2 Surprising Stocks Up 3,000%. Plus, Mid-Cap Picks.

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I tell you, I sat next to a lady on the plane and, uh, you know how people always brag about their kids?

Yes.

She was bragging that her son invented QuickTime for Mac.

That's a pretty good one.

She had no idea that she was talking to maybe the biggest, uh, QuickTime power user between us, using it to record the podcast.

And she wasn't like mistaken, right?

Like, you think it sounded feasible?

No, no, it was, it was feasible.

It was legit.

Sometimes people don't really know what their family members do for a living.

Like, I worked on Wall Street.

I was a stockbroker for like 7 or 8 years, and my sister would introduce me back then.

She'd say, this is my brother, he works with computers. I would say like, well, I— there is a computer involved, but that's not like the main thing.

Are we recording?

Yeah, we— I, I was recording that.

Good.

Don't want to miss— don't want to miss any of that QuickTime on the plain gold.

Tell me, what is the number one performing stock in the S&P 500 over the past 10 years? Surely you know this. You have to get this right.

It can't be NVIDIA.

It must be. Say it with confidence. Of course it's NVIDIA.

It's got to be NVIDIA.

NVIDIA gosh darn it. Yes.

Artificial intelligence chips have led the way. NVIDIA has returned, it's actually staggering, over 31,000%. And that's really detached from all the other stocks. But the number 2 stock is in quite a similar line of work. It's AMD, Advanced Micro Devices. And that one has returned 5,900% over the past decade. Both these companies, of course, were known at one time for their video game chips, chips that they don't think really hard about any one particular thing, but they can think about a lot of things at once. And that's great for the job of drawing pixels on a screen.. And it turns out that that kind of highly parallel thinking is just what you need for the job of artificial intelligence. And so it turned out that both of these companies were well positioned to fill modern data centers with their chips. Although as, uh, NVIDIA founder Jensen Huang has explained to us on this podcast, that was the plan all along. It's not like he was a video game guy who stumbled into artificial intelligence. He says he set out to build a supercomputing company. It just so happened that at that time, the, the best market that he could tap initially was video games. Okay, so those are the numbers 1 and 2 in the S&P 500 among current S&P 500 companies. The big question for purposes of this episode, Jackson, what are numbers 3 and 4? This is a bit of a setup. It's a hard one. Most people will not guess these. These— I don't think these are obvious choices. That's why they are remarkable to me.

I think in 2014 to now, maybe like fracking or, or oil drilling and exploration, and, uh, some medical device company.

I think those are decent guesses. Uh, Devon Energy, that's a fracking company, right? It's had some periods where it's done very well, but if you look at the past 10 years cumulatively, it is slightly negative.

So, but not a good guess.

I, I'm not saying that. I'm just, I'm just saying very, very wrong. There's definitely going to be a fracking company out there that's done wonderfully well, and somebody's going to email me and say, you owe Jackson an apology. Okay, let me— I apologize. I mean, and medical devices, I think right away of Medtronic. And over the past 10 years, that has returned cumulatively 67%. Which is, um, you know, that compares with 245% for the S&P 500. So not super duper.

The Jackson 2 is not—

it was underperforming.

But, but again, I'm sure there's a medical device company out there that's done fantastic. Okay, so the two lines of work that I'm thinking of are— one is lumber And the other is credit scores, which really narrows it down because there's only one company out there that's known for credit scores. Yes, the two companies are called Builders FirstSource. That one has returned 2,900%, roughly. And the other one is, of course, Fair Isaac. That one's 3,300% over the past decade. And that to me was a shock. Fair Isaac, when people pay for a credit score, you know how much they're paying? It's about $3.50 to get a score for a mortgage application, let's say. And I don't think of that as big bucks, but it is.

So, so $3.50, that's either like a drip coffee from Dunkin' or, or you can buy someone's entire credit history. What do you get? So who's paying the $3.50?

It's a good question. We're going to come to that in just a moment. Builders FirstSource is an even stranger sounding one to me. Lumber, it seems fairly commoditized, although I should point out that this company increasingly over the years has done more higher value work with lumber. It delivers preassembled components for houses. Trusses are a big part of what it sells. You know what a truss is? Truss is like—

keeps the roof on somehow.

