Sean Stannard-Stockton, Ensemble Capital, Intrinsic Investing

I’ve been an avid reader of Sean’s articles for many years. Sean and his team have a very thoughtful way of presenting sometimes not-so-intuitive or easy investment concepts. Sean together with Todd Wenning have been regularly sharing their experience and knowledge through writing. I highly recommend checking the episode notes for links, and looking up their work and articles.

Sean Stannard-Stockton is president and chief investment officer of Ensemble Capital, which he co-founded in 2004. Ensemble manages $1.5 billion on behalf of approximately 240 high-net-worth families and institutions. Their core equity strategy is a focused portfolio of 20 to 25 competitively advantaged companies.

• We talked about Sean's childhood and upbringing, exploring how it influenced him and paved his career path.

• We discussed Sean's article on Value, Growth, and Intrinsic Investing.

• Sean shared insights into the intriguing concept of the equity anxiety premium, explaining how "premium returns come from the successful management of anxiety."

• We touched upon the idea of equity duration. Sean elaborated on how stocks can be viewed as bonds, and lessons from the Nifty Fifty stocks of the 1970s.

• Sean shared his experiences with COVID-era pandemic investing, reflecting on the unique challenges and insights from his perspective during this time.

• Sean shared his thoughts on an interesting theme he's touched upon in his writings: the consistent underpricing of wonderful companies in the market.

• We discussed portfolio construction in detail, exploring topics like the number of stocks, sizes, turnover, holding period.

• We also talk about remote work, and Sean’s firm’s experience working remotely.

• To conclude, we talked about Sean's personal and professional definitions of success, getting a deeper understanding of what drives and motivates him.

• Stay tuned until the end, when we discuss benchmarks and outperformance.

Company site: https://ensemblecapital.com/

Blog: https://intrinsicinvesting.com/

Twitter: https://twitter.com/IntrinsicInv

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IMPORTANT: As a reminder, the remarks in this interview represent the views, opinions, and experiences of the participants and are based upon information they believe to be reliable; however, Sicart Associates nor I have independently verified all such remarks. The content of this podcast is for general, informational purposes, and so are the opinions of members of Sicart Associates, a registered investment adviser, and guests of the show. This podcast does not constitute a recommendation to buy or sell any specific security or financial instruments or provide investment advice or service. Past performance is not indicative of future results. More information on Sicart Associates is available via its Form ADV disclosure documents available ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠adviserinfo.sec.gov⁠Sean Stannard Stockton — AI-generated transcript, it may contain errors.

[00:00:00] Bogumil: All right, well, hi. Hello, Sean. It's nice to see you. How are you?

[00:00:04] Sean Stannard Stockton: Very good. Thank you so much for having me today.

[00:00:06] Bogumil: Well, it's lovely to see you. You know, I'm a big fan. Uh, my team and I have been reading your newsletters for many years at Sicart Associates. There are big overlaps with the way we think, and it's nice to know that there are people out there in the world that think like us and have similar approach to investing patient discipline.

And we look at the actual businesses and I learned a lot reading your, uh, articles and, uh, they brought some sense of, uh, you know, discipline into the thinking that we have. And it's been an inspiration to follow your work. I wanna get started right away, if you don't mind. And I like to ask my guests about their childhood and upbringing, and I'm curious how that time led you eventually to the career that you're on.

And I'm always curious about the discovery of investing. How did that happen for you? How did you discover investing?

[00:00:51] Sean Stannard Stockton: until. The summer after my freshman year of high school, I wanted to be the second baseman for the San Francisco Giants. I mean, that was just the, the absolute goal, no doubt about it. I never even had, you know, the slimmest chance of achieving something like that. But I didn't realize that till, till I got to high school.

And, um, there was a summer, uh, after my freshman year and I was on a road trip with my parents who were both from the East coast. And we stopped at a bookstore way back when, when they had bookstores. And somehow I ended up grabbing a book off a display case that was about stock picking. And it was written by a teenager for teenagers.

And in retrospect, I realized it was a terrible book. It would basically, it was like a get rich quick scheme sort of book written by someone who didn't know what they were talking about. But it was the first thing I'd ever heard about investing and this idea that, that there was this incredible game.

That was very lucrative and very interesting. And, um, and so as I went through high school, I started learning more and more about investing and went off to college, dead set on the, that's what I wanted, wanted to do. Um, so that was kind of what led me into investing. And it was interesting 'cause I really had no exposure to investing outside the rest of my life.

My father was a sociologist, my mother was a psychologist, and, and, um, I didn't have any exposure, um, to the investing world other than just my own discoveries as individual.

[00:02:13] Bogumil: But those two fields, sociology and psychology, can be really helpful in the investing world, don't you think? So maybe you were being shaped slowly to becoming an investor, not knowing about it.

[00:02:25] Sean Stannard Stockton: Yeah, no, I, I think that's right. One of my favorite books about investing I discovered very early on is by Robert Hagstrom, who is chronicled many of Buffet's works, but one of his books is called Investing the Last Liberal Art,

[00:02:37] Bogumil: Mm-hmm.

[00:02:37] Sean Stannard Stockton: and, and he argues that many of the most important. Crossdisciplinary lessons investors need to learn come from the humanities and from my way of looking at it, if you're investing in businesses, not just trading stocks around, but you're investing in businesses, you're, you're investing in groups of people who have collectively come together to create something of value.

And what is that, other than sociology and psychology, right? What are we all trying to do? We're all trying to figure out how are people going to behave in the future? How are the people at a company? What are, how are they gonna behave? How are their customers gonna behave? How are the people at their competitors going to behave?

All of these are just people, groups of people. And, and I completely agree that, that thinking about investing through the lens of, of humanities and, and all the disciplines of humanities is, is really key to what we do.

[00:03:24] Bogumil: I like what you said and, and sometimes I write about it, how it's a people's business because on one side we know the clients whose money we manage, and it's a huge responsibility. I. It's mostly families, multi-generational wealth that we manage. But on the other side, we know the people that are running businesses whose stocks we happen to own.

So on both sides you really think about people, their actions, their behavior, their emotions and incentives, what drives them, what scares them, and so on. So I think there's a lot to explore. I'm curious to talk to you about value growth and interesting investing. There are quite a few articles that you talk about the difference between value and growth and is there one or there isn't?

And you have a beautiful quote from Charlie Munger, and I'll read it to you. I'm sure you remember it Over the long term. It's hard for a stock to earn a much better return than the business which underlies it earns, even if you originally buy it at a huge discount. There's so much in this quote to unpack, but there's this ongoing battle.

Are you a value investor? Are you a growth investor? And we both know that it's not fair to look at it that way. Can you talk about your perspective?

[00:04:29] Sean Stannard Stockton: Yeah, the, the only value of a stock is your pro rata claim on the cash flow that the company's gonna generate in the future and, and be able to distribute to shareholders. Whether it decides to do that with that cash or something else is kind of a secondary question, but. That is that cash? That's what you're buying.

That's what, that's what a stock is worth, right? The problem is, is that all that cash is in the future and we don't know how much it's going to be. Right. But unless you're investing in some on the verge of bankruptcy company that might be liquidated or some sort of specialized asset play or something like that, most all investments that we all talk about and focus on or, or, you know, they generate cash in the future.

And so when we talk about valuation, whether something is cheap or expensive, we tend to use current results as some proxy saying, you know, this is some multiple, some current results or maybe next year's results. And, and that's can be useful for thinking about investing, but it doesn't tell you anything about the actual value of business. Determination of value is, is a business's future cash flow. And whether you're paying less than that today, and that's unknowable and unmeasurable, right? It can be estimated, but, but you can't objectively say something is expensive or, or cheap. And so the way we think about it is we're looking for businesses that have enormous cash flow production ahead relative to their current price in, in the market.

And sometimes that's businesses that are producing high levels of, of distributed cashflow yield right now, right? That what you might think of as a cheap stock, right? Maybe it has a low PE ratio. We have stocks in our portfolio that have, you know, low double digit PEs, and, and last year some of them got down to single digit PEs, you know, and, and then we have other businesses, um, like Netflix that we've owned for, you know, uh, going on seven years now.

