0:00
I'm aware that last year I thought they were going to sell 800,000 cars and they're on track to sell 300.
Search this video
0:03
And I'm also aware that last year I thought they'd make positive this year and they're on track to lose two billion.
0:10
And I'm also aware that the stock is down uh 99%.
0:16
But what I'm about to say is I think things are going to be okay.
0:20
And you can see how that makes you seem like you've lost the plot.
0:35
Cliff, I'm so excited to be able to do this with you.
0:37
This I I've been asking you to do this for at least 3 to four years, something like that.
0:41
Um, so I don't know what made you capitulate.
0:42
Um, but but it's an excuse to talk to you about investing in general and some very interesting specific episodes that you've been involved with specifically.
0:52
And I think we got to start broad because I want to set the context for everyone that doesn't know who you are or what your setup has been.
0:56
Maybe just give us like a history of how you started the firm. What was it 2012? Something like that.
1:03
Um why you started the firm and kind of what it's been since.
1:07
If you'd gone all the way back to when I was in high school, I thought I would have been an inventor.
1:10
Uh I sort of modeled myself as you know an Edison in my mind or something.
1:14
But when I went to school and I studied engineering, you know, a lot of inventing is kind of obsessively debugging like real things and nature is pretty unforgiving and and so what I learned about myself was that I didn't love that process.
1:26
It just wasn't as fun for me.
1:28
Um, and so I was sort of casting up for what I wanted to do and I and ended up doing an internship at a big private equity firm.
1:36
And and I just thought it was really neat that I could use and I discovered I could use a lot of these things I'd been learning in school like game theory apply them to these situations and that that brought novel insights that these people who've done this for so long weren't using and I was hooked like the idea of like you know being able to do that.
1:53
From there I was trying to kind of get into investing.
1:55
I thought I was going to do private equity.
1:57
I knew the path into private equity was through a banking analyst program but I didn't want to do a traditional sellside analyst program.
2:02
So I ended up um going into uh financial restructuring because I didn't want to do as much marketing.
2:08
So I worked at a place called Julian Loki which is a leader in financial restructuring and I did that for a time.
2:14
Uh I still wanted to get to the buy side.
2:16
So I went to for place called Silverpoint for a year and then from there I went to um UBS where I spent five years before I I started my business.
2:24
And while I was there, that was really where I think I did a lot of my my maturing.
2:27
And I I thought a lot about I'd come from a lending and and finance background.
2:31
And at UBS, I was, you know, involved in trading um investing in stocks, trading in stocks.
2:37
UBS at the time, it was it was the fund, it was their proprietary investing business.
2:41
It was the bank's own capital.
2:43
Think of it as a hedge fund with NLP.
2:45
And it did a lot of the sort of traditional things that I think a lot of hedge funds do.
2:47
They there was a lot of focus on on short-term performance.
2:51
there was a sort of desire to have yes we want things to sort of be misvalued but we want to have a bunch of catalysts that are going to cause the price to go up.
2:58
Um there was a lot of trading around events there was a lot of hedging and um as I was involved in that there was sort of an effort to teach me how to do it and it I I didn't like it.
3:10
I I sort of discovered that, you know, they would sort of say, well, we should we should do this and it would do this and and I'd sort of say, well, why?
3:18
And that doesn't make sense.
3:19
And, you know, I don't know why this stock has a three beta.
3:20
Why do I have to why do I need to short $3 of S&P for every dollar, you know, of of stocks we're going to buy here?
3:26
That doesn't make any sense.
3:27
And this led to like a really vigorous debate between me and some of my former colleagues there.
3:33
And to their credit, I mean, I was young and um incredibly difficult to have as a as a as someone working for you, right?
3:40
Uh um and and I just hounded them about it and eventually this debate went on and on and it became pretty clear to me that like I was right like you know and and I was naive enough to think I would just explain to them that I was right and they would just do it differently.
3:55
Further occurred to me that they couldn't change and they couldn't change be because they had a principal agent problem.
4:00
problem. The problem was that they had to deliver steady profits to the bank and if they had big draw downs that they would lose their money and so you know I started poking around quietly looking for another place to work and I realized that so did all the other firms in the industry had the same problem in fact it's it's it's endemic basically one
4:17
might naively think that that the investing business is about maximizing performance which but it's not it's about maximizing um marketability and performance is a component of marketability but really what you're trying to do is signal talent and the way you do at is by finding things with um short feedback loops with low amounts
4:34
of noise so that you can sort of show people look we did this and it worked and we did this and it worked and we did this and it didn't work but on average you know we win and the type of investing I was thinking about basically buying a piece of a company through the stock market and owning it for a long time you know these are multi-year 3
4:49
five 10year you know feedback loops that are incredibly noisy and they just don't lend themselves to it and you know if you think about it practically Let's say that um I meet with someone from an institution and you know first of all you know and I convince them that like I've got they're going to say like how do you pick stocks? I'm going say well I think
5:09
I'm going say well I think really hard.
5:12
Um and you know and they're going to be like okay cool like I I'm convinced Cliff thinks really hard and he's good at this.
5:17
But then they have to go back to their committee and the committee is going to be like well how does Cliff pick stocks?
5:21
and he's like, "Well, he thinks really hard."
5:22
And they're like, "Well, you know, that's not very credible."
5:25
And and then even if they do make the investment now, you know, they're going to own it.
5:28
And so, invariably, we're up, we're down, we're up, we're down. I look smart. I look dumb.
5:32
And and along the way, they're going to be like, "Why did we do this?"
5:35
Like, and by the way, we have a board that we're reporting to.
5:37
And like, we're down this quarter because Cliff thinks really hard.
5:40
Apparently, this is just a really challenging setup.
5:42
What this means is that, you know, when I started this, I wasn't fully aware of quite how challenging it would be.
5:47
But the premise was that I would start a business, you know, based on really focusing on long-term compounding, finding a relatively small number of stocks, treating it like owning a piece of a business, dealing with the volatility that comes with it.
5:59
And I figured would be max op max maximally optimized around returns and minimally optimized around market marketability.
6:04
And I think certainly on the on the on the on the marketability side, we nailed it.
6:08
Uh and and so um so that that that's that's where we are.
6:13
But I wouldn't I wouldn't change a thing.
6:14
It's it's how it's how I'm built.
6:16
So uh that's how I So what what did you tell your original investors?
6:21
Because they some people gave you money, including some, you know, well-known institutions.
6:25
What did you tell them and why were their decision-making processes different?
6:29
And how much did you start with?
6:31
Ah, so I launched with $5.
6:33
2 million the oldfashioned way. Uh-huh.
6:36
It was two million from me because I'd been successful at EBS and they they'd paid me.
6:40
I like to joke it was a lot for post crisis, not a lot pre-crisis.
6:43
Um and um I I also got 2 million from my mom.
6:48
Um she was a sympathetic audience.
6:51
Um I had 1 million from a friend and it was you know at the end you always ask people who they're most um grateful to.
6:58
He's I had two in mind and he's one of them.
7:00
He I'd known him for years and we' talked and he's he's a very successful person and and um I had this meeting.
7:05
It was like my third mark second marketing meeting ever and I I sit down and he basically like I'm absolutely going to give you million dollars like no problem and and and I was like wow this is going to go great like the next time I saw a check like that you know was years um and and um and then it was a couple hundred thousand from some other people that that I knew.
7:23
that that I knew. started with that and um you know over the years was sort of able to kind of steadily bring in a little bit of money here and there and compound and was fortunate you know I've had up years I'd have down years if you changed the order of the years get to the same place but I definitely wouldn't have raised any money so there's also a
7:41
meaningful component of luck and where does that bring us today so how many investors do you have what's kind of the capital base like how do you think about the firm today so I don't remember exactly how many investors we have it's sort of between one and 200 across a few different vehicles Um and the firm's moves around every day but sort of between a billion and half two. What
7:58
What is your view of investing in markets?
8:01
Like describe how you think it is supposed to be done in some detail.
8:02
The the premise was always you know let's find a handful of businesses that are publicly traded where I can buy a piece of that business in the markets and own them own it for for you know with a premise of owning it forever.
8:17
um and and then own it until basically I find something that I can upgrade that I think is even better.
8:24
Um or I discover that I've mis misunderstood the business in the first place.
8:30
And so there two ways out of the portfolio.
8:33
One is that the gap between what I think I find something better so I can you know upgrade or the other one is that I have some view as to what makes a business successful.
8:42
You can think about like a mental model of kind of how the business is competing and winning in in the ecosystem and that makes predictions about the world and and then you get real world data and you can compare the real world data to um to to to what your predictions of your mental models are.
8:58
And if you discover that your predictions aren't lining up, then you need to um update your role to model and it might be that you need to throw it out.
9:05
And at some point you sort of realize you don't know which way's up anymore.
9:08
and and then and then that would be an investment that you would uh jettison because you just no longer know over time we've sort of had kind of between like we'll call it four and eight might have been as many as 10 at one point but that that's kind of the number uh of investments we tend to over the course of time I've been investing I think on average I've sort of bought and or sold one thing a year.
9:27
Um it's a it's a pretty sort of lethargic um pace of turnover.
9:32
It's this idea that like businesses compete and win in certain ways.
9:36
there's sort of a minority of businesses that, you know, once you sort of figure them out, like you can just tell like they're going to be very successful relative to, um, other similarly priced businesses.
9:50
And so, um, and we can talk there's a lot of like mental models and stuff like ways that I think businesses can be.
9:55
It's sort of a taxonomy of businesses that I've sort of think about, but those are just, you know, my ways of understanding a really complicated world and sort of fi trying to find a few things that work. Yeah.
10:04
So, I guess like the the obvious and very simple but very big question is like what is a good business?
10:08
Like what what is that taxonomy?
10:10
Maybe this is the time to talk about one of my favorite ideas of yours that you like businesses you described as contained.
10:15
Um I I've always liked that description when we've talked about companies. Yeah.
10:19
Give give us your kind of view on what makes a good business.
10:22
If you think about it, in most markets, you shouldn't have a lot of profits, right?
10:26
of profits, right? like profits are kind of a fluke of some sort of um something about the setup that makes it so that some reason why you know competitive forces can't drive you know economic profits to zero and those reasons I mean there's sort of a lot of them and in terms of how to think about them I
10:42
gather different examples from sort of microeconomics from psychology from um business history um to try to understand different ways that companies have carved out a piece of the world that where they are advantaged um and then they And you know, you can think about a company's profitability over time as kind of its market opportunity times its advantage. And um so the um what you
11:02
And um so the um what you know, I mean, I don't think there's anything particularly exciting about like what makes a great business.
11:10
It's it's you generally want to have um you know, multi-threaded advantages, a lot of things working for you that are very hard for your competitors to replicate.
11:20
Um you know, you want to bring a lot of value to your consumers.
11:22
you want to, you know, um you want the things that are working for you to be generally invariant um with time as tech, as society evolves and changes.
11:31
Um and when you kind of have all those things lined up, um you should be able to, you know, have high returns on capital, reasonably good margins, you know, all those things grow, all those things people look for.
11:44
Um you know, of course, everyone knows everything I just said.
11:47
And so, you know, the the whole game is to identify the ones that other people, you know, have missed for one reason or another.
11:54
Um, and and you know, it's it's it's it's really um it's the emperor I I think investing is the emperor of uh activities in the sense of intellectual activities in the sense that you know in academia people write papers.
12:07
They're wrong, they're right, eventually they die with a bunch of ideas.
12:09
Most of them wrong, right?
12:11
Like in politics, people have views and like they're definitely wrong unlike, you know, a lot of them, right?
12:17
Um, and in business people, they have this narrow world and they kind of have to be really good about executing in their narrow world, but they don't necessarily need like a deep understanding.
12:25
Like you can run a deli without necessarily having like a deep understanding of like why meat prices are what they are.
12:31
But in investing you, you know, it is wildly accountable.
12:35
You're making predictions about which businesses are going to win, which are going to lose.
12:38
Um, which, you know, to understand businesses are sort of complex social structures embedded in our society, which is a complex social structure.
12:45
So what do you need to understand?
12:46
how a business's success or failure over time.
12:48
It's like you kind of need to know everything.
12:50
So it's it's and and unlike all these other pursuits, this one's like highly accountable.
12:54
So I think it's it's the emperor of like intellectual pursuits.
12:57
I think that no there's no arena to train people better about understanding the world.
13:01
And I think if you're just curious about the world, like there's nothing more interesting than study business.
13:05
Say why you like this idea, what a contained business means and and what an uncontained business is and and why you like to avoid them.
13:13
I generally think of a contained business as one where when you're trying to understand um a company if you find that it's just the problem starts to feel intractable in the sense that um it's very hard to think about how um changes in there's many things that could change in society that are changing that could cause your view of what the business could be to change over time.
13:40
That is a just a tough problem to live with.
13:43
Um you know if uh because it's it's just you know it's very susceptible like as the world evolves like you don't know where the company's going to going to go.
13:52
Whereas a business where the thing that makes it work or things that make it work are relatively narrow and in a sort of part of our of our lives that isn't evolving that much.
14:06
um that would be you know very contained once you sort of understand everything immediately around that other changes outside the that they're sort of happening feel less relevant would like software tooling be a good example yeah that would be a great example right so
14:21
you know I I you know who knows how how people are going to write software in 10 years like for what for quantum computers for you you know and it's just like a like you might have a business today, it's like building a castle on sand, right? Like it it's just very very
14:37
Like it it's just very very hard to make predictions.
14:39
But on the other hand, you know, like the cigarette business, right?
14:44
Like people the nicotine is habit forming there.
14:46
There's this phenomenon called secondary reinforcers, which is a psychological phenomenon that you can um you know, put into chachi PT. It'll explain it to you.