Yeah, it's like a framework. There's one for the roof and there's one for the floor. And there may be other ones besides those, but trusses are a big part of what it does, you know, big bulky assembled components for houses. So it'll make you a set of stairs and deliver them to the job site. And then you don't have to pay, uh, you know, carpenters on the site to do it. You know what? I'm getting ahead of myself here. We'll come to that too.

Okay.

So I want to just quickly go through these stocks one by one. And the purpose here is not because, uh, I'm sounding some kind of fresh buy call on these stocks. There are, by the way, firms on Wall Street that are doing that even now on both these stocks, and I'll tell you about a couple of those. But this is not about a buy list. So if you're typing out an email now that says, well, thanks a lot, Jack, you genius, you're telling me about a stock after it's already gone up 3,000%, right? First of all, I know you're not doing that.

You're— by— these listeners of ours are nice people, and they don't sound like that at all.

The purpose is not what you should buy. It's, uh, I want to look for clues. I want to find the characteristics. What can we tell about these two companies that led to their, what I think is surprising, success over the years? If we can tell what those characteristics are, maybe on some future date we'll spot them in other stocks. And two things to know about these companies right off the bat is, one, they both report earnings in the week ahead. And number two, even though they're both current members of the S&P 500 index, they were both added last year. They were smaller companies that worked their way up, which reminds me, in a moment we'll tackle a listener question on the subject of mid-cap stocks. Ready to dig in, Jackson? Oh yeah. Credit scores or lumber first? You want to go credit scores first?

Yeah, let's go credit scores.

Credit scoring music, please. Fair Isaac, what this company has really benefited from is being an industry standard for one thing. There's been a little nudge from the government that has helped, and it also has a long runway to raise prices. I'll explain. This is a Bozeman, Montana-based company. Jackson, is that my second Bozeman mention in like 3 weeks in this podcast?

Yeah, you guessed one of our listeners was from Bozeman.

Yeah. Bozeman on a hot streak. All of a sudden everybody's looking at you, Bozeman. Don't blush. We're just, we're all thinking Bozeman.

And then he also, he also referenced Yellowstone last week, which takes place in and around Bozeman as well.

That's Bozeman adjacent. Got it. So Fair Isaac was founded in the 1950s. Who's this guy Isaac and what makes him fair? Fair in this case is not an adjective. It's the name of another guy. Bill Fair was an engineer and Earl Isaac was a mathematician, and they started a data analytics company, and they introduced their first credit score in 1989. Today, everybody knows about the FICO score. There's a scale of 300 to 850, and it measures your creditworthiness based on things like your payment history and your loan balances. The Fair Isaac Company doesn't collect the data or even really calculate the scores generally. It licenses its algorithm for calculating the scores to the credit bureaus and other customers, and then it works on tweaks to its algorithm to improve the predictiveness. What stops other companies from doing the same thing? There are competitors. The three main credit bureaus have gone in on something called VantageScores. There's also a lending marketplace called Upstart that's powered with AI. But FICO is really the industry's big brand name. It helps that FICO scores are required for loans that originate with some government entities like the Federal Housing Administration. And the Department of Veterans Affairs, and for ones that are bought or securitized by Fannie Mae and Freddie Mac. So more than 90% of top lenders today use FICO scores, and barriers to entry are fairly high. If you're running a risk department at some big firm and you need to show that you've been prudent about scoring something that you're buying or selling, What are you going to do? You're going to buy some guy's credit scoring algorithm that he's selling out of a back of a van on a parkway somewhere? Are you going to say, hey, I went with the industry standard, FICO? Of course, you're probably going to go with FICO in addition to maybe some other scores. Credit scoring startups out there that are using AI to sift through various pieces of financial data to figure out some non-traditional ways of telling who's likely to pay, they have to be careful. You don't want to run afoul of discrimination laws. Fair Isaac has a more transparent process that everyone's familiar with. No one's going to get in trouble for using Fair Isaac, I guess is the point, which is why pretty much everyone does. Now, because of that, the company has been able to raise its prices by a lot. Its royalties per mortgage back in 2018, they were 50 to 60 cents. Now they're up to $3.50. In percentage terms, that's a humongous increase. But the dollar amount doesn't really draw attention to itself. If you're buying or selling a house, there are closing costs that are thousands of dollars, and somewhere buried in there is a credit score that costs $3.50. No one's really too alarmed. And those price hikes over the years have done great things for Fair Isaac's margins. There has been some antitrust sniffing around. In 2020, the Department of Justice opened and then closed an investigation with no enforcement action. Growth has been steady and impressive, and that's even considering that the company right about now could really use a mortgage recovery. Loan inquiries are running at only around half of pre-pandemic levels. That's due largely to higher interest rates. It helps that in addition to its scores, the company also has a software platform for predictive analytics and fraud detection. That's a fast-growing business. It brings in close to half of total revenues. Much of that is recurring revenue. And analysts say that one day that business could be a candidate for a spinoff. The company's fiscal year runs through September. So for the one that just ended, Wall Street expects it to report revenue of $1.7 billion, up 13%, and earnings of $23.53, up 19%. The shares are not cheap at a glance anyhow. Based on forward earnings estimates, they sell for more than 60 times earnings. But Oppenheimer in September initiated coverage of the stock at outperform. It says the valuation is a major pushback, but it writes that competition is likely to remain mild for years to come and that it thinks earnings power could top $35 a share by 2026. In other words, up what's that, about $11.50 from where we are now. So it's pricey, but it's a fast, dependable grower. And that is Fair Isaac. Did I leave anything out, Jackson?