And, and throughout that ownership period, you know, there was a lot of people talking about, you know, they called debt flex and talking about all the cash it was burning, right? And, and yet today, If you look at all of streaming, Netflix generates enormous cash flow and nobody else does. And you know, collectively Netflix is running away with all of the earnings and cash flow in, in streaming, right?

And so was it cheap when we bought it? Was it expensive? You mean You can have all sorts of arguments about that, but it's that future cash flow that matters, not not what you're buying at the time. Right? And, and so when I think about my own business at Ensemble, where I'm the majority owner and, and one of the co-founders, it's worth the cash we're gonna produce in the future.

It's not worth some multiple of last year's cash flow or this year cash flow, you know? And, and so as we think about value and growth and intrinsic investing, it's about understanding the intrinsic value of a company the cash is gonna produce in the future, the protective layers, the competitive advantages that that can give you some level of assurance of that forecast.

Um, and then comparing that to the current market price. You know, it, it's, it's a simple thing. It's hard to get right, but it's, it's pretty straightforward.

[00:07:20] Bogumil: You mentioned something that I found really interesting, Sean, that initially, initially when you look at an at an idea, you don't even look at the valuation sometimes. Correct me if I'm wrong, but that was my impression. So you're curious about the business and the valuation of the second thing you look at.

Can you talk about that? Because a lot of people get turned off by the valuation. They wouldn't even consider looking at the business.

[00:07:42] Sean Stannard Stockton: Yeah, so for us, we spend an enormous amount of time seeking to understand the companies in our portfolio, and we often own them for three years or five years, or 10 years or longer. And so what we're trying to, to do is really understand the business and if it was possible to kind of do a quick back of the envelope math to get you some sort of valuation that was even in the ballpark.

Well, what are we all doing with all this research? Why not just use that back of the envelope if it's, if it's an even decent proxy for real value? I mean, gosh, save a lot of time for yourself, right? And so the idea that you can have an opinion on valuation before you've actually done the work to understand a business seems totally nonsensical to us.

And we do think it's true that, you know, on average if a company's trading at just to make up some numbers, you know, under 20 times earnings and it's growing at a double digit rate and it's producing lots of free cash flow, like it's probably on the cheaper side. But that's such a generalization and we're only trying to own 20, 25 stocks.

A lot of times business that we own are, the reason they're cheap is they don't appear cheap, right? That if, if, if you could just go out and find stocks that were obviously cheap on the surface, and then be right about that assessment. I mean, all of us are just spending way too much time on this business.

Right. And, and we should just be just, just looking at some top line numbers. So for us, it's not that we don't care about valuation, it's that we think that an assessment of valuation is impossible before you've done really significant work. And so we try not to bias ourselves by using some sort of simplistic assessment evaluation as a screen on the way in.

And instead we we're looking for great businesses. And, but partway through the process, sometimes you start to say the stock's looking pretty expensive. I'm gonna deprioritize the, the work that we do on this one. Once you've done the work to have at least a partial opinion.

[00:09:36] Bogumil: We think of it as building a wishlist of businesses we would like to own at some point, and then looking for an opportunity to buy it. Which leads me to the second question that I have for you. A term that you introduced, which is called E Equity anxiety premium, and you talk about anxiety and stress in a couple of articles.

Can you talk about that? What is an equity anxiety premium, and how that can help us get better investment results?

[00:10:01] Sean Stannard Stockton: Sure. So, you know, the kind of academic theory for why stocks generate higher returns than bonds is because they're more volatile and they bounce around a bunch, right? And if in fact, um, the goal of owning a stock was to make money in a six week or six month or one year timeframe, well then volatility's kind of relevant because volatility is gonna control your returns.

Like there's almost no correlation between valuation. One year forward investment returns. Right? All, all this work that we all do on valuation is trying to achieve kind of multi-year, you know, appreciation premiums, right? It's over a one year period. That's just the wrong way to pick stocks. You know?

It's, it's, it's not the driving factor. And so in thinking about the longer term, and this is the, the kind of the math we went through in, in the post you're referring to is that most all investors can know that over long timeframe, say 20 years or longer, there's almost no instances where stocks have underperformed bonds.

Now we can't know about the future for sure. So the fact that stocks have kind of always outperform bonds over the long run does not mean that they always will in the future. But we do think that it's pretty conclusive that over, say, a 20 year, longer timeframe, you are very unlikely to make more money in bonds than in stocks.

Therefore owning bonds almost locks in risk over a 20 year period, rather than avoiding risk. The path will be slow, but you won't get anywhere relative to to stocks. Right. And so what is the risk? Why is it that investors who support to have a long timeframe, why is it that they also demand to earn on the order of four to 5% more per year in stocks?

If it's almost a sure thing that they're gonna do better than bonds? Why such a high premium? And we think the reason is, is 'cause it's terrifying to own stocks, right? To, to really, to really put all this collective wealth that you've generated over the course of your life and put it to risk in the stock market and have moments like the 35% decline over four weeks.

That happened in early covid. These are terrifying things. This is people's life savings. They're, they're, you know, the, the accumulation of all of their efforts over time to create value for them and their family and putting that at risk and having bounce around the stock market is terrifying. Right. And, and we talked in the, the post about, you know, if you weren't experiencing anxiety last year, then you weren't paying attention right.

To, to, to, to, to not be stressed out. Last year is not a mark of, um, you know, you're, you're just, you know, has such control of your emotions. It's to say you were not paying attention. Right? I think that's, that's, that's the case. Um, but over a very long timeframes, investors can expect to generate premium returns to bonds with very little risk of that not happening.

And therefore, what it is that they need to, to manage if in, in fact they're long-term investors, it is actually like your retirement money or whatever you need to manage your anxiety over that timeframe. And the markets pay you healthily to do that because most people are incapable and of actually managing your anxiety.

[00:13:01] Bogumil: Do you see this as an additional source of opportunity? Going back to Charlie Munger's, quote about some stocks trading at a big discount at some point in moments of distress, a panic, and it could be a market wide panic, but it could be one individual stock that people panic around. Couple of missed earnings, a product recall, management change.

We've all seen all kinds of things that seem like a disaster, but it's not a permanent damage to the business. Do you see moments like this as an opportunity to go in, keep your anxiety on hold for a second, and buy something at a bigger discount? Is that something that you also consider?

[00:13:37] Sean Stannard Stockton: Sure. You know, I think it's just, uh, it's all opportunistic, right? So for instance, um, in, in March of 2020, um, we really added to our positions in, the home builder in, the fast food company. Um, those stocks were, were tumbling and we just believe that as, as scary as the pandemic was and, and as potentially devastating it was to the economy, that, that in five years you're gonna still need houses and you're still gonna be, people are still gonna be eating out and that they're still gonna desire, you know, relatively fresh, healthy, fast food compared to the frozen beef burgers that, that everybody else offers.

And, and so taking advantage of that, um, is, is, you know, part of what we do. But I think where it comes into play more, we aren't necessarily investors who are seeking to, to jump in and, and grab a stock in the midst of a crisis and then catch the rebound as the crisis passed. We're seeking to own businesses for very long periods of time, and when you own a business, even the best businesses for a long period of time, you will pass through multiple crises.

Right? Um, all of our best investments have had some period of really significant under performance at some point over the, the long time that we own them. And so I think that's where most of. The alpha that we generate comes from is, is not so much arriving new on the scene to a company in crisis and, and, you know, buying shares in the cheap.

Yeah. We do that sometimes. Right. But I think more of it is that when a business that you're gonna own for 15 years and generate great returns four years into that, it underperforms by 30 or 40% and people begin to write it off. And you have the fortitude to understand that, that the crisis that presents itself is real, but, but temporary.

And that you hold through that and, and, and the value comes back. And, and so I think that's, that's where that kind of anxiety management is most important for, for long-term kind of focused investors like ourselves.

[00:15:30] Bogumil: So it sounds like it's more about holding onto it when it's really hard to hold onto it. That's what I'm hearing. 'cause it's very tempting to exit and move on in moments like this.