14:56
Um a and you know, but basically it makes people incredibly brand loyal to things that like stimulate the reward systems.
15:02
Um and and then there's also distribution economics and but like that is just not a an area where there's a lot of dynamic change happening.
15:10
It's also not an area where I need to think about 15 different moving parts to sort of have a general sense as to what's going to happen.
15:17
Of course, the problem with these contained things is is that if they're easy for everyone if they're easy to understand, then everyone understands them.
15:24
And and and so again, investing is this it's this incredibly challenging endeavor where you're you're dancing on the knife edge.
15:30
They're looking for these things that you know like on the one hand they're they're they're simple to understand so you can understand them but on the other hand they're challenging to understand so everyone else misses it.
15:39
Give us an example of the process you go through to explore a contained system.
15:43
You're coming across a new company for the first time.
15:47
You want to start to learn everything.
15:49
What is your method for doing that?
15:52
And and I I recognize that like to some degree this is like an obvious answer.
15:55
You talk to people, you read stuff, you you think about it.
15:56
I always love these moments where you get like some new click of understanding and maybe you could tell the story of one of those clicks of understanding or something from the from the investing history.
16:06
I have in my head a number of different frameworks for how a company um can make money over time in a competitive world.
16:16
Um and a simple example from microeconomics would be that of a corno oligopoly.
16:26
And um just for those who maybe forgot their game theory from college, there are um two broad types of igopoly in the economics literature.
16:41
One is Corno, the other is Bertrron.
16:44
The key difference between them is that in a Corno oligopoly, the competitors choose the quantity of things they're going to sell first and the price falls out.
16:53
It's the it's the thing that moves.
16:57
Um, in a pronopoly, the competitors choose the price that they're going to sell at and then the quantity falls out and it's the thing that moves.
17:07
And this seems like a subtle uh change, but it results in a pretty big uh difference in the competitive equilibrium.
17:15
So in um a Bertronigopoly that's non-ooperative, that is to say that people aren't figuring out a way to signal and to to sort of to cooperate.
17:25
Um, then what happens typically if you imagine like let's say I'm selling cookies at the state fair and there's me and there's another competitor and there's two spots that sell cookies and we both can manufacture all the cookies we want in a truck next to the next to the fair.
17:39
Um, and let's say people only buy cookies based on price and they're right next to each other and perfect competition all the rest.
17:45
So what happens is, you know, let's say each cookie costs a dollar to make.
17:50
Well, I start out maybe I started selling them for $2.
17:51
I want to make a dollar a cookie.
17:52
But my competitor realizes that if they charge $1.
17:54
99, they can get all the sales. And so they charge $1. 99 and then I charge $1. 98.
18:00
And pretty before we know it, we're both down to a dollar, then we're making no money per cookie.
18:03
And uh that's the equilibrium.
18:05
That's the coop that that's the non-ooperative equilibrium. We make no money.
18:08
But now, let's imagine instead that I had to bring a tray with a fixed number of cookies and I can't make more.
18:16
Well, what happens is that morning, I'm trying to figure out how many cookies I'm going to make.
18:18
And I ask myself the question, should I make one more cookie?
18:23
And if I make one more cookie, it'll have two effects.
18:27
One is I'll get to send an extra cookie and I'll make whatever the profit on the cookies are times that cookie.
18:31
But the other is it will increase the number of cookies in the market which will drive down the price of cookies.
18:36
And this will cause me to sell uh all of my cookies at a slightly lower price.
18:42
And so as I'm making this decision, you can see how there would be a natural maximization point where I maximize profits.
18:46
Now in this case, there's two competitors.
18:48
So when I add an extra cookie to the market, I lower the price for me.
18:52
I also lower the price for my competitor.
18:54
I don't internalize the effect on my competitor.
18:57
So I end up behaving like a like an like a monopolist, but a monopouist who only absorbs half of their price impact in the marketplace.
19:06
In other words, one who faces more elastic demand.
19:08
But I still behave like a monopolist just with one facing more elastic demand.
19:12
So there's still monopoly profits to be had.
19:13
So the equilibrium gets work.
19:15
We we both solve our differential equations at the same time.
19:18
we get to an equilibrium and lo and behold, we we we end up um we both end up making profits.
19:23
Okay, this is all very theoretical.
19:25
So, you start studying the cruise line industry.
19:26
Okay, just to pick an example of an industry I'm not that I'm not I've never owned a cruise line business, but it's been, you know, I've been around it.
19:33
It turns out that if they want more cruise ships, they can't just snap their fingers and have more cruise ships.
19:38
The number of cruise ships for a good long while is essentially fixed.
19:42
And and so what they do is this is perfect example of Corno Aliggopy.
19:47
Aliggopy. number of cruise ships is fixed um and in the short to medium term uh so they maximize yield uh which basically means they're adjusting price that leads you down a path of say okay this is a business where just from that perspective there's lots of other things to think about there's brand there's
20:04
distribution there's gazillion things but um from that perspective now you have a sense as to how this is a business where there should be some monopoly profits but you know what will mediate how much economic profits there are is how many competitors there are right and also um you know how much elastic of demand there is. And then of
20:17
And then of course other factors.
20:20
Um and then of course there's also the question of are you in equilibrium or did people accidentally bring too few?
20:24
Let's say let's say you show up at the at the fair and you brought your tray of cookies and it rains.
20:29
Well now cookies price of cookies plunges and you lose money, right?
20:32
Or let's say you show up and for whatever reason a famous singer shows up and there's gazillion people and now you sell the cookies at premium.
20:37
So you know are you at equilibrium is another, you know, good question.
20:40
But it turns out that like a lot of travel businesses are, you know, corno igopolis.
20:44
um you know, rental cars, um air air travel, um cruises.
20:52
So, this is an example of using a a mental model that allows you to understand like certain types of businesses in a somewhat systematic um way.
21:00
way. Okay, one of the investments I sort of cut my teeth the most on where I had sort of first had a lot of success was was in the construction equipment rental business and that is also um it is a cornoy um you know in any market there's a sort of fixed number of rental companies and the they own a certain
21:16
amount of equipment and their ability to change that in the short term is constrained and and therefore um you know uh it's a cornoy and uh it's also a good one because elasticity of demand is demand is very inelastic turns out Nobody said like, you know, I see the price of man lifts is down 100 bucks this week. I'm going to rent one. Uh, I'm going to rent one.
21:34
Uh, and at the same time, nobody ever said like, I'm I'm not going to build my building because the price of man lifts is up 100 bucks this month.
21:40
I hope that got to your question, but basically it you can think about there being many of these things like these concepts that that you can then kind of follow to their conclusions.
21:48
And of course, life is complicated and every company has like often a whole confluence of these things.
21:52
And what you're really looking for is a business where you have a sort of a bunch of these things that are working together.
21:56
with the cruise ship industry.
21:58
Like the idea that it takes a long time to re build a cruise ship and you can't just snap your fingers and have another cruise ship is fairly invariant to technological change in society.
22:06
society. like I guess maybe there's some future state where we can like you know print them out print them out but like for now and for the foreseeable future this is going to be fixed and and so um you're looking for you know relatively sort of technological change invariant
22:21
advantages you I again layered and and interwoven um that kind of give you the business and then and then from there you know I have a friend who who jokes that a good value investor's you know memo is like 20 pages about the business and one page on the valuation. So like
22:35
So like from then from there it's like I don't know like is it cheap?
22:38
Uh does it make a lot of money relative to the price?
22:40
Is it going to grow a lot relative to the price?
22:42
You know these are pretty trivial calculations.
22:44
If I was thinking about how you would spend your time, it would seem to be incredibly valuable to collect models like this over time.
22:48
Do you find your way to most of them through a specific business?
22:52
Which comes first, the business or the the mental model?
22:56
Oh, so you're asking how do you find the gold in the ground? Um the answer is yes. It's hard.
23:02
like in there's nothing I keep coming back to that but there's nothing about investing that's not hard.
23:07
Um we we look for you know I I've I hired a Stanford professor to assemble all of the economics um models in all of the courses in Stanford and just like walk me through all of them to make sure I hadn't missed any and I picked up a few that I'd like you know missed or forgotten about.
23:22
you know missed or forgotten about. I try to read broadly like you know um then of course you study companies and one after the other and for in various companies it'll sort of like click for you that something you know that something is happening to drive home the point can you do one more like the corno
23:36
oligopoly just to give us like a a flavored sense of like another thing that that you've used in the past secondary reinforcers so this just as a different place this is out of psychology it turns out that there's like a meaningful psychology literature that's been built up in animal studies and and uh people and all the rest. Um
23:52
Um which basically says this idea that when you give you know mammals uh something that stimulates their reward systems.
24:01
Um your brain for lack of a better term sort of captures the context in which it was received and then you know if it likes it tries to replicate that context and you can the sort of evolutionary reason why this makes sense is is self-evident.
24:19
Um, and what makes that interesting is that it turns out that the strength of these secondary reinforcers is proportionate to um the power of the stimulus um as well as it's proportionate to um the uh inversely proportionate to the time lag between when the stimulus comes and when you the pleasure sensors get stimulated.
24:46
So, you know, if something makes you feel good 3 hours after you got it, your brain kind of doesn't know where it came from.
24:51
If something makes you feel good, you know, within a moment of when you got it, then your brain knows um exactly.
24:57
And what's interesting about that is is these are called secondary reinforcers because um you can ass you create these associations between um the stimulus and other things that are in the context that it was received.
25:11
So, you can make rats um prefer cocaine that's given to them with a certain color light.
25:18
They'll continue to seek out that light even when you deprive them of the cocaine. Okay, cool.
25:24
That's a neat thing to know about the human brain.
25:28
Um where do I see that applied?
25:31
Well, if I were to rank by margins, the consumer package goods industries, I think the ranking might look something like this.
25:38
You'd have the nicotine cigarettes at the top and then you'd have like dip and then you'd probably have, you know, CocaCola and then you'd probably have coffee and then you'd probably somewhere have like candy and then you'd have like sugary sweets like um uh you know cookies and stuff like that and then you'd have like tomato sauce and bread and and then you'd have I don't know water, right? Something like that.
26:08
It's probably a rough like ranking.
26:10
Well, it turns out that if you go down that same list and you ask what is stimulating the pleasure people's like, you know, pleasure systems, well, in the case of nicotine, you know, inhaled through a cigarette or a vaping product, um, nicotine is incredibly powerful and the the respiratory system is a very fast delivery mechanism.
26:31
So you get this very rapid stimulation of people's pleasure sensors and lo and behold it creates these very strong secondary reinforcers which make people very brand low.
26:38
Um not only by if you ever watch smokers they're not only smoking the same brand they're smoking at the same time in the same place like every day.
26:45
Um it also helps that nicotine is addictive which creates a trigger for a habit which is a whole another brain function piece where you're kind of making and following habits.
26:56
Um, you know, if you go down the list, um, caffeine is a good a good stimulator, but, you know, it's not as potent necessarily as nicotine.
27:06
More importantly, you're taking it through your stomach.
27:08
U, and by the way, dip goes through your lips, so it's pretty fast, but not as fast as cigarettes.
27:14
Caffeine, you know, soda has sugar and caffeine.
27:17
It goes through your stomach, so it's slower, but it still creates a fair bit of um, uh, you association isn't that far isn't that far apart.
27:25
As you work, you then you get to things like cookies there.
27:27
The cookies mixed with fat and stuff, so it slows it down.
27:30
The sugars mixed with fat and stuff, so it slows it down even more, but it's still pretty potent.
27:32
It's a it's obviously a sweet.
27:34
Um, you work your way farther down, you get to your savories or whatever.
27:38
Here, you know, yes, these are things people really like, but like the the sort of stimulation is much weaker.
27:42
Uh, it's more time lagged.
27:45
Um, and as a consequence, you know, people like they have a preferred tomato sauce, but like, you know, in the end, you know, there's much less brand loyalty than say like a cigarette.
27:53
Um, obviously water other than if you think about brands that are more status focused, but like if you think about just sort of like a bottle of water, I don't think in the end anyone's that uh picky.
28:01
And I guess the valuable thing in markets would then be that markets don't properly value that insight.
28:08
Like if you look at Philip Morris, at one point it was the best performing stock in US history or something like that for like decades and decades.
28:15
So it would like corroborate this idea that it's probably like a valuable insight, but at some point it gets priced like like insights all get priced.
28:22
And so maybe that's what you were talking about earlier, which is you need a confluence of these things in an area that's been neglected to find an interesting opportunity. Something like that.
28:33
Yeah, you need something that scares people away.
28:35
Um, you know, I think the the you know, the example of I gave like I don't think it's a mystery to most people that like Coca-Cola is a good business, right?
28:43
I'm not totally convinced that like what I just laid out is like going to make you a lot of money in the public markets anymore because I think it's priced in.
28:51
I'm not totally convinced that the people who own these things understand it.
28:54
They just have observed that in practice these are very brand loyal businesses.
29:00
Um, however, you know, sometimes things come up and, you know, there there were um I was involved in a in a nicotine vaping company um which was reasonably successful and ultimately acquired by a large um tobacco company.
29:15
In the early days, it was not you didn't have necessarily all this evidence that um these were going to be really great businesses.
29:27
Um but the theoretical construct that I just laid out to you was an important sort of guiding factor in giving me confidence that um this was a business.
29:38
There's a lot of other factors, but this is a business that, you know, would ultimately be successful.
29:42
Or, you know, I have friends who um I didn't do it because I I thought I thought they were right, but I thought I had other things that were better.
29:49
Um, and there's opportunity costs to consider.
29:51
But I have friends who were successful investors in Philip Morris um international.
