New Constructs' Live Podcast: Intelligent Capital Allocation - 8 September 2023

As folks come in, before we kick off, could you talk to me a little bit about this slide? I know this is something you've been talking about for a long time.

Yeah, I think the fiduciary duty of care is one that often gets overlooked, and our research raises the standard there. It's been proven. And, and multiple journals and, and papers that we're providing a superior form of fundamental research. And fundamentals are necessary for meeting the prudent man rule, which is, would a prudent person make the investment that an advisor is recommending or making on your behalf? And if you are trying to make that decision without the best-in-market or the more complete version of fundamental research that we provide, Then you might not be fulfilling the fiduciary duty of care. Another way to put it is that it's really hard to make a straight-faced argument that you are fulfilling your fiduciary duty of care if you're not using the most reliable fundamental research out there. Are you purposely ignoring the footnotes? Do you want to ignore the footnotes, or do you want to make the most informed decision you can for your client? I recommend you ask your advisor if you're not sure. It's a fair question.

Yeah, I love that empowerment. I see in the chat too that you've got folks plus one-ing this. Fiduciary is not enough from Bill.

It's not enough now, that's for sure. It's for sure not enough. And it can be more and it should be more. And that's part of what we're providing. We're really raising the standard of care for our own clients and our clients who also have clients can in turn raise that standard of care. If they are using our research, it's proven superior. I don't know what else to say.

I love it.

Well, we're going to go ahead and dive in to the podcast then, folks. Welcome to our live podcast here at New Constructs Intelligent Capital Allocation. With you today, the 8th of September, you have myself as well as David Trainer and Kyle Guskey II. Here are our disclosures and disclaimers. They haven't changed since the last time you've seen them. And our agenda for today is quite extensive. We're really excited to be back. We had a great summer break. We hope that you did as well, and we're looking forward to getting your input on some topics here. We would love it if you used the Q&A feature right now to vote for companies that you would like us to do a reverse DCF on. Kyle will be doing a reverse DCF later on in the program, so this is your opportunity to tell him what you would like. We won't be able to get to more than one probably today, but we'd certainly like your feedback ongoing on the types of companies that you would like us to be doing some analysis on in real time with you. Also in the Q&A feature, please don't hesitate to ask questions throughout. We would like to take your questions throughout rather than have you hold them for later in the program. I do hope that you're with us already on the Society of Intelligent Investors. If not, please give me a contact at support@newconstructs.com. We'll make sure that you get involved in our online community as well. Before I hand it over to David for the interesting headlines, I wanted to point out the latest research. Last week there was a number of pieces of research. The S&P 500 Street Earnings, All Cap Index and Sectors, talked about GAAP earnings and ROIC. All-cap index and sectors this week, talked about free cash flow yield being flat, price-to-economic book value also being flat. And there were 2 different long ideas that came out. There's a lot to go through. It's back to school, folks. So it's going to be a good fall. Say, David, there's a lot going on out there and it's been a while. What have you been thinking about?

Well, I think the primary coverage is a great new addition. We're going to hopefully add another 500 or so companies, maybe more before the end of the year. This just represents a big step in a very, very long process that has been going on for close to 20 years. And that's the developing the technology to get smarter and do more. And really most of this year has really not been necessarily changing the auto parser or the intelligence, the machine learning as much as it has been reorienting our process around the machines. It's been very intensive on humans and the technology has up to this point been entirely designed around making the experts process faster and more productive. What we found is that we just don't need the experts as much because the machine has enough experience watching and tracking the experts that it can do a lot on its own. And that's caused us to reorganize our, our assembly line in some ways. And, and, and now that we're doing that, we're just knocking these things out. So we think the end of this year we're gonna again add, add another 500 or more. And then next year it's gonna be in the thousands. And then soon after that into the rest of the world. So we're excited about that. Real excited.

That's so cool. I'm thrilled about that. I know that the, the community is as well. And folks, please do keep your votes coming in in the Q&A for these different companies that you're really interested in doing DCFs on in the future.