[00:15:41] Sean Stannard Stockton: I think that's right. I mean, you know, Buy and hold sounds so easy, doesn't it? Just buy stock and just hold on for the ride, right? And, and yet it's not easy. It's, it's incredibly hard. You know? And, and it's not only that a business that you own may go through a crisis, it may be that the businesses that you own just kind of keep plotting along, doing fine, but really exciting stuff's happening someplace else.

And you think to yourself, I gotta go chase the exciting stuff. You know, I don't, what am I doing sitting in these boring, you know, executing businesses, you know? And, and, um, so there's always a distraction. There's always a reason to trade. There's always something to move on to. And, and, and yet simple buy and hold.

One of the posts that we wrote was that there's no such thing as buy and hold, because over the course of a decade, the businesses that you own are gonna transform them. Cells and you know, Buffett talks about something like, you know, 70% of the capital in business will be deployed by the company that, you know, while you own it over a 10 year period.

And therefore it's been mostly transformed. And so, you know, the, the sort of buy and hold that we do is buy and constantly monitor and analyzed all day, every day, week after week, month after month, year after year. And through all of that, we often will hold a stock and, but we'll change our position size, you know, from time to time.

Businesses get, you know, you have more or less confidence in a business at different points in time. And, and just, just because it was a great business when you bought it does not mean it will stay the great business the whole entire time you own it. And so sometimes when a crisis comes, you need to recognize this crisis.

I.

[00:17:15] Bogumil: It sounds like your exit strategy that I'm sure we'll come back to, but I wanted to ask you about emotions and anxiety from a perspective of whose money you manage. And I had quite a few conversations on this podcast with quite a few guests, uh, including Guy Spear about managing your own money, managing your family money, and then managing other people's money.

And it's not that one is easier than the other, they're very different experiences. But what I've learned managing money for other people that my emotions might be in check. But I have to take calls from clients and then absorb their emotions at times of distress. Can you talk about that experience?

It's even harder to hold onto certain investments when it's not just your own emotions that you have to address.

[00:17:58] Sean Stannard Stockton: Yeah, so one important thing to know about Ensemble Capital is that we're a wealth management firm serving private clients. We also have a significant amount of institutional money and our equity strategy, but we built the business sitting down with husbands and wives and. Individuals in the tech sector here in Silicon Valley who are looking to build wealth and REITs personal financial goals.

And I think for me, the, the, the, what I've taken away from that is this idea that, um, the returns that matter are the, are the real life outcomes in people's financial lives, you know, and it's really easy to get caught up in, in your alpha versus your benchmark and, and all these different sorts of things.

And, and those are not unimportant. But at the end of the day, we're managing money on behalf of real people who this is their real wealth that is critical to them living the lives that they hope to, to live. And so, you know, I think keeping that in mind, um, can be, uh, anxiety producing like the tr you know, the, the, the, the responsibility it carries.

But it also can keep you grounded and, and reminds you that, like, what is it we're trying to do here? We're not trying to dodge a bad earnings report. We're not trying to minimize a week or two of volatility. We're trying to build long-term wealth, you know, protect and grow wealth of, of the families and individuals as well as institutions and foundations and nonprofits that we manage money for.

And, um, and so for me, you know, I think that one of the things that we've become somewhat known for is the way that we talk about investing in, in very kind of digestible, easy to understand ways. So we have very sophisticated clients and we also have clients who are not particularly sophisticated as it comes to financial markets.

But, but our approach is to say, let's treat everybody like the intelligent adults that they are. And if we can't explain to people what's going on in the market and the economy and their portfolios in a way that, you know, a reasonable, intelligent, fully educated adult is able to process, then, then we aren't doing a good job with our, our communication.

I think that's really key because, um, I'd love to talk to about some point during this, this interview is this idea that it is not actually the returns that our strategies generate that will leave a mark on the world. It's the returns that we generate on client capital, that, that, that makes a difference.

And, um, not every manager with a great record is able to take all their clients along for that whole ride. It's, it's easy for clients to come and go at the wrong time and, and greatly underperform even a great strategy.

[00:20:33] Bogumil: There was a study, and I don't, I don't know if it was Peter Lynch that shared it, that the average dollar invested in the fund is not exactly getting the returns that the fund is getting because people come and go. There are multiple studies, but I think Peter Lynch was one of them that quoted it. And it's really interesting what you mentioned, having everybody on board through the entire journey with you so that the actual returns that the capital gets are close to.

What you think you're, you know, getting in the process. We talk about the capital that we manage as the capital that the clients don't immediately need. They're in a very comfortable financial situation, but it's also the money that can't afford to lose. So if it's inherited money or money created in their lifetime, it might be close to impossible to replicate it if it's lost.

And it sets a certain framework in terms of what kind of opportunities we're open to and what kind of risks we consider just unacceptable. So I see some parallels with the way you think about it and remembering that there are real people behind the capital. I think that that really helps. I, I wanna ask you about a couple of articles that you wrote about, um, duration and you compared, uh, equities to bonds and you touched on it a little bit.

And then you have some lessons from the nifty 50 stocks of the 1970s and maybe you can remind the audience what it was all about. I find that period fascinating. My senior partner, Francis, started working in 1969 and I always ask him about the seventies. I think there's a lot to, to learn from that period.

But let, let's talk about this concept of duration and stocks versus bonds and what happened with the nifty fifties. And it seems like the story repeats itself every five, 10 years in some other way.

[00:22:15] Sean Stannard Stockton: So just for, for listeners, let's just first define duration in a, in a straightforward way and, and we'll use bonds so you know, right now, you know you can earn 5% in a short term bond. But if you buy that bond, you are only locking in that rate of return for a one for one year. Right? And, but you could also buy a longer term bond, say a 10 year bond and maybe it earns 4%.

So you're actually gonna earn less by locking your money in for 10 years, but it's also locked in for 10 years, right? And so the duration of that bond is longer. And, and, and what, what matters about that is that the more interest rates move, longer duration bonds will change in value more because whatever that rate is, it gets locked in for a long period of time, right?

And so if you have, you know, you were, God forbid you bought a 10 year treasury at 0.7% at the end of 2021, you've locked it in for a decade. And, and now that you can go ahead and earn 5%, you know, just in, in money funds, well, it, it makes sense that 10 year bond has fallen a lot in value. So duration is just one of the kind of core concepts in, in bonds.

Remember we said earlier that, that the only value of a stock is the future cash flow that its, its company's going to produce. And that's the same with bonds. The only value of bond is the future cash flows, the coupons and the maturity payment that are going to be created. And so a stock has a duration, just like a bond has duration.

It's just that in the case of a stock, we don't know what the terms are. We don't know how much cash is gonna be produced or, or when. Exactly. Right. But that doesn't mean that there is not duration involved. And so what we talked about in the, in that post was this idea that a business that is going to generate, let's just use a example, like a consumer staple, like a Proctor and Gamble sort of business, right?

And it's going to produce, um, slow growth, but stable cash flows. And then you have another business, an early stage business that maybe is, is only break even at, at this point in time, but is growing rapidly and could be expected to generate a lot of cash out, out in the future. Just like a longer term bond, a business that's gonna produce more cash flows further in the future is a longer duration business.

Right? Complicating that with stocks is that the price you pay for a stock changes the duration as well, right? So if, if, if it's the growth business behavior, very low price, that can shorten the duration as well. But the core point we were trying to get across is that changes at interest rates and changes in perceptions around how long interest rates are gonna stay at a certain level impacts bond values.

Like, that's just a self-evident statement, but it also impacts stock values. And so we introduced this idea that last year was, uh, a period of time in which duration got extended and, and, or excuse me, duration shortened from an investor's perspective. So investors said, you know, I don't care about 2045 earnings anymore.

Like, like so many people did in 2021. Suddenly, I just wanna know what you're gonna earn next year. Right? And, and if you're gonna miss this quarter, but next year's gonna be fine. I don't wanna wait that long. Right? And, and so we saw this change of, of behavior and, and from our standpoint, whether we're invested in a, a low pe kind of quote, value stock or, you know, high growth, you know, quote, growth stock.