29:54
Morris um international. uh they they they were observing Zin and um you know a lot of this um like intellectual construct gave them a sense that like that Zin was going to have a lot of brand loyalty um you know where at that time you know it was sort of unproven um
30:15
and Zin of course is quite a big one has been has proliferated and and and and it's there's a lot of brand loyalty um but that wasn't obvious you know at least it wasn't in the historic historical data um until you know so so these were so the the you know all of these tricks uh they're they're not
30:33
useful until they are I guess would be kind of the way to think about it that you know if you think about the classical ways of of finding edge in markets it would be informational which seems kind of gone analytical which is a lot of what we're talking about and then I'll call the last bucket like
30:46
structural or behavioral or something like that what do you think about ESG like and it comes to mind because of the nicotine examples where there's just a class of investor that's not allowed to own it, which creates like a weird impact on markets, especially if those asset owners are very large. What do you
31:02
What do you think about ESG?
31:04
I think that if you manage money for other people, you're deeply arrogant if you are going to apply your ethical framework onto the way that you invest.
31:14
Society in aggregate comes to a collective view of what's allowed and what's not allowed.
31:19
And we call that the law.
31:19
And if a business is violating the law, you know, that's often a bad investment because, you know, obvious if societyy's evolving and the law is likely to change, that is a risk that one needs to factor into an investment.
31:34
And you'd be sort of silly not to think about that.
31:37
But if something is just disliked by a group of people, but they haven't built up the critical mass necessary to change the law in this country, and you don't think the risk of that happening is particularly high, but you decide that you're going to apply some moral framework and not make them money to do it, may not make money for your partners to do it.
31:57
to do it. That's a really fraught thing because like what you know sort of what gives you this deep wisdom about what's right and what's wrong that is better than like the collective will and unjudgment of society and by the way maybe you say okay fine I'm not going to
32:13
use my judgment I'm going to use my investor's judgment but then the question becomes okay well but which investor and how do you weight them like equally is it by by aum what what if it's an institution do you like do you pull the underlying like people at the institution like This is a wild thing. I
32:27
I think I think a much better approach is to just say that the goal is to maximize returns and um obviously in doing that you you know you have to companies have to comply by the law, you have to comply by the law and you have to take the change in norms into account.
32:45
um but laying any sort of further ethics onto that and and then of course if you maximize returns people can of course take that money and give it to whatever charity you know they they feel that they want to and and I think that that's that's sort of the only solution it's like a the only solution that that I think um kind of resolves this problem that isn't fraught.
33:05
I've noticed in my career that you know people in investing circles they talk a lot about like panics right this idea that you want to buy when things are bad.
33:11
I have noticed that there are certainly economic panics that have happened in my career.
33:15
I've also noticed there's sort of moral panics that have happened and um you know you can buy into moral panics much the way you can buy into economic panics and you can do well.
33:29
Now economic panics bring with them the risk that things could get worse and the business might not survive the challenges that lay ahead.
33:34
the challenges that lay ahead. moral panics bring with them the risk that um you you know you could bring about legislative or regulatory or rulemaking change that can that can hurt the company um and and so you need to take these things into account but um I think
33:50
that you know it's reasonable as an investor to look to areas where that are viewed as as sort of um bad but are not illegal and um and for what it's worth when I've dug into most things like this I've always discovered that the these things are far more complicated than the sort of naive, you know, coal is bad. Okay. Well, sure. But, you know, Okay. Well, sure.
34:10
But, you know, electricity is pretty good.
34:15
Um, you know, so it's complicated.
34:15
Um, I'll add one other thing which is this idea that you I think you mentioned which is funds that can't invest or whatever.
34:22
You know, that there's an implicit point that you're sort of saying which is an sort of elasticity of price concept.
34:27
And I'm not that I think the literature on this kind of agrees with me, but I don't think that like groups of investors deciding to forego certain asset classes like oil companies necessarily cause them to be like super cheap.
34:38
Um I do think that there can be sort of more broad-based things where people kind of don't want to own something for some reason and that can you know and if it's really broad it can have some effect.
34:49
Um, but I think mostly what happens is people just kind of get sc it's more of a panic.
34:52
People get scared like, "Oh no, you know, this company is going to get shut down because, you know, this group this group of people view it as terrible and they're going to try to kill it."
35:01
I think now is a great time to tell devote a long block of time to your investment in Carvana.
35:06
I I think people that know you and your firm's history will certainly associate you with the position.
35:12
It's been an enormous position for you over time.
35:14
You're one of the biggest investors in the business.
35:16
And for me, one of the reasons I've I've asked you so many times to do this is that, let's say, dating back five or six years now, I've had the chance to talk to you about this company through its many ups and downs.
35:29
And it's been one of the most interesting educations that I've received from another investor on investing, just talking to you every so often about this company and what you're thinking about it.
35:40
And so, I've been lucky to enjoy that, you know, audience of one.
35:45
And I thought it would be an amazing opportunity to hear you tell the story which is very complicated.
35:49
It's it's a complicated business story.
35:51
It's a complicated investment story.
35:53
Your own story about how you were going through it all is interesting and complicated.
35:58
There's all sorts of dimensionality to it.
36:00
You were joking that it's like five rivers coming together.
36:01
You kind of have to explain each river.
36:03
But we have the luxury of time here.
36:05
So I I don't know how best to start with which river. Uh maybe you can pick.
36:10
But I want to devote like a lot of time and I'll have lots of follow-up questions because I just think like you can go look at the Carvana price chart.
36:17
You can listen to my two conversations with Ernie.
36:18
Like there's lots of there's lots of stuff out there about Carvana.
36:21
But the thing that I find interesting is the investor's perspective as the person that probably had the biggest position, held on to it, bought more, um has been with it the longest.
36:32
You sort of had the most holistic perspective on it and I want everyone to benefit from what it's like to own and live through one of those episodes. Sure.
36:40
And and part of the reason I actually the b almost all the reason I said yes more than all the reason I said yes to coming on um is that it it is it has been such an a wild episode in business history and I sort of worried that if I didn't try to memorialize it to some extent um that it would get forgotten and it is such a it is such an interesting story um I think it deserves to be memorialized.
37:06
I was something that's sort of wildly misunderstood and it um in terms of like what happened to Carvana in 2022 and um and 20 and 23 and beyond.
37:13
So um yeah, I guess maybe a place to start just to level set for people who don't know it so well.
37:20
Carvana is an online retailer of uh used cars.
37:22
Um it was founded in in 2013.
37:25
You know the by Ernie Garcia who you've had on.
37:28
And if you were to broadly describe the company's history from 2013 to 2021, it was up and to the right.
37:36
the the business grew every year.
37:38
Its margins improved every year.
37:38
Um and uh it grew really fast.
37:42
It was it was doubling often every year.
37:43
Um slowed a little bit, but that was kind of roughly the p the pace.
37:47
You know, if you'd spoken to me uh in 2021, I but roughly would have expected a continuation of that trend.
37:54
And of course, what happened was was the business um slowed.
37:58
Um it lost tons of money. The stock went down 99%.
38:05
um which is more than pretty bad which pretty bad uh and and and then and then you know to to ruin the the story which I think most people like you know turns out that was all a mistake it turn company's fine uh it's it's right back it's it's a little behind where I sort of thought it would be but it's it's actually more profitable and it's back on track and the stock's mostly recovered and all the rest.
38:23
So that's kind of the the broad arc, especially now that we've laid the groundwork for how you sort of apply ways of thinking to understanding a new company and and so maybe even make it specific to you like how how did you encounter it?
38:33
What were some of the models that you know felt relevant to you as you tried to learn about the business and use that as a way to introduce like how the business works?
38:42
I first encountered Carvana in 2018 and uh they used to have a video up on their site, they might still that kind of describes the business.
38:50
It was a preIPO video, one of these things he put up or whatever.
38:53
And I remember sort of watching that video basically realizing this is an amazing business that's going to do great and uh it's incredibly underpriced and um I'm going to own a lot of this provided like everything they just said is true.
39:07
But obviously that's not how reality works in the sense that the reason why I felt like that was years and years and years of context.
39:15
And so to go further back over the prior years for, you know, like when you're when you're in my business, you you're waiting for your stocks to go up.
39:22
In the meantime, you're sort of looking at other things.
39:23
And so I had spent time studying CarMax and I had spent time studying car dealerships.
39:29
So I was sort of reasonably fluent in kind of how the auto retailing business works.
39:33
I'd also been involved in the auto lending business.
39:38
Uh, you know, I'd been a involved in credit acceptance, which is a oneonone auto lender.
39:42
I'd also, you know, looked obviously who hasn't like studied Amazon and like read the everything store and I'd also studied logistics companies um and I'd also looked at um uh you know manufacturing companies and all the rest and software companies and so it turns out that Carvana is like uh all of these things.
40:03
As they were explaining the business, it was clear to me that the the economic advantages that allow someone to build a a successful distribution company or a successful um retailer or a successful lender, all of them have, you know, economies of scale, scale, and trust.
40:21
And Carvana had in what Carvana was building was going to involve all of the advantages from all of these different businesses that they're effectively in at the same time.
40:30
And this is called economies of scope.
40:32
And by being great at all of these things, it was going to produce this very it could it could produce this very big um mode.
40:36
What I didn't believe uh necessarily um until I saw that video was that anyone would buy a car on the internet uh because that was just common wisdom and at the time this is you know this is a while ago.
40:50
This is before it was obvious but they just they had some co-workers and I was like well people clearly love this.
40:53
Um and and and and so um at that point like it was kind of like love at first sight.
41:01
Maybe to to sort of explain a bit about the business and why I it's I think it's so um the the things I identified turned into the tremendous advantages it it has today and our kind of the mode.
41:11
So let me just spend a few minutes.
41:13
So at the core the way the Carvana system works it will follow a car.
41:16
Carvana buy cars mostly from the public.
41:18
You take a picture of your license plate and you enter a few things and it's like four questions and they'll give you a price.
41:25
you can exercise it or not. You have seven days.
41:26
Once you do that, you can arrange to have someone pick up the car or you can for for a small fee or you can drop it off at one of their uh hubs and um you know get your money and the transaction takes no time.
41:38
Everyone gives them five stars.
41:41
Doing that's hard, right? Right?
41:42
Like what I just said, it sounds so simple, but actually being able to take a license plate to map it to a VIN, to map all the features of the car's VIN, to then be able to figure out like what you think you're going to be able to sell that car for, how much it's going to cost to ship it, how much it's going to cost to recondition it, and be able to work out from all that.
42:01
Therefore, what you think you're going to be able to make on the car, and then to figure out what you want to offer in order to maximize the profits like from this lead.
42:09
profits like from this lead. um you know and to do it all like you know for every car on the road like all the time across the country right it's like wild then Carvana owns a real estate footprint that real estate footprint consists of larger inspection reconditioning centers these are think very big facilities that
42:27
can recondition up to you know 40,000 cars a year with you know 6,000 7,000 8,000 cars in the parking lot which is a lot of cars then there's local points of presence they call hubs and those hubs would be you know there's one in um in Fairfield Connecticut um small um facilities that originally were sort of purely um uh non-consumerf facing. Now
42:45
Now they've modified them to be somewhat consumerf facing, but they're, you know, they're not very big.
42:51
Um and and so the cars at the hub, the hub is connected to the IRC.
42:58
Let's say you have the car picked up.
43:00
One of their nifty little single call haulers will come out.
43:02
It will they'll pick the car up.
43:04
They'll bring it back to the to the hub.
43:06
From there, that hub is connected to the IRC via logistics on a nine-car hauler.
43:13
Those IRC's are then connected to each other via um logistics um on ninecar haulers.
43:19
And what that does is it's built a hub and spoke logistics system.
43:24
It's it's like FedEx or something.
43:24
The sort of insight there which Ernie had was if you wanted historically if you wanted to ship cars, it was very slow and expensive.
43:32
And the reason is that sort of the amount of car shipping happening between Fairfield, Connecticut and you know Alabama and some place in Alabama um Mobile Mobile Alabama is just no volume and so the car you pointto-oint system doesn't work.
43:49
So what they've done in their in their in their hub and spoke system is they've collapsed down um all this volume onto like relatively narrow routes.
43:57
Most of the shipping is happening between IRC's.
43:58
There's a relatively small number of them and they're sort of sparsely connected.
44:01
And what that allows them to do is to move trucks continuously back and forth loaded with cars between these IRCs.
44:07
And you can think about them train tracks where the the vehicles are moving um can move continuously between these spots.
44:16
And what that does is you know if a truck travels you know 40 miles an hour on average and you know costs like you know $3 a mile to travel then you can work out what the cost on a nine-car hauler how fast cars can travel and what the cost is.
44:27
It's actually not that high.
44:29
high. Um and so um but running a hub and spoke logist network like this one it's hard right like logistic like building a logistic system requires a lot of density requires a lot of scale um there's also a lot of technology to it recruiting
44:43
drivers you know there's there's a lot um but that's the next piece of the system with that the car will come to an IRC and at that IRC it'll get reconditioned and reconditioning a car in an IRC is a challenging thing which dents do you repair how do you repair it? Um, and you can think about a
44:59
Um, and you can think about a reconditioning center as a bunch of different stations that do a bunch of different work that's relatively homogeneous.
45:06
So, changing tires, changing oil, inspecting, um, paintless dent repair, painting, whatever the thing may be.
45:14
A car starts out with a mix of work that has to be done to it that has to be ascertained in an inspection.
45:21
And then the car is going to be routed through the IRC to different stations and then come out and be imaged and put on the website. Sometime later it sells.
45:28
They take the car nine car hauler to the hub.
45:31
Now you'll see this is beautifully balanced.
45:33
The cars are coming back from the hub.
45:35
They're also going out to the hub. Sure. Right.
