helpful. I have quite a strict set of criteria in terms of what I’m looking for. They have to be in the industries I think I could understand. So, those are generally going to be more boring ones, more consumer, more industrial base, have to be in the geographies, have to have the types of business models I might be interested in. So, that’s one source.

But increasingly, I would say half my ideas come off my watchlist or companies I’ve looked at previously. They weren’t right for whatever reason at the time, but two, three, four years later, it turns out, things have changed. And so, yeah, I’m building up my own database or watchlist basically. More and more of the ideas should come off of that than totally new.

In terms of interest, it’s actually, I think a really good thing to follow companies that do things you find interesting, because you just understand them better, you’re just more naturally interested to follow them and I think that’s actually a good way to do it.

Tobias: Jake made a great point before about confidence exceeding competence when you’re collecting a lot of this information. Do you actively look for disconfirming evidence for that reason, and have you ever found any and can you give us an example if you have?

Chris: Yeah. I think it’s one of the hardest things to do to recognize that you might be wrong. I mean, just in anything including investing and to be really clear in advance what sort of things you’re looking for. And so, usually, when I’m talking to people, particularly after the initial research, when I’m just trying to learn about the company, my questions are all negative. Sometimes when I talk to the management team, I’ve got all these negative questions, I have to remind them I do own the stock. I think you just have to actively look for that disconfirming evidence.

So, for example, with TerraVest, we talked about, I went to this expo. Now, one of the things I found at the expo was that if you looked at a map of the companies exhibiting, TerraVest was one of probably three biggest ones. You could basically go talk to each of them. The number of companies that would be significant acquisitions today is much smaller than it would have been two years ago just because TerraVest is a bigger company. So, I actually left a little bit more negative from that expert. I would have left more positive if I had found 10 other companies of the same size as TerraVest. So, you just have to, yeah, be very actively look for that disconfirming evidence.

Tobias: So, you worry that TerraVest is bumping up against its growth-

Chris: That’s–

Tobias: -ceiling?

Jake: It’s harder to move the needle with each as it gets bigger.

Chris: Yeah. One other thing since I started writing on the Substack, I do get feedback from people and so you do get that feedback from the market. You can see what types of questions people are asking. There’s usually some commonality between them. So, that gives you a sense of, okay, this is basically what the market thinks is a risk. And that can be helpful as well.

Tobias: I like the model of buying a company and rather than trying to rip out costs by firing people, by [crosstalk] scale.

Jake: Stuff your suppliers instead. [laughs]

Tobias: Well, cut out the distributor, cut out the middleman. That’s a method as old as time. How unusual is that? Do you uncover any other businesses like that?

Chris: I think it’s unusual. I’ll actually tell you about a business I’m currently– I have a position in it, but I’m still actively researching. But I think it’s interesting is a company called Judges Scientific listed in the UK. They acquire small scientific instrument companies. There are a lot of those in the UK out of spinning out of colleges and so on. They’re able to buy these companies that are usually either a monopoly in a highly specialized piece of equipment that could be $10 to $100,000 for a piece of equipment, either a monopoly or really no direct competition.

They’re buying companies of those qualities at four- or five-times EBIT. Obviously, that’s not something I would generally be able to do on the public markets by quality businesses at four to five times EBIT, but they’re able to do so basically because they don’t make those changes and because the integrity of the founder. So, this is one thing I found really interesting is if you speak to the founders who sold to judges founder, they will basically all tell you it’s because judges has this reputation that they’re not going to make big changes. The company you built, basically, you’re just going to keep it the same. That integrity and reputation is the core reason I think why judges has been so successful.

Because if you’re buying at four to five times EBIT, you’re making basically a 20 plus pretax return just off your price paid and then they grow organically. So, it’s very rare. All the other companies in that industry that make acquisitions, they all look for synergies and so on. But then they have to pay a much higher price because the founders don’t want to sell to them.

Tobias: Yeah, I like that model. So, they don’t necessarily need to make any changes at all. They’re just getting a sufficiently good price.

Chris: Yeah. It’s a good enough set of businesses. Unlike, for example, TerraVest and storage tanks where these scientific instrument businesses are growing at 7% a year anyway. So, you can get your 20%, plus pretax and then some 7% growth and– Yeah, that’s why they’ve been successful.

===

Tobias: Tell us a little bit about Plural Investing. How many positions do you like to hold? How concentrated do you like to get?

Chris: Yeah. So, Plural Investing is the fund that I run. I generally own seven to eight businesses or stocks. So, it’s highly concentrated. These are all going to be small-cap stocks, generally US, Canada, UK in boring niche industries where they’re the leader. I’m looking at a three-to-five-year time horizon. That’s just an initial framing. It doesn’t have to necessarily stop at five years. These are all companies where they’re generally fairly good businesses, because they’re the leader in a niche. They don’t typically have huge competition, because the niche is small enough that it doesn’t attract major companies coming in.

Most of them have an owner, operator and they’re not the next, Amazon or OpenAI, but they’re able to generate 15% to 20% returns on capital and you’re paying 10, 12, 13 times earnings for these businesses, because they’re quite ignored. Usually, the advantage that these companies have is qualitative, and that’s partly why it’s misunderstood and partly why doing the scuttlebutt works. It can uncover some of these qualitative advantages.

So, whether it’s XPEL with more of a franchise model in my opinion than a pure supplier, or TerraVest or we talked about Judges, whether it’s the integrity and the relationships, these qualitative advantages that would be harder to figure out if you hadn’t done the work. And so, that’s basically the idea, so just to find these hidden gems, as I call them.

Tobias: I enjoy the pitch. Thanks very much, Chris. If folks want to get in contact with you or follow along with what you’re doing, what’s the best way of doing that?

Chris: Yes. I’m generally pretty open. So, the Substack itself is hiddengemsinvesting.com. So, you can take a look at some of the write ups there. The fund investment company is pluralinvesting.com. I’m pretty easy to reach. So, my email is on every quarterly letter. It’s [email protected], and generally quite open. So, I can definitely be contacted if you want to bother me.

[laughter]

Chris: But I’m always open to talking to people.

Tobias: Good stuff. Thanks, Chris. JT, any final words?

Jake: No. Thanks, Chris. Appreciate you coming on sharing.

Chris: Thank you.

Tobias: Chris Waller, Hidden Gems, Plural Investing, thank you very much. Folks, we’ll see you next week, same time, same channel.

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