Yeah, I'm liking the activities. Bloomberg, it's going great. There's a lot of potential issuers interested in working with us. So we're, we're excited. We're hoping that we're going to be able to announce an official engagement and launch here in the next couple of months.

But the truth is—

Yes, it is exciting. It seems like it's been a long time coming, but we think that the market's right for this. As I said about fulfilling the fiduciary duty of care, this is a fund that's going to help people do that with more scale and make people's jobs easier. And we're really excited about potentially partnering with an issuer that focuses on the advisor space so that we can really focus with them on advisors. I love the idea of empowering people who care more about their clients. And sometimes I'm in meeting with some of these institutional investors and hedge fund traders over the years. They care about one thing and one thing only, and that's making themselves a quick buck. And that's not what we're into this business for. That's not what New Constructs is about. And while those customers can pay us a lot of money, I get a lot more satisfaction and enjoyment out of working with advisors who are also focused and care about taking care of their clients, doing the right thing, creating wealth. And I'm hoping everybody's seeing the new Long Ideas. We've got a new format. Part of moving toward the advisor space, we thought we should share our bigger picture theses and ideas around our long ideas. These are typically done only usually in conversations with some of our larger customers. Our long ideas have really focused on the stock and in the stock done some big picture positioning. But Italo Mendoza, who works with us, has done a great job of writing our big picture thesis on a couple of different Areas in the market. And we think that the thesis we have on industrials and financials and basic materials is a good one. The thesis we have on the one we just published this week on moats and growth appreciation period and competitive advantage period is a really good one. It's a great way for our clients, I think, to better engage with the bigger picture thinking around how we come up with ideas, how we use our research to find these great stocks.

They're great articles. I really enjoyed it. Ido Loew's a fantastic writer.

Oh, and then I think the biggest excitement or the biggest, the biggest news here is that our Starter Pack 50 is coming out hopefully before Thanksgiving, maybe sooner, maybe a lot sooner. And that's our new individual investor product. As you guys know, we shut down the legacy Gold, Platinum, and Pro. If you were already a user, we've let you stay, but we didn't let any more people in. And we've really been focusing more on our professional clients and institutional clients. And that's a good move for our business. But we felt like we needed something at the top of the funnel again. And that's what the Starter Pack is for. It's much more designed for individual investors or anyone else who wants to get to know our research. And, and we're going to be making some changes to our legacy Gold, Platinum, and Pro. We're not changing the number of companies or reports you can access. We're going to probably be taking away some of the details you get, institutional data. And if you're an institutional investor, you know what I'm talking about. Details on the footnotes and reconciliation between net income and NOPAT and total assets and invested capital and all the valuation adjustments. That's really sophisticated data that is worth tens of thousands of dollars per company. When we launched the product to begin with, my goal was always to have an overwhelmingly strong value proposition. That's still the case, but we think we've got it. There are a lot of folks that are professionals at a hedge fund, and instead of having to hire 10 people to do this work, they can pay $49 a month and get that kind of data on 25 companies. And that's just not a good deal for us. So the new starter pack is going to be designed for individuals who want access to unlimited unlimited ratings on stocks, ETFs, and mutual funds. You get all the ratings you want. We're not going to give you the details on ROIC and economic earnings and things like that because that's really hard and expensive and valuable data. And we're going to price it at the individual investor level. And if you are an institution and you don't feel comfortable with jumping in at $1,000 a month, which is still a drop in the bucket as to what it would cost to replicate, you can take a look and get to know us. through this starter pack. And that's the idea. We want an introductory product tailored to the individual investor so that more people can have access to our research. And then when it comes to all of our reports and model portfolios, those are going to all be available à la carte. You can buy all of them now, every month, and we're going to be setting it up so you can buy a 12-month subscription so that you're not having to go in and buy it every time. You'll just sign up for the subscription and it'll get sent to you When the new reports are out, those will all be à la carte. So we're moving our business away from packaging things up and guessing as to the right package that people want and focusing more on either giving you everything like a professional or let you decide how you want to design your own package and price them all out individually, all the pieces out individually.