At the end of the day, every business we're investing in are business that we think are gonna create future value, right? Businesses that are relentlessly reinvesting in the future, right? Who, who take the Cashs they get today and don't think themselves, oh great, how much can we just pocket and, and put this away, but companie that say, is there a higher and better use for this cash?

Like, we'll give it back to our shareholders if we've got nothing better to do. But if we can generate returns that are above, just say the s and p 500, why wouldn't they? Right? And so we want our companies to be reinvesting in that way, and that means that we're focused on kind of future oriented, or you might think it's like long duration businesses, you know, um, during the nifty 50 era.

This all played out very dramatically. And, and what your colleague who worked that time will tell you is it's not just that there was a year of bad inflation like we had last year, and it wasn't just, there was like two or three years, there was a decade of ongoing double digit inflation and multiple recessions.

It was a disaster of a decade. And so stocks got down to single digit PE ratios and a lot of growth stocks just absolutely collapsed. But what we showed in the in, in that blog post was that if you had bought the Nifty 50 at its peak, at its peak, it would've generated the same returns as the SS and P 500 of the next 25 years, meaning that those stocks were not overvalued despite the fact they collapsed so much. What happened was they collapsed as people got worried about high inflation lasting very long time. And as that was resolved, even though it took a decade, once it resolved the values of those businesses came storming back and the contention we were making last year, Was that these, these growth stocks that had collapsed so much in value last year, if inflation was gonna stay high for a decade, well then they probably were, were not gonna come back anytime soon.

But if you believed like us, that this inflation, these economic challenges that we face today are nothing like the 1970s. They're very serious in their own way, but they're nothing like the 1970s. And that there was no particular reason to think that you would have a decade of high inflation or even worse stagflation.

That there was huge opportunity in, in those growth stocks last year and, and we continue to think that's the case.

[00:27:45] Bogumil: So in moments like this, uh, let's say that you were sitting there in 19 71, 19 72, what, what would you do in terms of, uh, being in stocks or in bonds or in, in different stocks, or would you exit the market? I'm thinking of Warren Buffet and, and with somebody, I had a conversation about Buffett's, uh, false retirements.

How there are moments where he would just say he, he's out and he closed the partnership, but he didn't actually leave. And I'm wondering what I would do in moments like this when you see that there's too much hype, the valuations are high. There are some risks coming in. How? How do you navigate for an environment like this?

I feel like the seventies, as you said, were very peculiar and we haven't lived through anything like this since, at least in the us.

[00:28:29] Sean Stannard Stockton: So I think there's kind of two reasons why an investor might kind of get out the way you, you, me. Um, I, I don't think it should ever be about observations about what. Is going to do, unless of course all you can hear about is buying the market passive fund. Right. In, in our, in our case, we're just trying to buy 20, 25 businesses.

And, and in my experience, and I think just thinking about it rationally, there's very few market environments in which an investor can say, I, I just can't find even 20 to 25 attractively priced stocks to, you know, it, it doesn't necessarily matter that the market's expensive. There are always values, you know, and, uh, we weren't running this strategy in, in 1999, 2000, but, you know, there were lots of, um, the dotcom bubble and all his collapse, but there was investors like David Draymond who was at SC Investments was like an early era of my, his stocks did great.

He owned these super low, low, you know, PE banks and, and home builders and things like that. So there's always opportunity in the market, you know. Um, I think that, that the two environments in which, which unity can, can dissipate dramatically is, is true bubbles, right? Like we had in, in 1999 or 1929, And then periods ahead of really disastrous economic periods.

Right? Like if we, one of us had a crystal ball and, and we could have told that, that the financial crisis was gonna come in 2008, well then yeah. Get out of the market ahead of time. Right? And same thing with early 1970s. If you had a crystal ball that could tell you that there was gonna runaway inflation for a decade, well yeah, you're gonna be well served to, to get out, right?

Um, but we think that latter case of, of anybody kind of having that crystal ball, it's just not real. Right? I mean, we all know, you know, stories of people who've made some big call and got it right? And there's famous people that maybe they got two in a row, right? And then they become really famous, right?

But somehow they never get the third one. Right. You know? And so we pay a lot of attention to the macroeconomic environment to understand the context in which our companies are operating. But we're never gonna say we're gonna get out because we're really negative on the economy. We just think it is.

It's not actual feasible. Um, achievement to, to, to strive for. Um, but when we can't find attractively priced stocks, we'll let cash accumulating into strategy and, and that's just what it is. That's.

[00:30:41] Bogumil: I noticed this phenomenon with quite a few investors that have been in the business for, you know, 50, 60, 70 years that I got to meet over time and then spend time with that. You can reach a point of being scared out of the market. You've seen so much bad that has happened, and I'm thinking even of Ben Graham.

There's a story of him that in the last years of his life, he was pretty much out of the market and it might have been a personal decision. He didn't have to make more, I don't know the context, but it kind of rhymes with this idea that if you've seen so much bad, at some point you panic. And I'll ask you about Covid in a second, but I took calls in March of 2020 from really experienced, seasoned investors that I admire that have been in the business for 30 years, and they were making an attempt to get out and some of them got out at the worst of times.

So it got to them in a way that. Pretty much derailed them, um, you know, their business and, and professionally and on a personal level because they missed out on a massive recovery that followed. Can you talk about that, you know, getting scared out of the market because you've seen so much bad, or somehow you're immune to it?

[00:31:42] Sean Stannard Stockton: Yeah, yeah, yeah. So when you're a brand new investor, um, it's really easy to be disciplined and to say like, Hey, the stock's trading at a P of 10, that just must be cheap. And so you buy it and it goes up and you say, yeah, I bought a cheap stock and it worked out. But what you didn't know at the time was all the very valid reasons why the stock was trading so cheaply, right?

So I'm talking about an early investor who is, who is naive, right? And then you, then you get to build some degree of expertise or wisdom or understanding of how businesses go. And as that goes on, I think what actually happens is you become more and more aware of how uncertain the future actually is.

You know? And, and so I think that, um, sophisticated, experienced investors know how bad things can actually go, right? And, and that is real, right? But the way I think about it is, I, I look back over the last, say, 75 years since the end of World War ii, and occasionally I'll have a client say like, well, I know the average return's been 9% or whatever the last 75 years, but those times are, are gone.

The good times are over. I just don't expect we're gonna have that, you know, if we do five or 6% a year over the next decade, I'm gonna be happy because. We benefited from so many tailwinds in in the past, and those are all over now. And then you look back at the last 75 years of the economic and, you know, human horrors that have been visited upon this earth, right?

I mean, I cold wars and hot wars and pandemics and decade long periods of inflation and crashes and technical crashes like 1987 that people still don't fully understand. And, and you realize that, oh my gosh, those returns were generated despite all of the challenges that humanity faces in its attempt to kind of organize and, and create value over time.

And that the future ahead will have all sorts of challenges as well. But if, if there were not to be challenges, imagine how incredible businesses would be. Imagine the advancements humanity would make, right? And so for, for us, it's not that we think, oh, things aren't gonna get that bad. It's that we think to ourselves, even when things get really bad.

Over the longer term, if you're doing your job right, and importantly you own businesses that get through the hard times to the other side, it's gonna, it's gonna turn out okay. But all that being said, I managed money into the thick of covid. I managed money into the thick of the financial crisis. And I think that in both instances, if you didn't understand that a global depression may have been in the offing, that you weren't paying attention there.

Those were not easy buys. It was not to say March of, you know, your, your experienced friends who got scared out. It's 'cause they were acting rationally. They understood that something terrible was happening all around the world and we did not know what the outcome was going to be. Right. And, um, so it's not, I don't think they got scared.

I think that they rationally recognized the dramatic events that were unfolding and they took an action that didn't end up being the right one. But it wasn't like, oh, they got scared and oh, it just should have known everything was gonna turn out okay.

[00:34:40] Bogumil: I had a fascinating conversation with John Jennings who wrote the book about uncertainty, and he makes a point how if we had that crystal ball at you, Mentioned in March of 2020 and you and I didn't know where the market will go, but we knew all about the Covid statistics, the deaths that we'll follow, the lockdowns repeated lockdowns globally.