45:37
So the car will go from the IRC it's at to the IRC closest to the customer along basically the rails and then it will go from the IRC to the hub and then from the hub it'll be delivered on the single car hauler or picked up um by the consumer.
45:49
That's in the physical system. There's also um finance.
45:52
If you go on their site and you enter information um instead of searching by price, you can search every car by payment.
45:59
So you can adjust the number of the months your down payment.
46:04
Um and you can see each payment for each car to the penny based on your individual credit score.
46:10
And this isn't an estimate.
46:12
This is this is exactly what it is.
46:13
In order to do this, Carvana has a fully verteated vertically integrated financing stack.
46:17
Um, so they're essentially underwriting you for every loan combination for every car in real time and then they're taking that uh and they're making it available to you through this like cool widget.
46:27
Um, to this day, as far as I'm aware, no one's like replicated this capability.
46:37
Um, in order to do it, you need to be vertically integrated into prime lending, subprime lending.
46:40
It just turns out that like no one else is.
46:42
And it's also very hard to get into the, you know, to do these businesses.
46:46
There's title and registration.
46:47
Obviously, you've got customer service.
46:49
You know, the thing about this business is you have to remember that like this is all great, but things go wrong.
46:53
Then you have to deal with like all the corn many many corner cases that can come up.
46:56
Um, if you want to entertain yourself, like go read the one-star reviews at Carvana.
47:01
It's like, well, I was moving and I ordered the car when I lived in Florida, but I needed it delivered to North Carolina and you know, then like there was a hurricane and as a consequence it was late, but then like there was problem with my title and you're like, "Oh my god."
47:16
That's kind of the the how the system works.
47:17
works. Now in in that whole system like let's identify some economies of like scale inventory turns out selection matters matters a lot and there's if you think about all the makes models trends years of cars uh as well as mileage like the selection space is massive massive
47:34
and Carvana's coverage even at its size is is still relatively small and so as a consequence um conversions go up as selection goes up and um so selection is like big economy scale everything store yeah um logistics, the cost of running a logistics system. Um you know, you can
47:50
Um you know, you can think about moving these trucks as like a fixed cost.
47:54
And if you want to provide complete connectivity and move cars quickly, it turns out conversion speeds matter a lot.
47:58
And by the way, when you think about the inventory space, inventory nearer to customers increases conversion because you can get to them faster.
48:04
Then you can think about these IRCs.
48:05
These are very large facilities.
48:07
It turns out that um run well, you can recondition cars for a lot less money and time because cars are depreciating assets.
48:14
if you have like a big facility.
48:17
So like if I have a a traditional dealership, the car comes in and like one guy does all the one guy or gal does all the repairs.
48:25
But the problem is that person isn't necessarily the right level of like they're overqualified for a lot of the things they're going to do on the car.
48:32
Um and they have to change tasks and th that slows you down.
48:36
If you're at Carvana, you can have people who are very entry level to do the cleaning and the oil changes and the tire changes and you can have advanced mechanics do just like a very narrow subset of stuff and you can have people at like specialized stations where like this is what they're doing and so they can be more efficient.
48:53
Now to do that though you have to efficiently route the cars through the system and all the rest.
48:55
Um also the dealership is in like an expensive place and so you have less overhead.
48:59
So like these are just examples of place but there's economies of scale to doing that as well as enormous like process power like economies of scale.
49:05
Underwriting uh loans is you know obviously a a a you know an endeavor where you you learn the way to do this over time.
49:14
You connect all these data sources.
49:16
You you learn how to predict defaults.
49:17
You then get data over years that cycles back into it.
49:21
Title registration like there's software that's built to run all this.
49:24
So this is this is like there's enormous economies of of scale um and skill in terms of like being able to do all these things.
49:31
And then you know I I would be really remiss if I didn't mention trust.
49:36
Um consumers when they buy a car it's an act of a sight unseen it's an act of trust.
49:40
Um we can talk about how Carvana grows.
49:43
Um, and it was one of the things that kind of went wrong in 2022.
49:44
But like getting Carvana is able to get people to buy cars because there's been an enormous amount of word of mouth built up over many years of delivering great experiences.
49:54
And you know, you can't buy that.
49:57
You have built it up over time.
49:59
That's trust on the on the buying side.
50:01
There's also trust on the selling side, although less.
50:02
Um, there's also trust uh in the financing business, right?
50:07
You make these loans, then you sell them.
50:08
and the people who buy these loans have to trust that you're making these loans to spec and that the loans are going to perform kind of as advertised a great originator subject to economic conditions.
50:15
The other thing about this business is if you think about a car transaction, it's a it's a whole series of things that have to go right.
50:21
And um if you get any one of them wrong, you you're going to lose money on the transaction and your customers going to be miserable.
50:27
And this is economies of scope, right?
50:30
So this is idea that you have to put this whole portfolio of things together and you have to get them all right and you have to get them all right every time.
50:35
And um you know this is it's this combination of things.
50:37
And if if anything I've said sounds easy, it's because I haven't described it right. Like it's so hard.
50:43
Um and and so that's why everyone who's tried to build this business besides Carvana has failed.
50:49
And that's why it's taken Carvana, you know, over 10 years and 10 billion dollars um to get, you know, where it is.
50:55
And you know, outside the outside the US, there are other people trying to copy Carvana in other markets.
51:01
And you know, some of them are doing okay.
51:03
A lot of them have failed.
51:03
Um but none of them are doing really great and and just the bottom line is that it it is so hard.
51:09
Just to pause on the on just like the concept of combining skill, scope, trust, you know, traditional economies of scale of different types.
51:19
Is there another business that comes to mind?
51:21
Maybe it's Amazon that you think captures all these same things that has interested you through time just to like draw a comparative point for people.
51:28
I actually love the comparison to Amazon.
51:31
You know, there's a famous there's a video I saw once talking about famous, but I love it where Jeff Bezos is describing why books is the first best place for an internet business.
51:37
And he talks about how the selection matters so much.
51:41
And then he talks about how you can get the books and you can ship the books and and um you know um and you can pay people can pay for the books.
51:48
Well, imagine if I I actually think that from a consumer's perspective, used cars is just as great as books.
51:55
The selection space is infinite.
51:57
selection matters an enormous amount.
51:59
Um, also what I described with Carvana system is a lower cost to operate system than the traditional dealership system.
52:04
It's a better experience.
52:06
But the thing about books is it's really easy to do.
52:09
Imagine if you had to start Amazon, but you couldn't just call up the manufacturer and get books.
52:16
You had to manufacture them.
52:16
And uh, imagine if you know, you couldn't just call FedEx and have them ship the books.
52:25
You had to build basically FedEx and imagine if you couldn't just like accept Mastercard, right?
52:30
You had to build a financing platform.
52:33
And Lord knows you can't just sell the person the book.
52:37
You have to do title and registration, right? And all that.
52:39
And you know, with books, the stakes really just aren't that high.
52:44
Um, and so people are willing to try it.
52:45
And if it doesn't go so well, you know, they're disappointed, but it's okay.
52:48
Car second largest purchase of your life.
52:50
and and so uh you can imagine how like that is also really uh challenging.
52:55
Um and and so in the sort of fulfillment sense of it uh I think you know used vehicles are probably the hardest uh thing um to build in uh but the analogy to to Amazon actually I think is uh is apt.
53:12
I've interviewed Ernie a few times.
53:14
I'll, you know, my bias is that I I I think very highly of Ernie and he's a much maligned figure because of everything that's gone on with Carvana and it's just it's so fascinating to me to hear all the different like Rashimon style parts of the story.
53:26
So I I'll put out there that I think very highly of Ernie based on what I've known.
53:31
I haven't studied the business like you at all. I don't own Carvana.
53:33
Like I don't have a dog in this hunt financially.
53:36
But I think it's important to say a little bit about management and maybe it's also an excuse since I haven't asked you yet to talk about how you think about management as it relates to certain businesses and where you fall on the spectrum of like leadership is everything to like the Buffett ham sandwich you know concept of a business that's so good that a ham sandwich could run it because someday someone will or one will.
53:55
Um so talk about Ernie the management team behind car the team behind Carvana and kind of your philosophy on management and investing.
54:04
If you'd asked me five years ago I would have put myself firmly in the let's focus on the business.
54:09
I don't think I bring much advantage to understanding management.
54:12
It's been an exciting five years.
54:14
Uh and in that time, one of the things that's come out is the businesses where if you'd asked me, okay, Cliff, I get it.
54:22
You don't care, but like rank them anyway.
54:24
And I'd ranked them the teams that I was involved with, I would like my that ranking would have perfectly predicted how how like things did relative to my expectations at the time.
54:35
So what I learned there was two things. One, it matters.
54:36
I knew it mattered, but more importantly, I think I can judge it.
54:40
And so now I fall into the obviously I care predominantly about the business and the price.
54:45
Like that is in the end the right thing.
54:46
A great team with a terrible business is is going to be a ch is going to be a slog.
54:49
There's just no two ways about it.
54:53
Um, by the way, just to go back to your contained versus uncontained point, like that's another idea is like there are businesses where there's a new problem to solve every six to 12 months and it throws up a never- ending series of hard problems, you know? So, you want businesses.
55:07
So, a contained one would be one where like once it's it's set it and forget it's the wrong term, but there's like an obvious like would you like to sell more cars? Yes. Yes, I'd like you. Um, okay.
55:17
So, now going back to management.
55:19
So, so I don't necessarily think I'm going to ever get to a point where I'm like these this team is great.
55:23
I don't care that this is a business that will throw up perpetually throw up bad hard problems. I'll buy it anyway.
55:28
Um, but I do think that I've now come to understand that like that I can judge it and that um there that management matters a lot.
55:35
So, it gets weighted into my thinking in a way it wasn't before.
55:39
For what it's worth, I'll add to you how I judge it.
55:40
I meeting with a management team is great.
55:42
It turns out all the people who become CEOs figured out how to sound great.
55:46
um you know, I learn a little bit, but uh and I certainly listen to them talk in public and you can definitely pick up over time who kind of is making what seem like sound business judgments and giving good reasons for them and people who you know aren't.
56:00
That being said, the really good way to do it I find is I talk talk to former employees and I'm certainly interested I'm using that to learn about the company, learn about how it works, how do you buy things, how do you sell things, blah blah blah.
56:11
Um, but I'm also just assessing them and you know a company which spits off people who worked there for 10 years left on good terms who you just like I don't get it like this guy's an idiot.
56:21
Um, that says something about you know the caliber of people in the organization and the human capital exhaust is kind of indicative of what's inside.
56:31
Um, and conversely, you know, when you when you find yourself when you talk to, you know, go talk to 10 former employees who spent at least five years at Capital One, they'll blow your mind.
56:41
That tells you something about what's going on in Capital One.
56:45
Um, and and so, um, I find that that's really the best approach.
56:49
Um, as to Ernie, I think, um, you know, at the risk of, um, inflating his ego, I I think that, um, someday people will con compare Jeff Bezos to Ernie Garcia, not the other way around.
57:04
Um, he's extraordinary, right?
57:07
This business is incredibly difficult.
57:10
As I've tried to emphasize so many times, there's a reason why they've succeeded where, you know, nobody else in the world has been able to um, you know, succeed.
57:22
And I'll also add that like I I'm aware obviously of his dad's history, you know, with the savings and loan crisis and um, you know, this is um, you know, I think it was either a 20 or $50 fine that he paid as like a late 20some.
57:39
And this is by the way his dad, not him.
57:41
And you know, this is um 50 years ago or 40 years ago.
57:47
It's just that, you know, it is um it is wild to me that people then take What his dad? Yeah. People take that fact.
57:53
They're like, "Therefore, this company, you know, is a fraud."
57:55
And it's like, "Oh my god, like this is the, you know, the guy was a billionaire.
57:58
What was his plan to like be make a few billion more, but send everyone he loves to prison?"
58:02
Like this makes no sense to me.
58:02
If you just spend any time dealing with talking to people who've dealt with the Garcia over the 35 years that you know since the you know guy you know made a mistake which you know if you actually go through the details of it it's not obvious he did anything super wrong but like whatever he got caught up in stuff everyone speaks incredibly highly of them.
58:26
They've done nothing but behave totally ethically.
58:28
if you go through the experience that the company had in 2022 or whatever, like there were plenty of opportunities for them to hurt us as third party shareholders and they haven't and you know, so I I mean Ernie does a great job of just tuning all that nonsense out.
58:41
As to like what he does well, he's incredibly smart.
58:43
Uh he's assembled a team around him that are incredibly smart and um he does a great job of thinking about things in a variety of perspectives that are very um you know, wise.
58:54
So on the one hand he'll analytically explain to you how as an outside investor you could look at CarMax and try to make a sensible guess at what Carvana sees as its price elasticity demand which is a fairly analytical thing.
59:07
fairly analytical thing. Um and then you know if we were to ask him a question about you know once upon a time I sort of said why don't you adjust your pricing to kind of like compete more aggressively with Vroom and he basically sort of described how if he made competing with Vroom something that
59:23
mattered then suddenly instead of focusing on the customer everyone in the organization would be sort of when Vroom wins we lose when Vroom loses we win we're not focused on the customer anymore and he was thinking about the second and third order like social effects on his culture um and he's very deliberate about things like that. All
59:37
All right, now we get to talk about the tough part of the whole story and experience.
59:42
What went wrong with the business?
59:44
Just tell us the whole story like what what it was like to be one of the larger investors in the business as this was going wrong. What did you do?
59:52
How did you second guess yourself?
59:52
What was the psychology like?
59:54
Like I'm interested in all aspects of it.
59:55
It's worth pointing out where the company is today because through most of the company's history, it was obvious that Carvana could grow.