So that's just it. They're just sitting on this algorithm and at some point they could just decide, all right, we're going to do $4.50 or $5.50. Is there any innovation happening behind the scenes?

They do make changes all the time, and I should note that there's more than one FICO score. We all think of the main one used for loan applications, but there are ones that are specific for the auto industry or the credit card industry. Sometimes FICO makes changes that affect average credit scores or how those credit scores are distributed, and sometimes they figure out new things that they should weight more heavily. For example, one recent change was to penalize people more if they consolidate a bunch of credit cards into a loan, and then they go out and they run up new credit card balances. FICO also has products that are geared toward people who don't have as much of a borrowing history. One of the things that the AI startups will do is they'll say, hey, look, we can go out there and look at non-traditional financial data and come up with a way to predict who's going to pay what they owe. But FICO does some of that themselves. They have products where for people who maybe they don't have a credit card history, but they might have a history of paying their cell phone bill, they'll use some of that other data to be as predictive as they can. What else? Anything Anything else on Fair Isaac? How's your credit score, Jackson? Um, you know, what are we— look, we're not asking you for a number. You strike me as a creditworthy fellow. I'm gonna guess you've got a high score.

I honestly, I don't check it that often. Like, I can't even tell you when the last time I checked it was, but I think I'm doing okay.

It's probably good. It's, you know, you know who it's good for? People who couldn't care less.

If you don't need any money, then you probably have a great credit score. If you need some help in the form of financing, then, you know, I got bad news for you.

You know, you want to find that sweet spot. You want to have a good score when you need it. You would think there would be a way for people who are older and they have excess creditworthiness, more than they can use, to securitize and then sell some of their surplus creditworthiness, right?

Like, sounds like a good way to start a financial crisis.

Just bundle up a couple of hundred points and sell them to someone who needs them more. What could go wrong?

Okay, not all these ideas are going to be winners. All right, I want to take a quick break. I also want to answer that listener question that we had about mid-caps. You want to do that before? Let's do it right after the break and then we'll get to the second stock.

After the break.

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Hi, Jack and Jackson. This is Michael from Bluffton, South Carolina. Goldman Sachs recently released a report showing that mid-caps have outperformed both the S&P 500 and the Russell 2000 since 1980. That was a bit shocking to me. I've heard many times that small caps can outperform large caps in the US over time, but never that mid caps do as well. So my questions are, if both small caps and mid caps outperform the S&P 500 over time, why is the S&P 500 so much more popular than both? Also, should a regular investor like myself be putting as much focus on small and mid cap funds as I do in the S&P 500?

Thank you. Thank you, Michael, from Bluffton, South Carolina. Jackson, heart of the Lowcountry. That's what they call Bluffton. Did you know that?