I'm glad you're talking about shop.newconstructs.com because I think that's a great way, very inexpensive way, get to know the research a little bit and understand better what it is that New Constructs is putting out. If you're curious about particular areas or particular model portfolios, that's a very low-risk space.

That's the idea.

Head out to Society. While you're taking over the screen, I am going to put a plug out there with regards to Society. We had a couple of support-related questions asked lately. One was on a stock ticker and what was going on with that stock ticker. And the other was about a particular product issue that somebody was running into. And I wanted to make sure that I was saying explicitly to folks, please do that in Society. I think it's great to have those issues brought up transparently because I think it helps lots of people very quickly. If you write in, I'm happy to write you back, but I only help you at that point. So I love the community aspect of the Society of Intelligent Investors. Please don't hesitate. To ask your product questions, or if you're running into stuff that you don't get, don't hesitate to ask that on Society.

Absolutely. So other stuff on Society to talk about today. One of the things I wanted to mention is, and Tam had this in a, in, in the notes here, how about Joshua Taylor graduating, going to business school? I think paying us one of the greatest compliments that a client can pay us, which is Hey, New Constructs inspired me to do that. I want to know more about how to allocate capital intelligently. And that means a lot to me, a whole lot, because that's what we're about. We think it makes the world a better place. We think it makes our market better. We think it makes our country better, and we think it makes our individual investor clients better off to understand how the market should work and understand What it means to allocate capital and how that does or does not create value. If the capital goes to a place where it earns more than it costs, that creates value. If it does not, it destroys value for the investor. It may make money for the bankers and for the executives running the business who are getting paid despite destroying value. The bankers who get paid despite destroying value. It's important. And, and that's what we're about. So Kudos to Josh. Thanks for writing that in. Thanks for that comment. Thanks for being a customer. I really, really appreciate that. And, and then I want to touch on— I love Giulio's comment here. We've all made bad trades. I got a lot of great stories on bad trades, and I appreciate you being honest. And I think that's part of intelligent capital allocation is that we've got to be honest about making mistakes and As one of our original investors and members of our board said a long time ago, the faster you make mistakes, the faster you learn. So thanks for being honest about that. I do want to cover this report we did on the difference between our stock models for financial versus non-financial companies. This is a clients-only educational post, but it's really cool and a detailed explanation. And honestly, it's been in the works for like a couple years. It got put off for whatever reason. But another way to say this is that when I started in this business, people said you couldn't apply our methodology to financial companies. And I thought to myself, look, all businesses have economics. That's the universal. And to think about the underlying economics of businesses in a universal way, I think that means you have to measure just 2 things very simply. How much cash flow does the business generate relative to how much capital's gone into it over its life? As long as you can get to that, this methodology applies to everything, companies and, and even people, right? Relationships. How much emotional enjoyment do I get relative to how much I put into it, right? We don't wanna waste our energy on things that don't work out well. So It works for financial companies and I explain why, and I show the nuanced differences on how you treat line items on how to get there. So I think that's a cool thing to focus on. And then we've got our new macro research out. Again, no one in the world does this in the way that we do. We are giving people a macro view on economic earnings, on free cash flow, on GAAP earnings, and we're doing it by sector. We're doing it for the entire market. It's a pretty amazing level of work. You can't get it anyplace else. We're really proud of it. Our models on individual companies are extremely detailed, understanding free cash flow, understanding core earnings and how different it is from, for example, S&P Global's measure of operating earnings. They say they take out all the unusual items, but they don't. And it's really clear when you compare core earnings over time to S&P's operating earnings, because their numbers are going like this when ours are mostly straight through. I mean, the proof is in the numbers and a lot of other places, as I always like to mention. A lot of good stuff there on Circle. Go get it. I'll pull over the presentation here. So I also wanted to take— talk about 2Q filing season since we've been off for the summer. And by the way, I hope everyone had a great summer. I did. It was a little bittersweet. My oldest son went off to college, so I admit I'm struggling a little bit with that. I miss him a lot. But we still crushed it for you on filing season. And again, this is part of why we had to make the changes we are making to our subscriptions offerings. I think all of our customers will understand that, look, we can't be a successful business and continue To provide for our clients in the way that we can if we're giving away too much good stuff at way too low a price. And for $49 a month to get the reconciliation between GAAP net income and NOPAT for 25 companies every quarter, that's worth around $650,000. So $49 a month or $150 a quarter, not a good deal. We're obviously willing to still provide extreme amount of value by giving you access to that for $3,000 or $99. $9.99 a month. That's still an amazing deal when you think about all the parsing that we do, the number of full-time employees it would take you and what you'd have to pay them to do this work being around really $660,000 when it's all said and done. Not to mention all the technology infrastructure you'd have to build to get there. You know what I'm saying? So we believe we got a lot of high value add here. And we really look forward to bringing more individual investors into the fold, give them— giving them access to more ratings. And then for people who want access to great amount of detail, they have the institutional and professional subscriptions. We think that's a much better way to divide up the universe, and we're excited to make our products more accessible to individual investors and more advisors and make it easier for you to design what it is you want to get from New Constructs as opposed to these predefined Happy meals, legacy gold platinum pro value meals or whatever. Not everybody wants chicken nuggets and milkshakes, right? So we're going to separate all that stuff à la carte.