1:00:03
Carvana could grow. margins however were improving but there was always debate around the economics of the business and I I said earlier that this is a more efficient system um and for a long time that was a matter of conjecture I could sort of work out unit economics and how much does it cost
1:00:18
to ship a car a mile and blah blah blah but like it didn't you know we couldn't see it like on the press release um as of now uh the company's margins IBIDA margins and they have very little stockbased comp and relatively little capex um are 10 and a half, you know, percentish and and rising. Um, and
1:00:37
Um, and they'll probably get to the 13 14ish percent range.
1:00:43
Um, based on what they've said, and there's nothing no reason to doubt it.
1:00:48
Um, and the average car dealership is about four and a half.
1:00:51
So, they make of the order of two and a half, 3x the margins of their competitors.
1:00:59
and we track every car that they sell and we compare it to similar cars sold by CarMax.
1:01:04
We also compare it to other market indices and we believe that they sell cars um of the order of sort of $500 $600 cheaper doing that.
1:01:11
Um now in fairness they charge a bit more on financing but um they it's still cheaper overall.
1:01:19
Um and they offer obviously a far superior um experience, far superior selection and they're growing um you know there's high frequency data that's published and so recently they've been sort of growing 45 to 50% um year-over-year.
1:01:35
And so the idea that they're putting all these things together at this point you no longer need to um so speculate about the power of the model.
1:01:45
It's also a model that gets better as it gets bigger. Right?
1:01:47
So as time goes on, the selection gets better.
1:01:52
And so I should make a note here.
1:01:53
A traditional car dealership is a monolithic unit. Certain number of cars.
1:01:57
Even if you think about like CarGurus, it's a certain number of dealerships in your area that collectively have some number of cars.
1:02:01
Carvana's pulled national inventory is like there are more cars available on Carvana's website right now than there are for us right now sitting here in the entire state of Connecticut from all the other dealerships. Right. Right.
1:02:10
And that's only going to improve.
1:02:12
Brand also process efficiency.
1:02:14
they still have a long ways to go.
1:02:15
Um, in terms of um, uh, fixed cost leverage, there's a long ways to go.
1:02:21
Um, so this is a business that gets better as it gets bigger and it's already so much better than its rivals.
1:02:29
And its rivals, of course, it's very challenging um, to meaningfully update the processes in a car dealership.
1:02:33
It's just not a very scaled organization.
1:02:35
How much technology can they really bring to pay? All the rest.
1:02:37
I thought I'd just finally finish finish that that that story. The company grows.
1:02:40
The company had enormous amounts of demand in 2021.
1:02:44
just put a car on the site, car disappeared, and they were trying in o to overcome the challenges of the pandemic to build supply to grow to grow tremendously into 2022.
1:02:55
Um, they sold something on the order of 425,000 cars in 2021.
1:03:00
They had ambitions of doubling or more in 2022.
1:03:03
To do that, over the course of all 21, they were hiring and hiring.
1:03:09
As it would work out, demand collapsed.
1:03:11
And um they discovered all manner of operational problems that they were having and it made 2022 really challenging.
1:03:18
You know when you tell a story like this you have the benefit of everything you learn during the whole period and everything you learned after and all the time to synthesize it and sit calmly later on and figure it all out.
1:03:28
All of this happened in a cloud of dust with incomplete data.
1:03:31
So it's all going to sound so neat and put together and understood.
1:03:35
And there were definitely pieces of this that I had nailed and there were pieces of it that I learned later but I just want to Yeah. Yeah.
1:03:41
You know, this was real life.
1:03:41
What happened was um at least my understanding of it now was a few things.
1:03:47
One is they had a bunch of latent operational issues which we can walk through.
1:03:50
Another was that there was uh just a very unusual used vehicle market which led to the used vehicle market being significantly smaller than normal in 22 and it still hasn't fully recovered.
1:04:00
It's only partially recovered.
1:04:01
In particular, it was bad for independence and we'll talk about that.
1:04:04
Another was the vehicle financing market um did totally strange things which made life absolutely miserable um for them and then of course because because things had to be the way they were they bought a DESA they added a bunch of debt the capital markets were close to them all the rest which is another set of
1:04:20
external facts so let's just in terms of um let's just do internal operational stuff because it's interesting the company had been growing year after year um circa 100% and when you're doing something as complicated as what Carvana is doing and growing as fast as Carvana is growing. things were always going
1:04:36
is growing. things were always going wrong and I would always hear kind of some horror story or another out of some part of the organization but you know you looked at the overall rate star ratings they had great reviews it was like well you know it's big organization they're growing really fast to put think about it like if you're doubling every year less than half of your employees on
1:04:53
average have been with you for like less than a year right this is wild they also had prior deliberately prioritized speed and growth over necessarily slowing down and like really hardening their processes and the reason for this uh was
1:05:06
that they viewed you know, this is a scale business and there was risk that if they weren't first to scale that they would be disadvantaged over time and at the time their competitors hadn't failed yet. they grew a lot of their um
1:05:14
they grew a lot of their um operations were more mediated by like I'd call it said tribal knowledge and culture and so silly example but but a real one there's a role at the IRC inspection reconditioning center for receiving trucks taking the cars off the trucks putting different cars on the trucks and sending the trucks on their merry way.
1:05:35
It sounds simple enough, but it's a lot of trucks and it's a lot of cars and there's this, you know, question of like where do you put the cars and uh what order do you put them on the trucks in?
1:05:44
And um by the way, if one of them doesn't start, what do you do?
1:05:49
And um how do you staff this operation?
1:05:51
Because it turns out fetching a car is, you know, in a 6,000 car parking lot is like it's not like walking down the street and getting a car, right?
1:05:58
and you know all of these things and you know if someone's done it well and sort of smart and they can kind of figure it out and they can do a pretty decent job.
1:06:07
Um but as you scale you're putting people into roles who you know may not be as good at this and um in 2021 in retrospect for the first time the business kind of in part because of COVID in part because of the growth the business's kind of reach outstripped its grasp from a process maturity perspective.
1:06:27
Now, in 2022, there's a software system, and the software system tells you like this is how many people you need at these times of the day, and this is where you're going to put the cars, and this here are your here's your protocols.
1:06:40
You're going to have a starter like like a a jumper.
1:06:41
You're going to keep it here, right?
1:06:43
And like this is how you do this.
1:06:45
this is how you do this. And it turns out that that this pro set of protocols locally and globally optimizes better than even the best people but also makes sure that everybody so it takes the best people makes them better and then takes everyone else and makes them almost as good as the best right that software had
1:06:59
never been written right because this was just not a function that someone had ever bought because think about how that's in and of itself what I just described is a fairly meaningful like project right before 2018 before 2019 I should say the company bought almost all of its cars at auction so the flow of cars was auction to IRC to customers. Starting in 2019, the
1:07:16
Starting in 2019, the company began buying cars in the public.
1:07:20
And this has been a wildly successful thing.
1:07:21
They make a lot more money doing this.
1:07:22
But it turns out that when you do that, you create the potential that if you buy more cars than your if you have a node in your system, an IRC, it's possible, unless you you've thought about this, for cars to accumulate at a node.
1:07:35
You can be buying more cars than you're than are leaving that system or more cars can be transiting in than are leaving.
1:07:40
And if you have finite amounts of parking um this can create congestion.
1:07:45
And what had happened what interestingly what happened for the first time in 2021 or so was the buying cars process became really successful and they were buying more cars for the first time.
1:07:55
They were buying and so now suddenly they had this shift in this in the logistic system sort of reduced the flipped the direction of net flow. This is fine.
1:08:03
You just you just need to build a bunch of things to change it.
1:08:04
But like this is an example of the sort of thing that was happening all at the same time.
1:08:09
A lot of this was covered up in 21 because they were hiring to beat the band.
1:08:12
And so when you have excess staffing, it kind of covers up a lot of blemishes.
1:08:15
As you get into the end of 21, the first indication that something was wrong was, you know, slightly weak November.
1:08:22
And then omocrron happened.
1:08:25
Their whole system became a disaster.
1:08:27
And the reason is that if you think about pro a car as like a series of events that have to happen one after the other.
1:08:32
If a let's say you have a truck and the truck goes out 250 mi, switches with a driver and comes back.
1:08:37
Well, if that driver calls in sick, like how does that truck route continue?
1:08:41
Okay, so now you have nine cars that just got stranded somewhere, right?
1:08:44
How do you get those cars moving again?
1:08:46
And now this happens all the time, but like if this happens a lot, you overwhelm your ability to like clear these things and now you have cars piling up in basically giant traffic jams throughout their whole system.
1:08:59
And then your delivery times that you're promising on your website have to get way extended because you just can't.
1:09:03
So your sales come way down which if you haven't had a system before where you could accidentally buy more cars than you're selling because that's never come up.
1:09:10
Now suddenly you have a problem where like you're pi buying cars they're accumulating the system you know and and you don't have your your flows to your logistic system haven't been optimized for this.
1:09:17
So the cars are piling up everywhere.
1:09:19
You're sort of shuttle you're shuttling cars moving.
1:09:22
This is what the system looked like in you know January of 2022. It was total wreck.
1:09:28
Um, and they were trying to fix it and you know it took them a few months to do it.
1:09:37
Like took them three, six months or whatever to fix this.
1:09:38
But the important fact is that it obscured demand which was falling off a cliff.
1:09:45
Underlying demand was falling off a cliff.
1:09:47
And it meant that they were still behaving in February like demand was as it had been in September.
1:09:54
Even though by that point in retrospect demand had materially declined.
1:10:01
Um they bought Adessa using tech.
1:10:04
They desa was just describe what Adessa was. Sure.
1:10:07
So Adessa um is a is an is a traditional auction business.
1:10:10
So um think a large lot people bring um car dealerships fleets they bring cars and they hold inerson auctions.
1:10:20
As you drive down a lane, people bib.
1:10:21
The inerson auction business will have a long tail to it, but it's eventually a decaying business over time.
1:10:26
But what they got with Adessa is 54, I believe, very large centrally located properties on which they can build and uh IRC's and store facilities.
1:10:37
One of the challenges in their business had been that you turns out they they worked out that they need that it is better for them to have large IRC's located relatively close to the customer because high fast delivery speeds are good.
1:10:49
access to labor pools is good and those are more important than kind of the benefits of being far away.
1:10:55
Um but it turns out that building getting 200 acres you know like zoned for um you know auto industrial in like you know within 10 miles of downtown Boston is difficult to say the least.
1:11:09
Turns out this is the sort of property that Adessa had and so they basically was they bought it for the commercial real estate.
1:11:15
It came with the auction business which has a lot of benefits to them as well.
1:11:20
um and uh makes all the sense in the world.
1:11:23
It's been in retrospect it's been a huge home run.
1:11:25
Um but you know they bought it with all debt.
1:11:27
They bought it in February of 22 after if you read the proxy or whatever they've been talking for years.
1:11:32
Um it just happened the timing was was bad.
1:11:34
So what happens is you get to March and they sort of realize that they have a demand problem and I haven't really addressed what was going on that caused the demand problem.
1:11:46
There were, as far as I my my best understanding is there were three things, although at the time I pretty much only sort of knew about two of them.
1:11:54
And it's worth pointing out that all of these things they kind of got worse and worse and worse and worse and worse over time.
1:11:58
So you thought you'd identified it and then like six months later it was like worse.
1:12:01
So the first there were chip shortages during 2020 and 21 which caused manufacturing shortages and caused used car prices to rise.
1:12:10
You think about the used car business as facilitating people swapping cars.
1:12:13
But what happens often times people are swapping cars is they're is they're upgrading and so if prices are higher um the cost of upgrading is greater and that tends to reduce people's propensity to swap cars.
1:12:23
As a consequence of that the used car industry which is typically about 40 to 42 million cars a year.
1:12:28
Um it was about 39 and change in 2021 fell to about 36 million cars um uh or 34 million cars.
1:12:35
I think it got as low as 34 annualized and the 36th year or something like that.
1:12:41
I might have my stats slightly off, but it fell.
1:12:45
And this doesn't seem like a huge negative effect, but it was bigger than you might realize because what happened was franchise dealerships, I think your Ford Toyota dealership, when a lease vehicle is returned, unless the customer exercises their buyout, the landing dealership, the one you return it to, gets the car at at a price that's been set at the time the lease was created.
1:13:06
And so when car prices rise, if the lease returning person, a horse dealership has no incentive to tell them that they have the right to buy the car, um, doesn't know this, which many people haven't read the fine print of their leases, and they return the car.
1:13:20
The dealership gets basically a really cheap car.
1:13:22
What this turns into is a big subsidy for franchise dealerships.
1:13:26
And those dealerships would then turn around and sell this car.
1:13:30
It would look to them like a big profit, but was actually really cheap relative to wholesale prices.
1:13:35
But what that's doing is putting enormous pressure on non-ranchise dealerships who don't have access to this super cheap inventory.
1:13:40
Oh, by the way, that's us.
1:13:42
We're a non-ranchise dealership.
1:13:44
Um, and and so the best example to understand the magnitude of this is CarMax.
1:13:47
So if CarMax in the Great Recession, CarMax briefly saw nearly a 20% decline in in comp store sales for like a few months and then it was sort of down like back up to like low double digits.
1:14:00
CarMax's comp store sales were down 20% for the whole year in 2022.
1:14:04
And they by the way like still haven't recovered.
1:14:07
Um I think they've sort of clawed half that back.
1:14:09
The reason was in part because cars are more expensive and and interest rates also made the cars more expensive.
1:14:13
And the other thing was this weird effect where franchise dealerships were being unusually competitive um because they had access to this unusual uh source of cheap supply.
1:14:25
So as a starting point you had the biggest decline since the great recession including the great recession bigger than the great recession um in the number of used transactions at a independent dealership which is a rough place to start to make matters worse um so that was the the used vehicle market. Carvana was facing that.