If we knew about the economic impact, the people that got and lost their jobs, if we knew all of that, I think a lot of us would not choose to invest because it's, the news was just so dark. But then there's the reminder that the stock market is not the economy. And uh, that's what helps us, you know, continue to participate.

I don't know if you have thoughts about it, but if we knew how bad it's gonna be, I think a lot of us would've chosen to just exit.

[00:35:26] Sean Stannard Stockton: I think this is a really important concept, um, that, you know, if, if you gave me the Wall Street Journal from 10 years from now, There was no stock prices in it. It just told me everything that had kind of happened. You would think that would just be the easy ticket to riches, right? That you would know what, what would happen and, but you don't, right?

So it's not even enough to know what's going to happen In reality, you also need to understand how stock price are gonna react, and it is. So, you know, there's so many complex cross currents there. You know, I remember when the market was storming back in April, May, 2020, and talking to people who were saying like, this is crazy because clearly the economy's in shambles.

But I think the way that understood at that time, if we just used the s and p 500 as as the proxy, was that small and medium-sized businesses were just being shut down. They'd basically been ordered by the government, you must shut down and only the big companies are allowed to operate. And so they were just sweeping up.

Wealth, right? And so if you thought about the market and you thought, well, this means like companies in aggregate, that's not what the stock market is. It's like 500 gigantic companies, right? That have the balance sheet and the wherewithal that have the systems be able to implement covid protocols in, in, in rapid order.

You know? And so it was really something quite different than just understanding the economy is to understand what those businesses were doing.

[00:36:45] Bogumil: So I have to ask you about Covid and that time and your, uh, experience investing for the pandemic. But before I ask about that, your firm was remote ready before Covid happened. Can you talk a little bit about that? It's, it's fairly unusual in the investment profession and C Card associates right now benefits quite a bit from being, you know, remote in many ways.

But it wasn't something that was common at the time in 2020. Can you talk about that, why you decided to be remote ready and then, uh, the transition to working fully remote and then market experience that you had?

[00:37:17] Sean Stannard Stockton: Sure. I mean, it certainly was not in anticipation of a global pandemic. I can, I can tell you that, um, you know, for us it was just, we were, you know, in the San Francisco Bay area and the traffic was getting worse and worse and we started to struggle just to hire people who lived in the Bay Area. Just the traffic within the Bay Area gotten too bad.

And so we started experimenting with remote work and I was actually, um, Kind of the most hesitant. I was really worried about kind of the culture impact and, and kind of free flow of information, all that sort of stuff. And, but we just started off and we told people, we told everyone in the firm, you can work one day remote without any kind of permission from your managers, put it on your calendar.

But, but importantly, you have to get your work done. So you need to work where you need to work to get your work done. You can't, you know, if you're a client facing person, you can't say, well, Tuesday my remote day, so I can't meet with the client. It's like, well, that's not what we're doing here. We're, we're, we're doing our work, but if it, you know, you can choose where to do that work if it facilitates getting the work done.

And that worked fine after a year, and there was like no negative repercussions. And, and then we made it two days a week. And then in the third year we just told people, you know what, just get your work done wherever it needs to get, get done. And, and that might be quite different for someone who's working in operations versus a client facing advisor and, and all those sorts of things.

And so we came into. Operating in a way that was what we'd call hybrid today. And, and, but it was very much directed less through some sort of policy around everyone in the office two days a week or something like that. And, and much more around work where you need to work to get your work done, you know, and, and, and sometimes it can be much more productive to be remote and sometimes it can be much more productive to be in, in person.

And I think in-person relationships and interactions are very important elements of being human and being part of a team, you know? Um, but then we just shut everything off. I mean, San Mateo County where our offices were in in 2020 was the first in the nation to be, to go into shelter in place. Um, you know, the order came out at like noon and I directed the entire team and said, at one o'clock you logged down.

If you haven't gone grocery shopping, go stock up. And, and you know, we're not gonna be coming back. Right? And, um, not for a while. And so we just operated that way for a year and a half. I, I know different parts of the country. It was like six weeks later people were back in the offices. That just wasn't the case in the Bay Area.

You know, if I had offered to meet with a client in person, you know, three, four months after Covid hit in the Bay Area, they would've fired us for, you know, not thinking. Right. You know, I mean, it was, so, there was no need for us to kind of go back into the office in, in short order. But interestingly, we did move into larger office space in downtown San Francisco from smaller space outside of, of the city.

And, um, I've had a co he'll ask is like, was that like a value investment? Did you get a great deal? And, and in our case, we were able to get the only vacant spot in a class A building that we never could have gotten access to. And, and that's kind of my kind of value investing, right? It's not, it's not super cheap on the surface, but it's a super high quality asset that's not often available.

And we were able to acquire it, you know, and, and so we use that space for, for group gatherings. We, we had a retreat in January, brought everyone in the firm together for three days. And you know, we, we work there regularly depending on the work. Um, but the default is not to say, go in the office and sit next to your colleagues.

I know a lot of people are doing that today. And what are they doing all day long? They're on Zoom calls while they're colleagues say next on Zoom calls with somebody else, you know? And so for us, this work that we do, it's, it's very much knowledge work. It's very, it's, it's, it works well on a remote basis.

I'm happy go more in the details, but I also recognize that not all businesses are equity research, right? And not all business can operate remote. And, and I have no kind of grand conclusions about what everyone else should do.

[00:40:50] Bogumil: No, I agree with you. And that has been our experience and we were remote ready, not knowing we're remote ready. So the senior partner, Fran Kar, he, he lives in multiple places and he wasn't always in New York anyway in our office. And we would set up Zoom before anybody. We knew what was Zoom and we were doing Zoom calls with him and with certain clients that are not based anywhere near.

And then we had, you know, cloud services and all kinds of solutions that would make it possible to work from anywhere. I was on the road seeing clients, and then when Covid happened, we just closed our laptops. We walked out, we left the office for a long period of time, and, and we haven't had not seen each other in person for, for I think almost a year.

And then we started to see each other. But continued to work, uh, you know, work remotely and clients embraced it. I had some concerns because they were used to seeing some of us, some of the time in person, and as you mentioned, quite a few of them were just not ready to see us for a while. And only recently I resumed some of my regular trips to see people in person and catch up.

And I think it's as important in the business because there are certain things that get lost over a Zoom call, but the Zoom calls help in between to keep the conversation going. So it's been a, a fascinating experience years ago, I went to a digital nomad remote work conference, and I came back with those ideas to my firm in six, seven years ago.

And a lot of people told me that investment profession is an in-person at the desk kind of job. And I can tell that you can, you agree that research work is something that can be done from anywhere as long as you remain productive. I, I wanna talk about the, the market experience. What was it like for you?

And everybody had a very individual different experience of March of 2020, and I'm curious, were you surprised, shocked, ready to act? Um, you know, what was it like for you, uh, on an emotional level and then also how your clients experience that time, especially the beginning of it.

[00:42:46] Sean Stannard Stockton: I feel lucky that one of the analysts on our team is, um, very science oriented guy and he began following Covid stuff before it. Dodge the, the downturn or anything like that. I mean, getting back to even if you can predict what's gonna happen doesn't necessarily mean, you know, what, what stocks are gonna do.

And, and neither he nor I or everyone ensemble believed we knew what the course of, of Covid was gonna be, but, but it did mean that we were paying attention to it relatively early on. And, um, and, you know, there was all of the mocking of, of how everyone became like a, you know, uh, epidemiologist expert overnight.

And, and of course none of us were, but this is one of the things about being an investor is that you need to, to get to understand or, or absorb the information from like a huge range of stuff. So during the financial crisis, well, we all had to go learn all sorts about collateralized debt obligations and things like that.

And, and, and, you know, then now a pandemic, you learn about these things. And, and to me, um, you have to be very careful about how much you can know. There's plenty of people out there who thought they could do a crash course in epidemiology and forecast the pandemic, and they were wrong. But you could get to understand.

The range of potential outcomes and, and sorts of things that may happen, especially over time and keep updating your understanding and your forecast. And so, you know, for us, I think one of the really big moments for me that I remember so well was, was when Covid first jumped to Italy. And you remember that, you know, in the hospitals there was just people dying in the hallways in Italy and, and you know, there was just, it was pandemonium.