I would've assumed it was on a bluff.

Did you know the tourists and residents come to Bluffton to see oystermen harvest May River oysters the old-fashioned way? I'm totally not reading this from the town's website, by the way. The old-fashioned way, using their hands, gloves, and small boats called Batteaux. I would—

did you know that? I'd love to.

Another fun fact off the top of my head: they observe 6 holidays for trash collection, and if your collection falls on one of those holidays, you've read the entire website at this point.

I've read the whole internet.

All right, enough of this nonsense. Mid-caps are an important topic, Michael. Thank you for bringing them to our attention. They're so important that I wanted to call in an expert. I spoke recently with Amy Zhang. She's a portfolio manager at Alger specializing in small caps mid-caps, and I asked her your question.

Yeah, he's a very insightful investor, and what he said is absolutely true, that mid-cap as the asset class— mid-cap has outperformed both small-cap and large-cap in the last 30 years. But it's like a hidden gem because most U.S. equity portfolios are in a barbell-like structure, right? So it's either small or large. I think mid-cap has the best of both worlds. Compared to large-cap, the market is more inefficient, right? It's covered less by this so there's more discovery value compared to, say, S&P 500. They also generally have some advantage over small cap because, you know, mid cap, the company has already stood the test of time, right? And they have already survived and they have higher financial quality than small cap. And when structurally, when small cap becomes mid cap, you can always generate outsized return or alpha in that period. And then they're also more liquid than small cap. So it's really a sweet spot.

Amy calls mid-caps underallocated and cheap.

Also, the other interesting factor is that it's very underallocated. For example, mid-cap stocks represent about 20% of overall U.S. equity market, but only 10% invested assets. Furthermore, at this point, mid-cap in the last, like, say, 27 years, mid-cap has always traded at a premium to S&P 500, 14% premium roughly. Now is trading close to about roughly 14% discount. So you see that the valuation gap is very big. I do believe that the valuation gap is going to narrow and eventually close. And from discount to premium, that's a big swing.

I asked Amy for some of her favorite stocks right now. She mentioned Constellation Energy, which we've spoken about on this podcast. That company has a deal with Microsoft to restart Three Mile Island and provide nuclear electricity for data centers. It's up on that news, but Amy sees more room for the company to grow.

I do think the pie of utilizing carbon-free energy is becoming bigger, given that the need and requirement for hyperscalers to use clean energy, and that will serve as a strong tailwind for Constellation Energy.

So you also mentioned two companies we haven't spoken about before. One's called Vertiv. It does cooling and power management for data centers.

AI as a theme is still very important. It's transformative. So the data center is a very critical infrastructure.

The other company is called AppLovin. Jackson, when you heard this first, you thought the name was what?

Thought it was App Eleven.

App Eleven. But it's AppLovin. Remember There was a 2007 movie, a comedy called Superbad, and there was a character in there who was like this kind of nerdy guy who went and got a fake ID for trying to buy alcohol, and he put his name on the ID, and the name was simply McLovin. Remember that?

Changed your name to McLovin?

McLovin?

What kind of a stupid name is that, Fogel?

What are you trying to be, an Irish R&B singer?

Oh, they let you pick any name you want when you get down there, and you landed on McLovin.

That McLovin apparently has nothing to do with how this company got its name, even though the company was founded in 2012, so you could figure that movie was still fresh in people's minds. But one of the founders has said that the name was actually inspired by a content organizing site called BlogLovin, and that he was able to register the name cheaply and he didn't put a lot of thought into it. Anyhow, Applovin, one word, no apostrophe on the end, does platform stuff for mobile applications.

Here's Amy. It's for mobile apps, right? Like, so their AI engine called, um, Exxon 2.0, they leverage an AI technology to power recommendation targeting engine. So the goal is for users for mobile game to download more games, and they are the best at monetizing inventory. Using machine learning, as you know, the engine gets smarter, right? And then you can even do more, like meaning have people spend more on the, on the mobile games.

Thank you, Amy. The tickers on those stocks: APP for AppLovin, VRT for Vertiv, and CEG for Constellation Energy. Don't confuse that with Constellation Brands, ticker STZ. They do booze and wines. And America's most popular beer, Jackson?