1:14:43
The second thing that happened when interest rates rose, the sort of naive thing you would think was certainly what I thought was it wouldn't matter all that much to Carvana, right?
1:14:53
Okay, so interest rates will rise.
1:14:54
That could affect the overall market a little bit.
1:14:56
It it it will probably affect car prices a bit.
1:14:57
So the depreciation curve of a car, but in the end, people's propensity to sort of swap cars shouldn't change that much.
1:15:02
And yes, to Carvana's financing business, you know, they just finance a spread off of rates.
1:15:08
So whether rates are, you know, one or or four sort of shouldn't really matter that much.
1:15:12
And that's totally correct.
1:15:13
And that's exactly where we got to. But there was a catch.
1:15:19
You see what I didn't know?
1:15:24
This is where the 99% part comes from.
1:15:28
Um, you see what I didn't know was that when rates would go up, so the auto finance market's made up of a bunch of credit unions and small banks and then a bunch of larger banks who compete and then independents like like Carvana um, who compete.
1:15:39
The credit unions price their loans I mean it depends on the credit union but like off of deposit rates or off of fed funds or off of a you know a napkin.
1:15:50
The two-year went up and fed funds were low and deposit rates were low and the credit unions and when I say the two-year it's worth pointing out the average duration of a pool of auto loans including prepayments and defaults is about was about two years.
1:16:04
So the two years is a reasonable proxy for the appropriate kind of risk-free benchmark.
1:16:08
So, in in late 21, as the two-year goes racing up, as people expect Fed funds to rise, all these competitors just didn't raise rates because because they didn't.
1:16:18
You there's no there's no like academic reason why they shouldn't have.
1:16:22
They just sort of didn't.
1:16:23
Um, and then even as the Fed as Fed funds began to rise, they were super slow.
1:16:27
And you know, I remember there was a long period of time where like Navy Federal was offering car loans at a discount to Fed to the Treasury of the comparable duration.
1:16:38
And this is a big problem for us.
1:16:40
Like this is funny except for the fact that we have to compete with this every day.
1:16:47
Industrywide auto loan spreads by late 222 were at the lowest levels in the whole time series.
1:16:53
I have going back to before the crisis, before the the financial crisis in 2008 and was a wild time for that to be the case because every other consumer credit spread was wide for a whole bunch of really good reasons and the underlying auto collateral was the most kind of overpriced it would ever be.
1:17:09
So auto loan should have been really expensive um on a spread basis, but instead they were at their all-time.
1:17:16
reason was that there was just all these dumb competitors and then you'd call these you know you we did research into what was going on.
1:17:22
what was going on. um and it you know be like well our asset liability management committee meets like once a quarter and then we try not to raise rates more than like 25 bips at a time and you just like all the and then it takes us 60 days to like implement the rate changes because our systems blah blah blah and you're just like but guys like it's kind of like when oil goes negative
1:17:43
like this is not supposed to happen right it's like this is definitely not in the textbook but so the problem so CarMax they just ate it they just originated at low spreads and then the next year and even to somewhat it's
1:17:55
getting better now but if you look at their financials you could see they paid for it a year or two later but they they aided at the time they they sacrificed a bit of the future for the present. Carvana was not in that position right
1:18:02
Carvana was not in that position right like we you know the company needed the money um so Carvana had to price to to reality and um that meant that Carvana was in the market with loans that were like meaningfully more expensive than competitors which did not help.
1:18:15
Um, and to just put this in context, Capital One also priced to reality because they're smart.
1:18:22
They saw their auto originations fall 5050%.
1:18:27
Um, so Carvana is dealing with both of those things.
1:18:28
The other thing, which I think is more subtle, but I also think is true, um, has to do with with early adopters.
1:18:34
And to explain this, I need to go back and explain a little about how Carvana grows.
1:18:38
Um, and this is one of these this is the part that I was least aware of at the time, but I've done more work on and I've I've I've come to understand a lot better.
1:18:46
Carvana, you know, if you think about a market like Connecticut, Carvana has I don't know exactly how big Connecticut's, you know, used like fleet total used vehicle inventory is, but let's say that Carvana has something like 3/4 of all the inventory, including Carvana's inventory in the state of Connecticut just to make up a number.
1:19:03
One might ask why we don't have like threequarters of the sales um because they probably have I don't know Connecticut sales have my head like 1% something like that.
1:19:11
And so, you know, the first thing you might do is throw out, okay, well, there are some cars they have there in California. There's shipping fees. There's delays.
1:19:16
Like, let's only look at cars that are nearby.
1:19:19
And so, you cut that inventory down.
1:19:19
And then you might say, well, let's throw out people who haven't heard of Carvana.
1:19:24
Turns out they have like 80% awareness, but we'll throw out some people.
1:19:25
Okay, let's reduce some half of people say they don't want to buy a car online right now, although the number is gradually falling, but like let's throw out, you know, that half.
1:19:32
You're still left with a number that's way higher than where they are.
1:19:36
So, like, where are the sales?
1:19:37
the sales? And also weird is okay you go into a market you have all this huge inventory this great this great product why does it take all you know why does why do sales kind of ramp like this as opposed to just like step function like what like what is what is delaying people adopting this I didn't have a great answer for that for a long time
1:19:55
but I kind of thought it was word of mouth I was kind like you know I think just takes time word of mouth and but I and my evidence for that was that if you surveyed um people who bought from Carvon asked them if they recommended it to people I think it's something like four they would recommend to four people on average which is an enormous like you know never viral thing. Yeah. And so Yeah.
1:20:09
And so that's where I'd left it.
1:20:11
Um but as you know in the sort of wreckage of sort of trying to figure all this stuff out you know I started thinking harder about this and it occurred to me that I' I'd never done sort of two things which seem obvious in retrospect.
1:20:24
One one is I'd never asked people how important this word of mouth was to their decision to buy from Carvana.
1:20:29
So we added to the survey something to the effect of um uh you know um like did you get a recommendation from a friend or family member? How important was it?
1:20:38
And we found that 70% of people said that it was either somewhat or very important in their choice to buy from Carvana.
1:20:44
Therefore only a third of people were buying from Carvana without um the recommendation of a friend or family member.
1:20:50
And you know once I saw that that got me thinking like like I wonder what's going on with this third of people you know who are buying without the recommendation.
1:20:57
So that convinced me there's virality, right?
1:20:58
Like you know, but what's going on with these people who are who are buying without the recommendation of a friend and family member and my theory was, well, they're early adopters.
1:21:05
So we we survey people who bought from Carvana.
1:21:08
We ask them questions like, do you have a Robin Hood account?
1:21:12
Have you ever owned like Bitcoin?
1:21:13
Um, you know, do you do online grocery shopping?
1:21:16
And the answer is like, of course, I do all these things.
1:21:18
Like, you know, all yes, yes, yes.
1:21:18
Way higher than non-carbon.
1:21:20
higher than non-carbon. So now I can say look many people won't do it unless someone says okay some people will just give it a plunge right and those and in general the more early adopterish you are the less nudging you need from relations to do it and that's what drives the the the growth curve it also
1:21:36
gets us back to 2022 you see back in 21 let's say that you were the sort of person who had a Robin Hood account and you might have speculated in some spaxs and some cryptocurrencies you might have had a windfall and you might have thought you know Look, this isn't like billions of dollars. This is thousands of dollars,
1:21:52
This is thousands of dollars, tens of thousands of dollars, maybe.
1:21:54
You might have thought that given your windfall, you were going to go buy a car.
1:21:59
And you might have thought to yourself, um, since you're the sort of person who owns like spaxs and cryptocurrencies and shops online, obviously the place you were going to buy a car was Carvana.
1:22:08
Now, you may or may not have actually bought that car at Carvana because, you know, Carvana was sold out and they might not have got what you wanted.
1:22:13
You might have gone somewhere else. But here's the deal.
1:22:14
You pulled your demand forward.
1:22:17
So from Carvana's perspective, even if this is like Carvana in 20 um 21 had like 1% share. So even if this is.
1:22:23
3% of the market, this is does not have to be a lot of the market for Carvana to feel this enormous demand pull, which they definitely saw.
1:22:30
And it also means that you roll forward a year and all these people are in the exact opposite position.
1:22:37
They've just had the opposite of a windfall, whatever you call it, a sort of unexpected loss, estimation. Yes.
1:22:43
And the year before they all just bought a car.
1:22:45
So turns out from Carvana's perspective, although none of us sort of realized it at the time, this isn't great.
1:22:51
So I think that was the third contributor that was unique to Carvana.
1:22:54
You have these three, you've got the overall market is down more than the Great Recession.
1:22:58
You've got the tightest auto credit spreads ever and you can't match and you have this unique thing where you kind of all of your sort of bleeding edge customers bought last year and you just bought this big asset with a bunch of debt.
1:23:12
and you just bought this big asset with a bunch of debt and it turns out that you're learning that like a bunch of your processes like eventually I I always sort of thought that Carvana would have bumps in the road operationally like sort of but you turns out they're all now. Yeah.
1:23:25
And that none of that was totally obvious at the time.
1:23:28
There were like bits and pieces.
1:23:30
You're kind of learning as you go.
1:23:32
The rate stuff was pretty clear.
1:23:33
The market stuff was pretty clear.
1:23:35
Um the stuff I described, you know, like but the all this data comes at a lag.
1:23:40
Like there's just a bunch of like it was all in a cloud of of uncertainty.
1:23:43
And then you do what Carvana has to do, right?
1:23:46
Which is you start cutting.
1:23:48
And this is a one of the things that's glorious about this business is that as it gets bigger, it gets better. And size begets size.
1:23:53
It's just a virtuous cycle. But here's the thing.
1:24:00
When you cut that a lot because of all this like stuff, um that all runs against you.
1:24:07
So you slash advertising, you slash inventory and then over external demand gets even worse and you've reduced things that drive down demand further.
1:24:17
And they were like chasing a ball down a hill all all year long.
1:24:22
And you know Ernie told you the story on your podcast about kind of how they got better organizationally at being at focusing on efficiency and how they kind of learned their way into it.
1:24:32
And you know, look, the reality is is like the sort of 10,000 foot telling of the story was they were okay at getting more efficient between March and November of 2022 and they got really amazing at it after November of 22.
1:24:42
Took them six months to figure it out. That's fine.
1:24:46
So, I lived for their six months.
1:24:49
It did not feel like I just described it.
1:24:55
Um, it felt like a very long time.
1:24:59
And for context, it's by far your biggest position.
1:25:01
You know, by far it's my biggest position.
1:25:04
And you know, didn't help that nothing else seem to be doing well at the time either.
1:25:07
You know, by the time you get to the fall of 22, um demand just keeps going away and they hadn't by that point caught up on costs to like fix it.
1:25:19
So everyone at this point, not everyone, but that there was a narrative out there like the problem is it doesn't work.
1:25:24
The problem is they're trying to get to profitability, but there isn't they can't do it. keep cutting costs. They can't.
1:25:28
They said, "Okay, in Mar in May, they just operate operational plans like, okay, so I'm going to re-underwrite everything and I think they can do this. This makes sense to me."
1:25:36
And they have a lot of liquidity to make this work.
1:25:38
Fast forward six months, they've burned a lot of liquidity.
1:25:43
They're way behind, right?
1:25:45
And now at that point, you're like, well, if next year looks like this year, we're going to run out of money kind of in 13, 14 months.
1:25:52
You'd ask, well, is that going to happen?
1:25:55
He's like, "Well, no, I don't think so."
1:25:56
You know, like, "I don't think so.
1:25:58
I think they're going to fix it.
1:25:59
I think the union economics work."
1:26:01
And by the way, this crazy thing with the credit markets is going to end at some point.
1:26:04
And like, I'm sure Navy Federal isn't going to give away free money forever.
1:26:07
And but then you'd say, "Yeah, but of course, I never thought the Navy Federal would be giving away free money for like, you know, nine months."
1:26:13
Like, I thought it was going to be like a few weeks, right, before they noticed that interest rates had changed.
1:26:18
I never thought it' take them this long, you know, that they'd have so much trouble chasing demand this far down.
1:26:22
And so at that point, that was when it was the most challenging like part of the uh of the investment because at that point like you did have to put on the table like Ernie would say like we're we're cutting costs and we're burning cash.
1:26:34
Um and there's you know as our costs go down like eventually we'll be profitable but like as to the pace of that versus the cash burn like reasonable people could disagree as to whether like we'll get there in time.
1:26:46
Um which is like you know super reassuring.
1:26:51
Um and then what happened was they got much faster at cutting costs the banking system kind of you discovered that interest rates had gone up and that really helped and sometime instead of January February um of 23 uh instead of chasing demand uh it looked like they were um restraining it and and
1:27:13
you can sort of see that because if you think about delivery late lead times on the website as a as like a line you can sort of see how long the lineines line is to get a car and and you could see that like the units were steady but the lines were longer if that makes any sense. Yeah. Um and and and so and then Yeah.
1:27:28
Um and and and so and then rates you know fixed themselves and the industry seen you know as car prices manufacturing improved car prices ground lower and and over time you know unit volumes have improved you know industrywide a bit although they're still pretty low.
1:27:45
they succeeded in cutting a lot of costs and you know and and and uh got to the place they are today which is you know that everything worked.
1:27:54
Uh oh I should I forgot to mention because everyone thinks the whole story is they got this deal with Apollo.
1:27:58
Um yeah so so basically uh along the way one of the levers they had to pull was was putting their their lenders in a prisoner's dilemma.
1:28:06
So you have multip you have bond holders and you basically say look we we might not be able to pay any of you but like the first person who accepts less gets paid first.
1:28:13
Um, and if your documents are written, you can do that the right way.