Yeah, some of us want milkshakes and salads.

That's right. That's right. Now you can do it that way if you want.

All right.

I do want to remind folks as we are moving into the DCF section here to please get your questions in. So we can be sure to get to them.

Oh, David mentioned it and Nvidia was the Clubhouse leader. So we'll go with Nvidia. I think David called Nvidia recently the new Tesla of the stock market with the crazy valuation that we've seen since, what is this, October of last year? We've gone from $125 a share to $480, $475, all on the hype of AI and what that could bring with the different chips and everything. And so pulled up the model, and while you guys have been talking, I've put together a few different scenarios— neutral, pessimistic, optimistic, different margin assumptions, different growth. We'll see what those look like. As you can see, the valuation as it is at $460 is looking very expensive. You get market implied gap over 100, PEBV 12.8. There's massive Profit growth is baked into the stock price. I've put that into the model here. In the neutral scenario, revenue consensus for the first 2 years, 97% and 43% in year 1 and year 2. I did 20% from there on out in the neutral and optimistic. And then the pessimistic, quote unquote, I did 15%, which is their 10-year average, I believe, revenue growth rate. So it's looking a little bit lower than that 20% and obviously a little below consensus here. On the margin side, wanted to look at 3 different margins. This optimistic one is the highest ever margin that Nvidia has achieved. It was 2 years ago. 34.6% is the TTM margin, and then 24.9% is the 10-year average. A range of margins there to see what it implies for the stock price. We look at these assumptions. I kept the ROIC, change in working capital, change in fixed assets, 30% of revenue in all 3 scenarios. This gives them an increasing ROIC in each of these scenarios. So an optimistic projection there. If we assume maybe ROIC stays the same, these scenarios would have to be even higher growth or higher margins. We can go in and look at each of them, but optimistic scenario with the highest ever margins and 20% revenue growth out into the future. They have to do that for 22 years to justify the current stock price. We're looking at best-ever margins, consensus revenue, and then 20% revenue growth out for 22 years just to justify the current stock price. So we've got massive expectations in that current stock price. We can look at this DCF review page and see what that means in terms of actual revenue numbers. I'll pull that up here on the optimistic side. And we've got, we'll go way out here to '22. Usually when we're looking at the danger zones, we cut it out 10 years.

Nvidia went up. Kyle, when you did it the first time, I mean, the stock was a lot lower, but now it's just like it's blowing out everything. I mean, that's the, that's the cool thing about this analysis. Your model doesn't just break when the stock price goes up by 20%. You're like, oh, now instead of 10 years of that, I need 20 years of that.

Yep.