And I had this huge LinkedIn network right, just from, you know, writing about investing and everything. And, and I did a quick search and for Italy and, and I managed to connect via a zoom call with a, a senior executive at a bank. And it was on a Sunday night. Um, and, and he got on the phone with me and he said, Sean, the grocery store is closed on Friday and I don't know if they're gonna reopen on Monday.

[00:44:39] Bogumil: Wow.

[00:44:40] Sean Stannard Stockton: And that was the moment when I was like, oh,

[00:44:42] Bogumil: It's different.

[00:44:43] Sean Stannard Stockton: this isn't like, oh my gosh, some people are gonna get sick. This is about society coming to a halt. And, and what is that? Look like and mean. And, and so the way we approached, um, covid in, in say this, uh, you know, during say the month of March, 2020 when the mark was falling so rapidly is we just tried to say, okay, ha, rather than think about what's going to happen, let's underwrite, what would happen, what would need to happen to this business for them to actually run into some operating concern issue, right?

Like their cash flow comes to a halt and they don't have cash in their balance sheet, whatever that might be. Let's model that and decide do we believe it's not gonna get that bad? 'cause the goal here is to get to the other side. That's the only goal of that point, right? And we exited one stock in our portfolio.

It was, it was a maker of parts for automakers. And it occurred to us that auto production was gonna halt and you could have had rolling bankruptcy across the auto OEMs. And that this mission critical low cost parts player that had the great competitive advantages. Those just might not work at all matter at all if, if your customers are bankrupt and not paying their bills, you know, and, and we exited that, but we also added some new, some new names, right?

So we, we stayed invested and, and the kind of, the, the way I thought about it is that the reason we do all this work in researching companies and, and trying to find companies that have defensible cash flow streams and are well run all sort of stuff, is to say we don't know what the future's going to hold.

So we wanna make sure that we're in businesses that have the tools to get through unknown crises, you know? And, and so what we did in the second half of March was just look and said, let's make sure, like, are we ready to ride these companies? Like we're going into a storm and you can't jump out once the storm started, right?

Then you just die in the waves, right? So yeah, you're gonna have to ride through the other, the other side are these the stocks that we're willing to ride, you know? And like I said, we, we dropped one stock out of the portfolio of 20, 25 companies, but everything else, we just, we decide just to ride through.

And, um, that ended up being the, the right choice. I mean, not, not that every stock worked out, but, you know, we really didn't have any businesses in the portfolio that got, you know, devastated by Covid, with the exception of the online travel agency whose stock recently, um, has, has now performed, I think just about in line with the SS and P a hundred since, since before Covid.

And there's a business that went to negative revenue. They had more refunds than, than new collections in April, 2020. And, and yet we own, we held it and it held it ever since. 'cause we didn't believe Covid would do a thing to change the human desire for travel. It's hardwired into our D n A and, and, and we decided to hold it 'cause we were saying it, it could be a while.

Um, but the good thing is they had such a great business model that they were able to operate without revenue for 18 months, um, as the beginning of the pandemic. And we just figured that.

[00:47:26] Bogumil: I like to say that I want to be the least wrong. I think a lot of people go into investing because they want to be right. And some people go into investing that I don't even think they wanna make money. They just wanna be right. And I think it's a dangerous place to be. And in moments like this, uh, We were trying to figure out how can we be the least wrong?

What kind of businesses we shouldn't own, what kind of businesses we can add to, and how we can participate in a potential recovery, even if it takes 3, 5, 10 years. And to me, moments like this, I like to look at at history. Uh, I love history and reading about history, and I had quite a few guests on the podcast that always remind me, if you don't know the answer, look up a history book.

And, and I was reading a book about plagues, the history of plagues that we've had as a. Uh, humanity. And one thing that I walked away and I had more notes that at the time was that each plague comes or pandemic, comes in waves. They're always waves and they're very irregular where they peak in different pi parts of the world at different times.

And I thought that's a very powerful idea because we're made to believe that this is over in two weeks. But that's not how any of the pandemics ever worked. And I was trying to imagine what it would be like for businesses to survive and manage through multiple waves of lockdowns that happen at different points in time.

And that allowed us to, you know, sift through some ideas and, and benefit from it eventually. But there are all kinds of things you can learn from history, and I'm sure you, you read quite a bit too, just to see the parallels of. Things have happened before. Not exactly the same, but there are some big sim similarities.

You have a, a great remark in one of your articles that I wrote down and I really liked You say how the market can consistently underprice wonderful companies and we were just talking about some wonderful companies. Why is that that market that everybody's so smart, reading everything has access to everything, but the market still somehow consistently under prices.

Some of the wonderful companies that you like to own.

[00:49:24] Sean Stannard Stockton: So the market overall rationally prices, stocks. Such that their growth rates will slow over time. Right. And, and moderate and kind of con con converge with the meme. And that their return on invested capital, right? That, that the returns they turn on, each new dollar invested in company will also kind of converge with the meme over time.

And, and what is a wonderful company, right? Well, a company that can buck that trend to some extent, that somehow it is not subject to mean reversion. What is mean? Reversion is to say, to become average, right? So by definition, a wonderful company is one that does not just become average, right? And so if, and only if you are able to correctly identify a wonderful business, a business, that there's something about the company, the business model, the dynamics in the industry, the dynamics with the customers that allows the company to, to break the very compelling trend towards mean con, uh, mean reversion, then it makes sense that that.

The stock would continually outperform. Right? And, and of course there are um, lots of other people looking for wonderful businesses. So sometimes you can find a wonderful business and it can do well, you know, better than average and the stock can still underperform. So it's not just as simple as saying, just find wonderful businesses full stock.

Right? You then have to quantify that wonderfulness, right? A business might be wonderful, but it doesn't mean it has in infinite value, right? And, and so I think where the alpha that we seek to generate comes from is, is much more about the competitive advantage period of a business as opposed to how fast it grows or how cheap we pay for it, right?

And, and if we, getting back to our opening comments about kind of growth and value and, and what we do, the value investor says, I pay a really low price and even if bad things happen, I'll do well, right? And the growth investor says, I gotta find business that are gonna grow really rapidly and who cares about the price?

'cause everyone loves rapidly growing businesses, and if it keeps growing rapidly, the stock's gonna go up. Both of those perspectives are kind of right to a, to a degree. Um, for us, we're trying to play a different game, which is to say, what are truly competitive advantaged businesses? What are businesses that there's something about the business that truly protects its future cash flows in some meaningful way.

Um, if you find a business that's wonderful today and is super lucrative today, well guess what? They're competitors and venture capitalists and owners of capital all around can look that up on Bloomberg themselves, right? So a business that has amazing profitability today, in my mind, is nothing more than a company with a target on its back, right?

It's not a sign of of it being great in the future. It's just, it's a target. People are gonna come after it. And so therefore, you need to find businesses that have something about them that prevents other people from coming and stealing those profits. And if you can correctly identify those right and correctly is the key, right?

It's one thing to, to find it, but then you have to be right. And that's hard. And we've been wrong plenty of times in our career, right? And so if you can figure that out correctly, then you're able to own the business for a long period of time. As the, as the market typically will, will only kind of extend forward its view of the competitive advantage period for a couple years at a time.

And it's rare that the market will actually price a stock, understanding it's gonna kind of stay wonderful for a decade or longer.

[00:52:34] Bogumil: That makes sense. I wanna ask you about something that you mentioned throughout the conversation, but your big picture portfolio, construction, thinking, how many stocks, um, how do you think about the sizes, how do you think about the turnover? And you touched on it a little bit, but I want to come back to how you think about benchmarks.

Outperformance, I I'd like to explore that too.

[00:52:54] Sean Stannard Stockton: It matters a lot to us to outperform the benchmark over the longer term. Um, it doesn't matter to us to construct a portfolio that replicates the benchmark in some way. In fact, if you're gonna replicate your benchmark, you're likely to perform just like the benchmark, right? And if the goal is to perform outperform, that means to perform differently, right?