1:28:16
You can written you can the right way. You can do that. And they were.
1:28:18
Um, and so they ended up negotiating this new secured loan structure and people converted their debt into new debt, which is safer, uh, more higher priority at a discount.
1:28:30
Um, and that whole exchange happened in the in the summer of 23.
1:28:34
And a lot of sort of the retelling of the stories and by virtue of that exchange, they like saved the business.
1:28:40
By that point, the data I was looking at said that everything was great.
1:28:44
Um that was just kind of like, you know, the the cherry on top because that saved them a ton of money in terms of interest, expense, and debt.
1:28:50
Um but um it it was not by any stretch the the thing that turned the business.
1:28:56
Can you talk about your investing decisions because I during that period like every day is kind of a decision like not selling is a big decision as the information comes online.
1:29:06
What what did you do like did you buy more?
1:29:08
Were there constraints on how much you could buy?
1:29:12
Would you have done anything differently in hindsight?
1:29:13
Like what were the frictions that obviously you would have bought more hindsight? Stupid question.
1:29:17
I would have sold all stupid questions.
1:29:19
I would have sold all of it at the peak and bought all of it. Uh very stupid question.
1:29:24
I think you know what I mean.
1:29:25
Like what were what were like the real walk us through like the psychology, the the barriers, the like Yeah.
1:29:31
You know, the real hard stuff.
1:29:34
I knew the issues they were having logistically in Q1.
1:29:39
like I could I could see it and when I say I could see it like we look at a lot of data on the website so I knew that omocrron was an issue and so the the disappointing surprise was that as omocrron kind of cleared up you know it was like I was waiting for like some units to come out of the system and I
1:29:53
was like why why are they not selling any units it was kind of clear there was a problem but then the stock had thirded um and it went down the first sort of most of that thirding was because things were really bad during omocrron but until you realized that there was a deep demand problem that seemed the sort of
1:30:09
thing that happens in markets when you have like short-term operational hiccup and it was only once demand didn't kind of recover that you're like uh oh something's wrong but by then prices go down so much you're kind of like well I didn't actually buy any the whole way down to there uh and the reason was just
1:30:24
um it was a big position and and I generally don't buy more of things that are over a certain amount and um of the fund and I was sort of waiting you know like was kind of like well if it gets below that I'll buy more if it doesn't it's fine um And then I bought a bit more um after that, but by then I was something was off. So I kind of didn't
1:30:43
So I kind of didn't buy a lot.
1:30:44
And then they came out uh with this like operational plan and they did this issuance at 80.
1:30:49
Um and I thought, okay, like this this is this is they'll fix this. This is it.
1:30:55
So I bought a bunch more.
1:30:56
And then the stock went all the way down to uh then 20.
1:30:59
Uh and in that intervening period, um I'd gone out to visit them again and I'd gone through the whole operational plan with them and like tried to re basically do a blank sheet of paper like underwriting and I convinced myself that this would work.
1:31:17
Um no, Clifford, you weren't a Yes, the stock was down 95% but like but like this was this was you know okay and and they'll be fine and it's just it's just you know they'll be they're gonna sort it out.
1:31:28
Um and and so um but I realized at that point that um there were more kind of deep operational fixes in the business um than I had realized.
1:31:42
And so my thinking at the time was like they they should be fine.
1:31:46
I'll buy half now and I'll buy half when I can see it turn.
1:31:48
And in order to see it turn, what I'm going to do is is we work with a um thirdparty consulting firm that basically um does like analytics like you know web scraping and database, you know, go get credit card data and match it and blah blah blah.
1:32:05
And um and so we're like, okay, we're going to just go like we're going to instrument the heck out of this in a way.
1:32:11
Like we already were instrumenting it somewhat, but like we're really going to turn our attention like to focusing on instrumenting this and we're going to we're going to focus on the things we think we're going to see first when we see the turn.
1:32:18
and when we see the turn, you know, we're going to know and maybe we'll have to pay a little bit more, but we're going to get that's when we buy the second half of the stock. And that was May.
1:32:25
So, I bought the first half and I think um sort of in the mid20s was where I ended up getting kind of most of it.
1:32:31
And so, I bought some at 80, some in the mid20s.
1:32:35
Um and uh smidge like 100 and 80 and mid20s.
1:32:39
And then, um and then we we started instrumenting and we start waiting and like things just get worse and worse and worse.
1:32:45
It's like every marginal data point was like worse.
1:32:46
Um, I remember I uh, you know, thanks the week after Thanksgiving.
1:32:51
Sales always fall off in Thanksgiving and then they always come back the week after.
1:32:54
It's always a little lower because of seasonality.
1:32:57
And it was like sales fall off during Thanksgiving and then they they like just didn't.
1:33:01
And it was just like what the heck.
1:33:07
Um, and like you know, you're living this in real time, right?
1:33:10
You're just like, what the heck?
1:33:11
Um, and so I was really glad I hadn't bought the second half.
1:33:14
Um but I at this point we had things pretty well instrumented and um you know we had all this rate data which I hadn't had at the in the beginning of this process.
1:33:22
We had um just a lot like a lot of ways to capture how cars are moving. There's just a lot.
1:33:28
So then you know the year ends they put out this poison pill and the poison pill basically said that anyone who owns over 5% which was like me and like two other people can't buy more stock.
1:33:39
Uh and they had very good reason to do this.
1:33:42
The reason is they had big uh NOLs uh and um there's IRS rules having to do with turnover and if there too much turnover amongst the 5% holders then they would have destroyed the value of those NOLs because the um the way they repric if a certain amount of turnover happens they repric the NOLs based on your market cap.
1:34:00
So the market cap was super low and the NOLs could turn over and there'd been a bunch of turnovers.
1:34:04
So there was a risk they were going to cross some threshold and so they put this poison pill in which made all the sense in the world for them but was not particularly helpful for me.
1:34:10
But you know to be honest my initial reaction was like well that's annoying but I wasn't planning to buy any right now anyway, right?
1:34:15
Um but then as as fate would have it, you know, six weeks, eight weeks later and looking at all of my data and like it's all green shoots and I'm like darn.
1:34:21
Um that wasn't what I said. It was a different word.
1:34:30
Um, and um, so I'm I I tried to reach out to see if they could make an exception, but of course, you know, they can't, all that stuff.
1:34:36
So we ended up not being able to buy anymore.
1:34:38
Now, I should say when I made the decision to buy half now and half later, I promised myself that I wouldn't beat myself up if I sort of said, "Listen, Cliff, you you will be a happy, successful person if you write about this whether you buy this other half or not. So, it's all good." Mhm.
1:34:53
Um, and so I'm still telling myself that. Uh, man.
1:35:00
So, so say a little bit about the the range of psychology and maybe like how close you got to thinking, you know, just really deeply questioning yourself.
1:35:12
Like you're one of these investors that typically knows when I've talked to you about companies, you've known more about the company than anyone else I've talked to about that same company.
1:35:20
And that's always been the case with Carvana.
1:35:22
And I think that was true prior to the 99 decline. It's prior to today.
1:35:27
But even despite that, even though you knew so much, it's sort of like the Navy Federal Credit Union Xactor thing. Like how are you wired?
1:35:35
Like how distraught did you get?
1:35:36
I'll talk about how how it was super miserable and like it's pretty easy to imagine how it was super miserable.
1:35:41
Um, but it is worth just making a point like we were not fighting the Japanese in the Pacific.
1:35:48
like it sucked, you know, but right in the realm of human experience, I've lived a blessed life.
1:35:53
I would say one way to think about it is there were two versions of me.
1:35:58
There was the me who you spoke to who I think would sort of cogently say, well, there's this weird thing going on with rates and it can't last forever and when it gets better, I think this will get better.
1:36:15
And there was the me who was laying awake at night at 1:00 am who was just kind of like, you know, my inner voice was not being kind to me.
1:36:23
Um, and I' I've always thought of myself as a person.
1:36:27
I think I am sort of naturally one of these people who has pretty good control over his inner monologue.
1:36:31
And um, it was the first and only time in my life where I I like lost control of my my inner monologue.
1:36:38
Like I, you know, would lay awake at night.
1:36:40
I never lose sleep over things.
1:36:41
sleep over things. I sleep and I would lay awake at night and I would you know fret and berate myself and it's super hard um to live like that but you know like again I didn't have terminal cancer I wasn't fighting the Japanese in the Pacific like it was you know within the
1:36:59
wrong experience but like it is super difficult and you know you you have partners that you've let down right and I mean I say you've let them down as though you've let them down like have you let them down like your view of the world is that maybe you haven't let them down it just like this is you know just a very big wave. Um but like then your partners
1:37:16
wave. Um but like then your partners would you you know some some like you got different responses you know I had some smaller partners who are no longer partners who you know were mean but like I had other you know partners who would very sensibly and totally appropriately like want to grill me about it but you
1:37:34
but that grilling didn't wasn't like mean it was totally reasonable but like it didn't it didn't come from a place of confidence right um that you know we'll eventually get to people I'm grateful for but there was one partner who drove you know a long distance to have lunch with me. And turns out that was the only
1:37:48
And turns out that was the only reason they drove this long distance.
1:37:52
And we get to lunch and like this is not going to go great.
1:37:54
This, you know, I these meetings are haven't been going my way recently.
1:38:00
And and we sit down and he goes, "Cliff, I'm I'm just here to express my and everyone I work with's view that you're awesome and you know, you're going through a lot and we're just I'm just here to say like you're great. We support you.
1:38:13
let us know if we can be helpful, but like we're, you know, we're we're team Cliff.
1:38:17
And like I didn't cry, but I was like, "Wow, what a thing."
1:38:21
And he's like, "No, look, we're we're here for lunch.
1:38:24
I drove here just to meet with you.
1:38:25
Um, we can talk about investing.
1:38:27
Yeah, we can talk about other things. I don't really care."
1:38:29
But like this is what we're And I was just like it was like wow.
1:38:31
And so that would be the other thing like I was that I still to that day and I think it makes me a better person because I remember how that affected me.
1:38:37
Like the other day there there's a CEO in a company I'm involved in and he's wrongly getting a lot of crap from really dumb investors.
1:38:48
So I wrote him like a I sent him like a hug like I sent him like a nice like a really nice email I think as nice as I could write it.
1:38:53
But it I think it makes me a better person to to be on that side and to hear it and remember.
1:38:58
So in terms of other things I'm grateful for that would be another one.
1:38:59
But you you've let people down and you internalize that.
1:39:03
And there's also this weird thing that happens where like when you own a stock that's down 30%, you know, okay, here's what's wrong.
1:39:11
Here's we're going to fix it, right? Blah blah blah.
1:39:12
When it's down 99, like so, so you know, someone meets you say, like, what's up with Carvana?
1:39:17
You're like, well, I'm aware that last year I thought they were going to sell 800,000 cars and they're on track to sell 300.
1:39:23
And I'm also aware that last year I thought they'd make positive this year and they're on track to lose $2 billion.
1:39:30
And I'm also aware that the stock is down uh 99%.
1:39:35
But what I'm about to say is I think things are going to be okay.
1:39:39
And you can see how um that makes you seem like you've lost the plot. Yeah.
1:39:45
And there isn't a good way to like say that that doesn't make you seem totally nuts because basically the you say all that and they're like, "Oh, you you denial bull market baby like you know you."
1:39:58
And so I um that was another real tricky thing was like I there was no good way to and and and there was you know there was at some level deep uncertainty because things had gotten bad enough where I couldn't be like look I'm 100 like this is like I couldn't be like yes yes yes we're fine.
1:40:13
And I was like, well, you know, look, things are way off course, right?
1:40:16
And for reasons I never would have predicted.
1:40:19
Um, and so, so how, you know, so, so how do you have that meeting, right?
1:40:24
And then how do you have the 30th version of that meeting, right?
1:40:29
Because you do these over and over, right?
1:40:30
And, and then of course you get you leave that meeting and you've sort of done it and then like you you drive and the stock's down another 8%, right?
1:40:39
and you know, you're like going to the gym and you're like, you know, particularly, you know, whatever.
1:40:43
Like, you sort of try to manage yourself and then you can't sleep.
1:40:46
It's just it's really it was really hard.
1:40:48
Um I'd rather not go through it again.
1:40:50
It it's it's such an in I'm so glad we did like the long version of the story because um whether or not people care about this specific stock, I just think like as an investing and business story, it is very singular.
1:41:02
Um I I said this on the Ernie episode.
1:41:05
We looked because he gave me that stat about going down 90% is like going down 20% 20 times or something like that.
1:41:12
Um, and each one's painful.
1:41:15
There really is not another example of a company that was that big by market cap or something that went down 99% that survived and like wasn't a fraud.
1:41:21
Like it it it like it does that's an one.
1:41:23
It doesn't exist in the record.
1:41:26
And so it's so cool to hear its major investor talk through the entire thing from soup to nuts.
1:41:33
And I guess in in conclusion, I'm curious how you think you will most approach future investment opportunities differently as a result of having had this specific experience personally.
1:41:44
One thing I mentioned earlier was the importance of management teams like the if I rank things and sort of how they ultimately turned out over the full span, the management teams were wildly predictive of my of outcomes versus my expectations.
1:41:58
So that that's like a practical learning.
1:42:00
practical learning. Another is that in general I have a new and deeper appreciation for how much harder it is in reality to go from profitable from unprofitable to profitable than it is on paper and like I that you know I everyone like I feel like that's kind of
1:42:18
trit but like the thing is you do this analysis you're like okay this is you know the incremental margins and blah blah blah and like it all makes sense but like now I've seen this like play out like up close over and it's hard like it's so hard. It's so much harder
1:42:30
It's so much harder than it looks.
1:42:31
And so I think my it's not that I won't invest in lossmaking companies, but like my willingness to underwrite to that is just adjusted.