So you can really quantify it in a, I'm sorry, I'm, I'm on my high horse about this because we've been doing a bunch of classroom training and talking about why the reverse DCF model matters. And this is it. This is it. You can, you can specifically quantify just how expensive something is instead of saying, oh, well, the PE is 25 or 30. Like, I don't really know what always that means. That's a high number, but what specifically does that imply? And, and here you are just crushing it.

So in that year 22 of that scenario, we've got $2.4 trillion in revenue. Not with a B, with a T. And that's on that 38% margin. It gets us to that shareholder value of $451 a share. So a little bit below current stock price at around $460. But even in that scenario, we've still got ROIC up at 62.7%, so 63%. The current ROIC is 50%. This already assumes margins continue to rise. ROIC continues to rise, profit revenues 20% plus a year out for 2 decades. That's not something we would say is probably the easiest bet to make, especially on a company with, I think in the past they've had years of margins in the teens. They've had prior years where margins aren't anywhere near this high. So we go back to the other scenarios. We looked at the neutral scenario. Actually, let me get the decision page first. We'll get the gap on that one. This one was if they can keep margins at the TTM level, that was the neutral. So instead of that 22 years, you're looking at 27 years of growth, and that was margins of the TTM. Revenue growth rates remain the same as the optimistic scenario. So you can see the margin falling increases that gap by 5 years. And then on the pessimistic, if margins were to fall to the 10-year average margin, And you've got a gap over 100 years. So they've got to grow at the 10-year margin and 10-year average revenue growth rate as well for over 100 years to justify the current stock price. We would say in this case, massive expectations. And if they were returned to historical, you're looking at a stock that, you know, the current stock price can't be justified.

And AI hype's going to take over the world and Nvidia is going to be the only company that benefits. Boom. That's what it's priced for.

Essentially what is priced in. Yep.

There's not going to be any competition. You know, this is like a rerun of the internet and of the crypto. And what was the last one? The last recent phenomenon? It's always like, oh yeah. Oh yeah. Electric vehicles. Tesla's going to be the only electric vehicle maker and they're going to have 100% market share. That's what it's priced for. And we've, we're seeing in real time. The competition come online and take major market share. And in China, Tesla's already completely getting its tail kicked. Beware of expectations this high, period. Beware, beware. This is risky.

Yeah. And we can look, even if they get that TTM margin for 15 years instead of that 27, and stock price is $276, a significant cut from that $460, and that's still giving them credit for 15 years of 20% revenue. The CAGR on that would be, you know, 25.5% revenue growth, ROIC of 57%, and that margin of 35%. You're looking at $276 a share. So we've got massive expectations and the downside could be large if they do not meet those expectations.

With Nvidia, this is a combination of like ridiculous levels of revenue growth and A higher return on invested capital. That almost never happens. When you grow that fast and you take that much market share, you've got competition, you got people offering products at a lower price in order to try to compete with you. That means your return on invested capital usually goes down, not up. Companies can usually do one or the other, improve margins and return on capital, or grow at great rates. Almost never Can they do both? And that typically only happens, you know, early in an industry, early in a company's life when it's super small and it's coming off a small base of revenue and a low ROIC to begin with. When it's already been growing fast and it already has a really high ROIC, expecting both to continue that well into the future is extremely optimistic. As Kyle likes to say, we're not talking about what the company needs to do for you to make money. The company has to materially exceed the expectations that we've quantified in order for you to make money owning the stock now. That's what this analysis shows, that the company has to do materially better than this. All right, and we're already showing what it's saying— it's got to do great things. It's got to do even better for you to make money in the stock these days.

So we have a question. I know you guys already hit on the fact that of course Nvidia will have competition I was wondering, isn't ARM having an IPO? Is ARM in competition with NVIDIA?

Could be. Yeah. Right now, you know, ARM provides most of the CPU process or core processing units from smartphones. They're getting into the consumer electronics. They've got large market shares on that side of it. Not as much in the GPU business as NVIDIA, but it's definitely customer competitor, all intermingled there. We could go in and put in if competition knocks revenue growth rates or knocks margins down a little bit, the downside in this one could be even larger.