So we have no constraints in our strategy that mandates that we have a certain amount in a certain sector industry or anything like that. Um, but we own 20, 25 businesses. Um, so on average it's say four and a half to 5% position size. Uh, our max position size is 10%. At any given point, we, we often will have something in the order of 60, 65% of our portfolio in our top 10 names.

And we spent a lot of time, you know, well over a decade ago now, kind of really thinking through the position size framework that we use today. And, and I, I think that position sizing is like one of the great unexplored areas of investing, right? Like all day, every day people go on C N B C and tell you buy this stock or sell this stock, but they never tell you how much.

Right?

[00:54:01] Bogumil: You don't

[00:54:01] Sean Stannard Stockton: and, and this is actually one of the really key considerations. You know, someone can say like, well, I. I love Google. Great. Do you love it? Like it's a 2% position or it's a 40% position? Those are totally different points of view. Right. And so, you know, for us, we, we, there was kind of two drivers of where we ended up with this 2025 stocks.

And we don't think it's, it's kind of some perfect position sizing. It's just right for our strategy and for us as, as investors. So the first is that if you randomly select stocks out of, say, the s and p 500, what you'll find is that the volatility of your randomly selected portfolio will be very high if you've only picked like a three stock portfolio, be much higher than the, than the market.

But as soon as you get out to 25 to 30 stocks, the volatility of your sub-portfolio begins to mimic the s and p 500. And adding anything more to the portfolio only diminishes kind of volatility or, or, um, or drift away from your benchmark by, by a little bit very small amounts. And on the surface that seems odd, like how could you just pick 20, 25 stocks outta 500?

[00:55:04] Bogumil: Mm-hmm.

[00:55:05] Sean Stannard Stockton: Yet achieve the same level of diversification. But think about political polling, which has gotten such a bad rap in recent years, except you know it's accurate to within like one, one point a half percent. It's just that that's the margin of error in politics, right? And if you look at it, they only poll, you know, like tens of thousands of people and yet they get an assessment on a hundreds of millions of voters, right?

So it turns out that if you're randomly selecting, your sample size can be relatively small out of this, out of your entire sample, right? The number that you actually pick from. And you can kind of replicate the under the underlying trends, right? So there doesn't seem to be much reason to own many more that stocks in that if all you care about is minimizing volatility versus, versus the benchmark.

And then the other piece of it is that there's only so many good ideas out there. Like the biggest limiter to our success is trying to find enough. Great, wonderful businesses that also traded a reasonable valuation. They're, they're just not super common, right? And so because of that, imagining trying to own 150 stocks like the average mutual fund does, tells me there's no way you can know all those companies, and there's no way that you can even believe yourself that they're all great investments.

It's just, it's too many, right? I mean, nobody has that many great ideas. Even if you have a team of analysts, it's just, you know, it's just, you just don't, right? And so for us, kind of 2025 is the amount where we capture the benefits of just raw diversification just by having a certain number of stocks.

And yet we keep and narrow enough that we have our money in our best ideas that we truly know inside and out. And look, we get stock picks wrong sometimes. There's no doubt about it, but there's never once you know, that we're sitting around saying, well, it's just, we just weren't paying attention to that.

What was going on in that company? We, we might have been paying attention and had an incorrect conclusion. But with this number of stocks, you know, you and a small team can understand 'em inside and out. And to me, you know, that's what the key is. Like when the chips are really down, when a stock is just puking and you're, you're worried and you think you got it wrong.

You, you have to be able to lean on what do I actually know about this business? And is, is the stock price reflecting what I really, truly know and believe about this business? Or is the stock price overreacting in some way? But the only way you can do that is to truly know your businesses, to live them and breathe them, to know everything about them.

And it just seems implausible to do with, you know, 150 stocks. So

[00:57:23] Bogumil: No, I agree. When or how often a new idea enters the mix. So you have the 2025, you probably add from probably trim sometimes for various reasons, but a completely new character in the story. How often does that happen? I.

[00:57:36] Sean Stannard Stockton: we have about 10% turnover of the companies in our portfolio. So about two to three new companies enter the portfolio each year and two to three exit on average. Um, and you can look at our, our kind of long, over the long term. As you know, that works out about 10% average holding period. And uh, again, is at the company, not each share count, because on the flip side, we pay live engine position size.

And so we may own a business that we've owned for over a decade now, but we've owned different weights of that name all along the way. And so we absolutely trim stocks or add to stocks and, you know, we, we are not, um, just buy and hold and sit on our hands sorts of investors.

You know, I think the turnover, the full turnover as you would calculate on share count rather than companies in the portfolio in our strategy has often been about on 30%, 35%. So we're turning over any given shares every three years. But if you think about the idea that stock prices are kind of, um, Get out of whack with intrinsic value, but they revert back to intrinsic value over a period of time, and that's the whole basis for buying an undervalued stock.

Then you would imagine that over like a three year time period, some of that would occur and that you would therefore trade in and out of, out of stock. So we are aggressive in, in maintaining the position size we want, but in terms of the actual companies that we own, it's, it's, it's more like a 10 year holding period with about 10% annual turnover.

[00:58:53] Bogumil: And they come and go. Benchmarks are quite a, a frenemy of the investor in many ways. And I'm thinking, you mentioned the position sizing. If you look at the equal weighted or the market cap weighted and, and you mentioned s and p 500, so let's, let's talk about that one. When you look of over long periods of time, they're per.

They're periods when they are not in, in sync, equal weighted and market cap weighted, and especially this year. We happen to be talking in, in 2023 in August. How do you think about that? Because then you might have a small group of companies, and it happened more often in the last five, 10 years than I remember before.

Maybe I'm, I'm, I'm forgetting where you had a small group of company, nifty 50 obviously back in the day, where you have a small group of companies with massive market caps that basically move the whole ship in whichever direction they, they they're going. Can you talk about that? Because when you have the 2025 and you have none of those five, it's a different story.

[00:59:47] Sean Stannard Stockton: Yeah, that's right. So, um, our strategy is a high active share. It's over 90% persistently. That just means that how much of your portfolio is different than your benchmark, right? And, and again, if you're gonna outperform, you have to do something different. And to be different means you need to own something different in your portfolio.

And so we have this high level active share, but what that means is that our relative returns to the benchmark as much as we focus on how our companies are doing. The other thing is how do the companies that we don't own, how are, how are they doing? Right? And so there are years, like this year where having, um, concentrated strong performance in stocks that you might not own can be very damaging to your relative returns.

Um, I think that's an important thing to pay attention to. Like, so for instance, this year, understanding that, you know, just round numbers, the market's up 20%, but the average stock in the estimate is only at about 10%. I mean, that's an important thing to understand when you're looking at your portfolio and trying to understand the performance of the stocks that you own.

Understanding that all the stocks aren't up 20%, right? Is, is, is important. But I think that over the long term and, and that's where performance really matters. Um, the s and p 500 market cap weighted is perfectly fine, right? You can look at the equal weight and the SS and P 500 market cap weighted over like 30 year timeframes.

They have, you know, almost identical. Returns, returns, but you go through periods and when they swing around. And I think that's an important thing to, to understand. I think it's important for investors to understand why they're outperforming or underperforming, you know, just to understand what the drivers are.

Right? And so I think this year it's important to understand if you don't own Nvidia and you don't own Apple and Amazon and, and meta, there might be that that might be the reason why you're out underperforming, right? Not just the stocks that you own, but the stocks that you don't own. But that's never excuse over the longer term.

The longer term. It's just what are my returns and what are the benchmarks?

[01:01:37] Bogumil: You mentioned earlier in our conversation how when people were thinking about the economy during Covid and we were looking at the SM P 500, it's only the 500 companies, but there's so much business outside of those companies. But I'm thinking, and there are all kinds of metrics, how the. Weight. The representation of very few companies is so much bigger in the s and p, whether it was just tech, but not just tech, but the top five or top 10 stocks have such a big share in the s and p 500, and if I remember right, this is higher than usual and it's close to to peak levels.