1:42:42
There's like a base rate adjustment that I'm that's more salient for me than it was before.
1:42:46
I have like a less of an interest, I should say, in investing in businesses that have narrower advantages.
1:42:52
Um because like life will throw massive curve balls at you and and like you know there's sort of an interesting point which is like if you'd asked me why I owned so much Carvana back when it traded for like 300 back in 2021 I would have said this is an incredibly stout business.
1:43:07
People do not appreciate how stout this business is.
1:43:10
And in retrospect I was right. Right.
1:43:14
like the world threw like three like once in a generation curveballs at these guys at the same time while they were having all kinds of internal problems that don't happen that often and they added debt and like you know whatever at the same time and they did it like they got through it.
1:43:29
So it turns out it really was that stout, but it it's but had it not been that stout.
1:43:34
Had there had these sort of advantages been, you know, if if this business all grown up in Super Great was a 5% margin business and not not a like a 13 or 14% margin business, I'm not sure they'd have had the wherewithal to make it.
1:43:46
Um, so I, so I have a greater like my sort of just my reaction to companies where yeah, like it works, but there's just this consumer surplus isn't that much and the advantage isn't that big, but like pencils.
1:43:59
It's just kind of like move on.
1:44:02
Has it made you think any differently about your appetite for concentration?
1:44:06
Just just like I think of that old quote like the only rational deployment of our ignorance is diversification. Yeah.
1:44:12
And and that like it's not ignorance so much.
1:44:15
it's not ignorance so much. is just like the Navy Federal Credit Union factor like that stuff happens in the world and a simple way to protect against that you know the idiosyncratic math of like whatever I have 15 positions the idio risks all gone and like why not have 15 positions instead of five like has it made you request that
1:44:34
stuff your portfolio is the answer to this question so maybe the answer is no um but curious what you think it's made me request that well I think on the on the one hand you You know, one of the things that I have said to people who've asked me about this is sort of like the lessons from this period are important, but it's a teaspoon of medicine, not the whole bottle. So, on the margin, I'm
1:44:55
So, on the margin, I'm less interested in lossmaking companies, but I'm not excluding them. Yeah.
1:45:00
but I'm not excluding them. Yeah. on the margin I think there's probably room to be a little more diversified but you know like we've had a lot of success over the whole history of the fund up to through and including you know this period that success was in because of how we did things and if I
1:45:18
were to have thrown out the concentration over the whole life I think we come out in a worse place albeit maybe with less volatility um and and so the lesson is yeah like on the margin there's room to be more diversified probably, especially if you factor in the idea that you might have some companies that are less like stout. Um, but teaspoon of medicine, not the
1:45:39
Um, but teaspoon of medicine, not the whole bottle.
1:45:42
Well, it's an incredible story.
1:45:44
Um, I'd love to take our remaining time and talk about the world and the future and investing kind of rip more large.
1:45:50
One of the things I think we're allowed to talk about IQ again, um, which is why I'll frame the question this way.
1:45:56
If you think about like the world's stock of processing power in human brains, you know, some measure of the number of people with a certain amount of processing power plus like how efficiently they use that or if they use it productively or if they just play video games or something.
1:46:11
And then we think about the introduction.
1:46:13
There's a question about the introduction of artificial intelligence into the world, which I'm curious for your take on generally, but I'm also more specifically for cur curious for your take on the introduction of intelligence and processing power into the job of investing of like ingesting information, looking for stuff that overlaps, training on past pattern recognition and what's worked in businesses historically.
1:46:38
And if we fast forward 10 years or something, um, what it's going to be like for even a very smart human to invest in a world that is full of artificial intelligence.
1:46:50
And I'm just curious, I don't I haven't talked to you about this before uh in in such specific terms.
1:46:56
I'm just curious for your take on the whole thing, how you've processed watching it unfold in the last couple of years, and how you think it'll affect this job.
1:47:03
Yeah, you you should ask someone really smart about that. And here we are.
1:47:07
I'll tell you a few thoughts on artificial intelligence that are super narrow.
1:47:10
Uh because I you know the world is big and complicated and you know I think maybe one of the lessons of 2022 is that you don't know a lot.
1:47:17
I find these tools to be super helpful.
1:47:19
I I I use various AIs every day.
1:47:20
Um you know I I in particular for for businesses where there's like a lot of information on the internet right?
1:47:28
So if you're studying Medicare advantage or Medicaid managed care companies you know let's take Medicaid managed care.
1:47:36
think tanks and government reports and RFPs and you you could fill a room with the materials that are on the internet and you can't possibly read all of it and most of it's kind of boring anyway.
1:47:45
Um but you know the the these things can and so then you can ask it questions like okay like who who won you know the RFPs uh the did the incumbent win or did did the entrant win for Medicaid RFPs in the last 50 RFPs by state and like what were the major qualitative factors identified in the you know decision that
1:48:04
like drove each one make me a table right and that's a ton of work and you know it takes two seconds with a with a with an AI so the I have I think that in the playing field of life it advantages is someone like me who works um you know fairly independently I don't have like a
1:48:20
giant team in investing um you know as to whether these like right now an enormous amount of information is not in the internet right so if I were to grill um an AI about all things like Medicare Medicaid managed care it knows a lot um if I grill it about Carvana we pretty
1:48:39
quickly run out of stuff like this interview will get in there but um you know Most of what I know about um Carvana I've learned from, you know, a lot of thinking, a lot of talking to people who used to work there, a lot of data scraping and other things that just aren't in um the internet yet. And so
1:48:54
And so the tools, you know, these like if you spent a bunch of time trying to learn about Carvana from an AI, I don't think you'd get very far.
1:49:03
Um, that being said, you know, over time, maybe they have agents that are able to gather information, put it into the internet.
1:49:11
Maybe the internet, this corpus of information in the internet gets bigger because more stuff is put in there in other ways.
1:49:16
And um, and of course, these tools are only going to get better.
1:49:18
Um, you know, when when AIs get to the point where they can make uh, investing decisions, there's probably not a lot that's pretty far down the spectrum, I think, of things they can that they would require doing.
1:49:28
Um, it gets it's kind of like asking about the singularity.
1:49:31
singularity. It's like ah you know I sometimes I'm grateful that I've had a chance to sort of do well you know before um before all this happened because um you know it it might be hard to do well after all this happens if I reflect on um the future sort of big picture I mean I people used to ask me
1:49:52
what my macro opinion was and they always meant like interest rates and GDP growth and I always give them some version of it something like look I I'm fully confident that my great-g grandandchildren will marvel at my poverty Um, and unless they're all dead, but hopefully they won't be. I I I think
1:50:05
I I I think these tools make it all the clear how we're going to get there, you know, especially if quantum computing happens, right?
1:50:12
Because because the ability to create synthetic data with real world simulations using quantum simulators and then to train the AIS on that um seems like a wildly interesting uh tool.
1:50:21
Your portfolio is I don't know if it's entirely, but it's been historically mostly US companies.
1:50:28
If I think about the US, you've got all these incredible advantages.
1:50:31
We're the we're the home of innovation.
1:50:33
We've got this incredible geographic, you know, isolation and abundance here domestically.
1:50:37
Our currency has been the reserve currency of the world.
1:50:40
We sort of control the m, you know, control our own destiny in those ways.
1:50:44
Any observations just about like the US as the what historically has been the most fertile soil for finding great investment opportunities and kind of the modern era and whether or not that is changing one way or the other.
1:50:57
you know the the US is an amazing system.
1:50:59
Um I think there's a lot of reasons for that.
1:51:02
that. I mean I I tend to think about the idea that um there was meaningful selection effects in the people who chose to migrate to the US um versus the people who chose to stay behind and that probably led to us having you know the
1:51:15
US having a a gene pool that you know in aggregate is selected for people the sorts of people who will create businesses and be sort of independent-minded and you know get on a ship and travel to an unknown land across the other side of the sea for a better life. I don't see that, you know,
1:51:25
I don't see that, you know, changing in any in any deep way.
1:51:27
But I don't necessarily think I've invested in the US because it's such a great place, per se.
1:51:33
I think I've mostly invested in the US because um you know, I always use the following example.
1:51:39
Um you talk to some investor and they're telling you about their like British, you know, restaurant investment or something.
1:51:43
You say, "That's so cool.
1:51:44
Sounds like you really know England really well.
1:51:46
Um why don't you tell me three places you could buy a power drill in the UK?"
1:51:49
and they sort of like realize that they don't know, right?
1:51:54
And there's just an enormous amount that you learn about a place by being there.
1:51:57
And so, it's not that I could never invest outside the US.
1:52:01
It's just that like I'm keenly aware that like overcoming a certain degree of naivee is very very hard even for some places as seemingly close as like the UK.
1:52:10
Um, and and and so I I just think that like the US is an enormous market.
1:52:16
There's lots of interesting things to do.
1:52:17
And you know, someone will pitch me some like you know, Chinese stock and I say that's fascinating.
1:52:20
I'm sure it's going to be great.
1:52:21
I'm going to put on the bottom of my list right after all the American stocks. That served me well.
1:52:25
I'm sure I miss all kinds of stuff, but we got to pick our lanes.
1:52:26
I think it's so interesting and and funny that lots of the big investors out there have gotten to the position they're in owning Microsoft and Amazon and these exciting big like no one gets faulted for this.
1:52:40
And we're talking about used cars and subprime lending and you know things like this.
1:52:45
I used to own multi-level marketers too, right? Of course.
1:52:49
Um, and it's just so interesting how many different ways there are to do really well in investing.
1:52:53
And and maybe the last question I'll ask before my traditional closing one is just how you process the the really big like I'm sure you think Microsoft is a great business like objectively it's just a great business.
1:53:06
How do you process those ones that are that are so dominant in the market that are such a huge percent of the market's market cap or whatever?
1:53:12
Um, how do you think about for your own money?
1:53:16
I know you're a huge investor in your own funds, in your own fund.
1:53:20
Do you want exposure to those things?
1:53:23
Like how, you know, market exposure?
1:53:25
What do you think about market exposure for the average person?
1:53:26
It seems like a very sensible thing for the average investor.
1:53:29
Like do you do you ever feel strange that there are these like massive incredible what seem like enduring businesses that you have nothing to do with?
1:53:39
I have a fairly boring view like everyone else.
1:53:41
I think the for the average investor, you know, an S&P 500 ETF is a great way to go.
1:53:47
Maybe an all market ETF or whatever.
1:53:48
But, um, I've certainly looked at all these big companies.
1:53:50
They are great for a reason.
1:53:51
Um, you know, I've certainly thought at times that they represented like good to even superior, you know, returns.
1:53:59
It's just never they've never kind of I mean, one of the hardest parts about my job is like I sit around and I study all these things and I find plenty of things where, you know, I said a joke in the hundred billion dollar portfolio, there's definitely room for that.
1:54:10
um but we don't you know we're not managing hundred billion dollars and as it is you know I the opportunity cost of selling A to buy B doesn't work.
1:54:16
So the hardest part about this in my one of the harder parts about my business about my day-to-day is like spending a lot of time on something getting to know it really well concluding that it's a great investment but just not quite as great as the other thing you know that's frustrating.
1:54:30
Um, and there have been times I remember, you know, back in 2010, like Google, my a friend of mine put it really well.
1:54:35
There's Google sitting there looking all cheap, right?
1:54:39
And, you know, he was right.
1:54:39
Uh, but thank goodness I didn't buy it because I think the things I owned, you know, did better.
1:54:44
But, um, not all of them.
1:54:44
So, you know, wish I could have picked the worst thing I had, but like that's not how life works.
1:54:48
These are great businesses.
1:54:49
Um, if I ever, you know, retire, um, I imagine I'll I'll stop thinking about stocks and diversify and I'd own them.
1:54:56
And if I had a someone who wasn't, you know, if my mother wasn't invested in my fund, I'd you know, tell her to, you know, buy buy that.
1:55:00
But, um, you know, there's a lot of businesses I don't own.
1:55:05
The key isn't to understand everything or to pick the even to pick the very best one.
1:55:08
The key is to pick a bunch of things.
1:55:10
You a handful of things that you know well and you know are going to do well and watch them closely and don't worry too much about all the other stuff.
1:55:17
Whenever we talk, time flies by.
1:55:19
There's 20 things I could ask you about.
1:55:21
Maybe I'll convince you to do this another five years.
1:55:22
We could talk about those then.
1:55:24
But for now, I have to ask my traditional closing question.
1:55:27
What's the kindest thing that anyone's ever done for you?
1:55:28
So, I had the two that I mentioned earlier.
1:55:30
um one was um the guy uh who you know right when I was starting my fund um invested uh you know in it and um you know I didn't quite appreciate at the moment just how rare that was and um but it turned out to be a major kind of um event uh that played a big role in in me ultimately having some success.
1:55:53
Um and then the other one was um you know in 2022 that partner who went out of his way um to just come and you know basically buck me up uh over lunch um you know didn't have to do it. What a kind thing to do.
1:56:07
I mean, and you think about how I mean, I'd lost the guide fortune, right?
1:56:10
At least on paper, right?
1:56:13
And and and and it it not only did it make me feel better at the time, but I think it it's made me a better person because I can reflect on that now and try to make sure that, you know, you got a management team, things are not going well, you know, like what are you going to do?
1:56:29
On the one hand, you have an obligation to understand, so you have to ask questions, but on the other hand, like they're trying, right?
1:56:33
Even if they're idiots, they're trying, right?
1:56:36
And so, you know, it's important to sort of remember how I felt then and how I was treated by different people and like how I want to treat people.
1:56:43
Um, and so made me a better person. It's great. Beautiful stories.
1:56:47
Cliff, thanks for finally doing this with me. Thanks for your time. [Music]