Modelo.

Of course it is. We did a whole episode on it. All right, but I want to get back to stock number 4, the number 4 best performer among current S&P 500 companies over the past 10 years. 1 and 2 were Nvidia and AMD. Of course they were. Number 3 we talked about earlier, Fair Isaac. And number 4 is called Builders FirstSource. This is the kind of company that you might never have even heard of. But once you tuck it away in the back of your mind, then you start to see their trucks rolling through your town now and then. Builders FirstSource is profiting from, for one thing, an urgent demand for new houses, also a shortage of skilled builders. And I would say a fragmented industry of suppliers. The company started in 1998 when a group backed by investors bought a supply business from the homebuilder Pulte. Builders FirstSource first sold shares. Well, that's a mouthful to say, that whole company name. This is like they need one of these modern names where it's like Bleep Bloop. This is Bleep Bloop. They do, you know, you can't actually say what you do anymore. That's old-fashioned. Anyhow, the company first sold shares to the public in 2005. That was just before the bursting of that big housing bubble that we had. Sales back then were just over $2 billion. Last year they were $17 billion. And the share of lumber, like basic lumber kind of commoditized products, that share over that time period has fallen from 40% to 24%. The company sells all kinds of manufactured components. We mentioned earlier trusses and I think stairs. They also have prefabricated wall panels. They have I-joists and rim boards, glued laminated timber or Glulams.

I want—

I feel like putting on my tool belt while I just read this list. Okay, so results for the company recently have hit a soft patch. There's been some cooling in multi-family construction. A lot of folks thought that mortgage rates would have fallen more than they have by now because the Federal Reserve has cut short-term interest rates. That hasn't really happened. And affordability— anyone who's out there shopping for a house can tell you that affordability is strained right now. And so what builders are doing is they're responding with smaller homes. Smaller homes use less materials. Those are near-term trends. Longer term, the setup seems favorable. There is a shortage of single-family houses in America. I've seen estimates of 2 to 3 million houses. There's also a shortage of skilled builders, and that has pushed up the average construction time for homes that are built for sale to 7.5 months. That's up from a pre-pandemic 5.5 months, and it's near a record. So considering all that stuff, the pitch for Builders FirstSource is pretty straightforward. If you build house components in a factory instead of on-site, you can save weeks worth of on-site labor. You can also cut down on wasted wood. Builders FirstSource is the biggest in the business. It has 280 factories. Its customers include most of the big builders, and it has software and logistics services that can help smaller builders come across as more sophisticated to their clients. Home builder supplies— that's an industry that's made up of many smaller players. A lot of them are family-owned operations. And that makes Builders FirstSource a natural buyer. It has done dozens of deals. It generates a lot of free cash, and it's recently put part of that cash toward buying stock, $1 billion worth during the first half of this year. That stock goes for 15 times this year's projected earnings. Wall Street expects the company's growth to resume next year. UBS just launched coverage at buy. They see 30% upside for the stock over the coming year. Jackson Builders First Source. Anything I didn't cover? Are there questions out there? Can you anticipate any questions on the minds of our listeners? Are you still studying truss diagrams? What is the web page in front of you right now? Give me the— give me the name of that site.

It's called dimensions.com. And did you know that there's something called a double Howe truss?

Double Howe, like as in Jack Howe?

Uh, H-O-W-E. Okay. 5 vertical posts, 4 diagonal webs. Sounds about right. They're typically used in bridges and other structures that need to support a lot of weight.

Oh, Jackson. I've been hitting the Halloween candy hard. Is that what you're saying?

I didn't. I just, I was the name.

Thank you for listening. Jackson Cantrell is our producer. If you put on a couple of pounds, he'll give you a nudge toward the treadmill disguised as an engineering tip.

It was purely about trusses.

You can subscribe to the podcast at Apple Podcasts, Spotify, wherever you listen.

You can send us a question if you'd like us to answer it on a future episode. You just tape it on your phone, you use the voice memo app, and you can email it to jack.hough@barons.com.

There's also a triple how, by the way.

Thanks and see you next week.

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