Do you have some thoughts about that, especially given that you pay attention to the benchmark itself, but the benchmark, the nature of it is evolving and changing. It's a moving target,

[01:02:17] Sean Stannard Stockton: Um, so I, two thoughts. One, um, if you have greater concentration of market cap value in the index, Then to justify that you need more concentration in the earnings power of the companies in the insect

[01:02:31] Bogumil: right? I.

[01:02:33] Sean Stannard Stockton: And to be honest, it's completely reasonable to me to believe that there is more concentration of value generation occurring in the economy today.

I mean, these businesses like Apple and Google, that, that it's truly new for businesses to be able to have the breadth of, of sales that they're able to on a global basis and, and, and also be able to grow at the rates that these maybe businesses are still growing at. Right? And so I don't think that it is, that's some rule, like some of people will say, well, this is the highest, you know, weight of the top 10 of all time.

Therefore it must go down as if somehow the past was some like iron natural law that must be obeyed. It just reflected the degree of concentration of, of value creation. And I think it's pretty self-explanatory. People look around and say like, oh, guess what? I. Earnings has been concentrated within a relatively smaller number of companies in the past, and that might persist.

So for the most part, I, I don't get too worked up about those sorts of statistics. Um, the other piece though, I think it's really important is we wrote a post, I think it was in 2017, called Technology is Dead Long Lived Thing. And, and what we were saying was that all the great companies were being pulled out of the technology sector and being put in the communication

[01:03:46] Bogumil: that's why I, I, correct. That's why I corrected myself, because I realized that these days, a lot of those names are allegedly not tech companies anymore,

[01:03:53] Sean Stannard Stockton: Yeah. And so the argument that we made at that point was that we showed that our portfolio was dramatically underweight the tech sector as it continues to be today. But you look at the actual businesses that we own, they might be called, you know, communication services. They might be called healthcare, but what are they, they're organizations that are leveraging and deploying technology in the service of creating value for their customers.

And if that's not a tech company, then, then what is right? And I even think that concept of a tech company is really outdated. Like, are there any businesses that don't use tech in their right? I mean, there was a time when electricity was relatively new that people talked about electric companies, right.

You know, electrified companies, you know, and, and so, you know, it's, it's like we used to call it.com. Well, what's it, doesn't every business have a.com u r l that they own? Right. So, you know, for us, I think that the concept of a tech stock has, is, is just dated honestly. Right? Um, and what matters is, is not how the people at SS and p categorize stocks and sectors, but that you own businesses that are on the right side of, of future trends.

Um, and that you own businesses that are diversified according to their, the end market demand. Not, not to however they're categorized by some people on a.

[01:05:08] Bogumil: No, I think it's a really good point, but also the fact that we are living in a world of a winner take all kind of situation. And I'm curious about your thoughts about it because. The first book I read about investing was One Up on Wall Street by Peter Lynch, and he would mention that he would come across this new concept, usually a retail business, not necessarily, but in many cases.

And it would be popular in one part of the US and then suddenly popular in half of the US and then coast to coast and maybe going global. And it was the story of the story of the story of businesses that we knew us is such a big market. It's easy to test a new idea. If it works for the US consumer, we'll probably sell in Europe and elsewhere.

And, uh, There was a time when you would have a regional winner, you know, a regional retailer and grocery store that would win, but then they became global, national. And nowadays you don't have a Google of Argentina, you have Google, you don't have Apple of Thailand, you have Apple. Right? Like you, you just have the same brands everywhere you go.

And consumers want it because the US consumer loves it and they want it too. So it's an aspiration to have the, the phone and, and the device and, and use and be on the, the us uh, launched social networks and so on. Do you have some thoughts about it? Is this the world where once you have a brand that works, it will be a global brand over and over again because it happened to Spotify, Uber.

Even Netflix is doing something remarkable that we've never seen before, where a very fragmented industry where you would have even a release of a movie at different times, at different points in different markets. They're releasing their own production at the same time around the world. Do you have some thoughts about it?

Is it a winner take call future? Mm-hmm.

[01:06:41] Sean Stannard Stockton: I think it's very case specific. You know, I think that what is, what you're observing, I think the driver behind it is the way in which the internet has stitched together this global communication network and, and that communication allows people to organize the activities of their business all around the world.

So, so you said, you know, you don't have like the apple of Thailand and the Apple of India and the apple of, of the United States, which is true, but Apple has employees in each of those countries. And really what's happened is rather than the idea of like, oh, this, this US company has somehow sold to be all around the globe, is that the US company is not, they're a global company with activities all around the globe that are organized everywhere and they just won all of those markets, right?

Um, and so the internet has allowed people to coordinate companies across, you know, around the globe, but also coordinate. Customer demand, right? And, and interests, right? So, you know, today people in Dubai and London and Tokyo and San Francisco often watch many of the same movies, wear the same clothes, drive the same cars, care about the same topics, right?

And this is the global coordination of information, right? And so, um, it doesn't surprise me that you have more of this kind of, um, winner take all dynamic, but I also don't think that it is just something inevitable. It's not like capitalism is evolving this, um, natural end state of winner take all in all areas.

And I think that it's in, you know, investors can, can be mistaken in thinking, well, all businesses will follow this path. And, and that's just not the case. Uh, I, I expect that over the next decade or two, we are going to see the rise of a couple disruptors of these huge successful so-called winner take alls, and, and they're going to.

I don't know. I can't, don't have a recommendation on which one that is. We're, we're doing our best to stay outta them, but you know, there, there is not just this natural conclusion that all winning businesses just will go on.

[01:08:44] Bogumil: Going back to the image that you left, uh, about the profits. So those big companies are big. Pools of profits that everybody's looking at, right? And the apple has a big pool of profit, and we're talking about numbers that are hard to imagine. There are a lot of people that are willing to take a little slice of that pie in various ways, and those companies will be probably vulnerable in the future.

Sean, I could keep you here all day, but I have one big question. One last question for you about success. What, what's your definition of success on a professional and personal level if you're willing to share? I'm curious how, how Sean thinks about success.

[01:09:16] Sean Stannard Stockton: Well, professionally, you know, we're stewarding over $1.5 billion on behalf of, uh, two 30 families, institutions. Success for me is, is the continued stewardship of that capital in a way that is superior to what some other, you know, group would do. What, what the average group would do. And that's one way of saying outperforming the benchmark, right?

But, but beyond just doing that in their, in their investment strategy, it's also advising them, which the advisors on our team do, and, and helping our clients understand their own goals and define their own goals and reach their own goals, which is not just about alpha in their equity portfolio. It's about a lot more than that, right.

So professionally, you know, I look back over the last 20 years and think about how we steward people through the financial crisis and steered them through covid and, and, you know, the, during the periods that we outperformed are the periods that we underperformed. I'm proud of the work that we did. I think we've stewarded our client's capital well, and I believe we will continue to steward it, you know, well over, over the, the decades to come.

But to me, that is the professional accomplishment that I care about. I, I want. Our clients to reach their financial goals and to be the group that helps them, helps them do that. Um, personally, listen, I'm fascinated by investing. I'm obsessed with investing. I, I get paid to study basically every little aspect of, of human culture and everything that impacts how humans behave.

And that's great, but also I'm an individual in a network of relationships and with my, my family and my kids and my wife and my friends and my coworkers and, and professional success, excuse me. Personal success to me is really about those relationships, right? And, and renewing and maintaining and developing incredible relationships with people, you know, throughout my life.

[01:10:57] Bogumil: I love the sound of that investing is, is a fun pursuit. People think of it as just making money, but it's a very intellectual pursuit. And, uh, the fact that you can make money by picking the right investments, it's kind of a, a side effect, but that you can explore new ideas, learn new things, get challenged.

I think that's where the growth and fun happens. And hey, I mean, if you're right, you'll end up making money. That's, that's a, that's a bonus. Sean, thank you so much for today. I learned a lot. It was a wonderful conversation and I think we touched on so many different things and gave the audience a, a great idea of what you guys are about.

And I will include everything relevant in the notes to the episodes so they can explore more and follow you and read your regular articles. So thank you so much for today.

[01:11:41] Sean Stannard Stockton: Thanks for having me. It was really delight to be here. Great conversation.