I swear there for a second Nvidia was going to buy Arm.

They attempted to.

But it didn't happen.

Yep. Regulatory issues. And then they ended up terminating that agreement, which then kicked off the Arm IPO process.

Yeah. Which is an important point. I think, you know, that, that You know, they tried to sell it at a certain price and couldn't. So now they're coming back to the unsuspecting public investors and being like, oh, you know, these guys, really sophisticated, wouldn't buy it at this price, but maybe you will. Be careful.

Oh, there's a, there's a Doomberg article on Arm that just came out this earlier this week. Love to— Justin let us know.

That's awesome.

I'll have to go check that out. Thank you, Justin.

Yeah, I love Doomberg. Doomberg is hilarious and extremely good writer too. Unbelievable. And it's entertaining. Very rare are they entertaining in this space, especially like the economist types.

It's hard to do.

It is.

It is hard to do.

It's not—

macroeconomics is not always entertaining. So yes, Dan has this question about competition will be working hard to take share away from NVIDIA. Yes, competition is working hard to take market share away from everybody at all times. Name one business where you don't think anybody's trying to take market share from each other and competitive businesses. I mean, even in the nonprofit, they're competing. Competition is life. That's what a free market is about. We are all free to pursue our own self-interest. And in a world where there's a limited amount of money, at least in theory, we've all gotta compete with each other for that pot of money. So that's competition and that's what we do every day.

Alrighty. Unless there's any last questions. And again, thank you for getting your votes in for future DCFs. I am writing them down as we speak. And they're being recorded for future use. So please don't hesitate now or in the future to let us know particular companies that you're interested in. Shall we move on to stock picks, Kyle?

Yes, we can do that. So it's been about a month. So we looked at a few different, just want to look at 2 here, but AMC being the big danger zone mover, down 82% in the past 30 days. And a lot of that was on the news that the APE shares would be, you know, stock splits and reintegrated back. And then they also immediately after doing that announced another share sale, which was the exact point of that whole process. It was telegraphed. They said it and people still bought into AMC.

It was so telegraphed. There was even a court case about it. This is just the apes running over the cliff. I mean, full speed, there's a cliff there. Hey, we're going to—

It was almost a challenge.

Yeah. I mean, wow.

It's funny. I can make that jump. It's going to be fine.

Yeah.

Yeah.

I'm jumping off the end of the earth.

Then the other one, Peloton, down 32% over the past 30 days. That's been a big mover as well. There's quite a few. I picked the, I think, 2 largest down, but we had definitely many more. A lot of the zombie stocks down 15-20% in the past month or so. We've seen some of those high flyers come back to earth a bit as the earnings euphoria dies down. On the flip side, we got Owens Corning and NVR. Owens Corning up 66% year to date, NVR up 40% year to date. Both of these long ideas, they've been good performers. We think they can keep moving higher. NVR in the home building, Owens Corning also Home building, construction, all those building materials poised to keep moving up with strong fundamentals and quality valuation.

Fundamentals matter. I think the second half of this year might be more like the second half of 2021. Saw a lot of reconciliation. As a guy said on Fox yesterday when I was doing the interview there, you know, what good news have we not already had? Like it's been an amazing Goldilocks experience for 20 years. No bad news, or if we do have bad news, it quickly gets forgotten. It feels like the risk gets higher and higher, and at some point there's got to be, continue to be some reconciliation. The zombie stock list has not changed this summer since we last talked to you. Those could all still go to zero, and we're better off if they do. That capital in those bad businesses and overpriced stocks should be reallocated to better businesses. and underpriced stocks like the ones on the screen here. These companies deserve the capital. These managers deserve the capital. Those other companies, that's just a way to siphon shareholder money into bankers' and executives' hands. That's not good for society. That's not what the stock market is about.

Thank you, Kyle, for those stock picks. Thanks folks for joining us again back in our live podcast. We're really excited to have Be back. Uh, we're looking forward to seeing you next week. We've got a great special guest coming next week, so please stay tuned and be sure to join us.

Have a great weekend.