Sydnee Gatewood: Hello everyone. Thank you for joining us on GuruFocus Value Insights. GuruFocus is pleased to have Dave Sather, the founder and president of Sather financial group join us today. Founded in 1999 as a fee-only RIA, his Victoria, Texas-based firm manages more than $1 billion in separately managed accounts.
In addition to heading up Sather Financial, Dave developed and leads the bulldog investment company internship at Texas Lutheran University. He also chairs the investment committee, is a member of the Business Department's Executive Advisory Council and the board of regents.
Dave has previously been a guest on our Value Investing Live stream series and has been a speaker at the GuruFocus Value Conference in Omaha, Nebraska on two occasions.
Thank you for joining us today, Dave.
Dave Sather: Thank you for having me.
SG: You're welcome. So let's go ahead and dive right on in. First off, how would you describe your investment approach in the current environment of high inflation and elevated interest rates?
DS: Well, hopefully it doesn't change a whole lot, but it just gives you more to think about when the interest rates were so low for 15 years. I don't wanna say it was free money, but it's certainly made it easier for marginal investments to perform. Well, and so I would say that we conceptually spend more time looking at the competitive advantage or the moat that a given business has to see how they're changing how they're being scrutinized. Obviously, you spend a lot of time looking at gross margins to see if they can actually absorb the inflation and maintain that gross margin or if inflation is causing gross margin to dip off. And at the same time is their market share, is it staying the same? Is it improving possibly because of weaker competitors?
And then, you know, the other big thing is interest rates go up, the financing of debt becomes a lot more challenging. And so spending a lot of time to look at not only interest rates, but the maturity of when different rates, different structures of debt are gonna have to be renegotiated and then ultimately see how that impacts free cash flow generation. That, as we have discussed previously, there are some businesses that actually do better in the current higher interest rate environment for some unusual reasons that are a bit different than they would have done 40 or 50 years ago. So really trying to figure out free cash flow and how and why that's being generated is very important.
SG: All right, thank you. I think a lot of people are just keeping their, you know, their tried and true, tested strategies and, you know, just not trying to panic. So,I definitely agree with that. What metrics or factors do you pay the most attention to when analyzing stocks in any market conditions? I think you touched on that a little bit.
DS: You know, when we look at why things fail, you know, if you're looking at good investments, if it is a good investment, ultimately, you'll be proven right with time. But I think we spend a lot more time trying to figure out what's gonna go wrong and inevitably whether it's governments, companies or marriages, the biggest contributor to failure is typically taking on too much debt and associated obligations. So looking at leases, pension shortfall, preferred stock, things of that nature, to try and figure out again, going back to the pandemic when things happen that are unexpected, that are really stressful to an organization. Do you have enough cash flow to deal with your debt obligations, because your banker really doesn't care. And depending on what type of bank it is, if it's venture capital, for instance, your business, which you thought was operating fine, may not be your business anymore if there ends up being a default event. And so really analyzing the debt, the structure of the debt, the cash flow needed. And then you can start looking at return on equity and return on capital to try and figure out just how big, how profitable is this business? Are they able to take the profits that are coming in and redeploy them to keep growing the net worth or are they struggling to produce growth? Um, and if they are struggling to produce growth, that's not necessarily the worst thing. You just want them to do intelligent things with the cash that the business generates. You know, whether that be pay a special dividend or maybe strategic buybacks, you don't want them to just build a kingdom just to build a kingdom, right?
SG: That's definitely a great thing to think about; cash and profitability and debt and all that is obviously very important for pretty much everyone. So, moving on, at the GuruFocus Value Conference in May, you identified some companies that you characterized as “battleships,” which I really enjoyed that analogy. One of them was Brown-Forman (BF.B, Financial). However, I noticed in your 13F filing for the second quarter, I haven't seen your third quarter yet, you slightly cut back on that holding. Are you still seeing the same qualities in the company now or has something changed? What do you find appealing about the stock?
DS: Yeah. So, just put that out there, we still like Brown-Forman and we like the spirits industry. It's very resilient relative to economic hardship. People don't typically change their drinking habits a huge amount. You know, they, they don't, uh, go from being a drinker to not being a drinker or vice versa. It may change the amount that they do depending on certain circumstances, but the other thing I might add just to clarify and be transparent with everybody in your audience, when you're looking at our filings, our firm is a little bit different in that we're not managing one pool of money; we manage individual accounts for each of our clients. So for instance, if a client has a need for liquidity, uh Brown-Forman could have been one of the places where we go or occasionally we have a nonprofit of foundation that will say, “Hey, we're really kind of uncomfortable holding alcohol or spirits.” So there's a lot of things that can cause us to either increase or decrease a given position that may not necessarily have something to do with how we see it as an investment. So I would say in this particular case, we still like Brown-Forman as well as the industry a lot. It's a very well run business. Fifth generation of the Brown family is still involved. They continue to manage the brands based on where they want to be in 10, 25, 50 years. So it's a very different mindset. You can see them be very logical, very methodical. And unlike any of the shows you may have seen on the Discovery Channel about making moonshine and stuff like that, this is the furthest thing from it. I mean, you're talking about people who have Ph. Ds in chemistry, who are operating in a manner that would be no different than a very high-end biotech type company in terms of manufacturing processes.
So again, very high-quality business. But that said, there was probably a pull forward of some of the business that was out there during the pandemic. And as a result, there's probably a little bit of a lull or a lag post pandemic, a little bit slower growing. And in the specific case of Brown-Forman for the last many years, they have been taking middle-of-the-road brands and selling those off and repositioning to higher-end, super premium categories, whether it be whiskey, tequila, gin, rum, whatever. And so obviously, money is a little bit tight, the bottom half of people in the economic spectrum, they are probably being challenged a little bit more to pay their bills. We're seeing that auto delinquencies and credit card delinquencies and revolving debt. Those are all starting to come up and now we're dealing with the repayment of student loans. So anytime you start seeing that you recognize that probably people are still buying as much whiskey as they did, but they're not buying the super premium, they're probably buying something that's a little bit more middle of the road and that impacts overall profitability. And so I think it's wise for everybody who's in that industry to kind of understand some of those dynamics that are at work.
SG: Oh, that's great insight. That's things I hadn't thought about before. Thanks for sharing that with us. With regard to your recently published article, "The Implications of Higher Rates for Longer," you mentioned "The shift away from the industrial economy has been remarkable. The stock market will not ‘die' simply because rates have gone up. However, the wise investor must understand which businesses benefit from higher interest rates versus those that are hindered by them."
Please tell us which businesses you think benefit from higher interest rates. If you are using the GuruFocus screener, what filters would you use to find these companies?
DS: Here is just a little bit of context for everybody who probably hasn't read my article, but just going back in time, you know, if you go study the net profit margins of the S&P 500, they have increased significantly since 1980. So profit margins have grown from less than 4% to nearly 12% today. So just assume that you're a manufacturer of something, whether it be a car or a plane, anything industrial, if you're really good in your domestic market, let's just assume it's the United States. If you want to expand into another country, whether that be Europe or India or Asia, in order to be able to do that, you typically went to a bank, you borrowed a ton of money and then over a long time frame, you built a new factory in that market and that took a lot of time, a lot of borrowed money to be able to be in that position to be able to expand into that market. So obviously, in a rising interest rate environment, if you are an entity that has to borrow money to fuel that expansion, higher rates obviously will pinch profitability. Additionally, we know that the accounting provisions for depreciation, they don't really reflect the true economic cost to replace plant property and equipment over time. So you've always got to keep that in the back of your mind too. So in the current environment we're in, we are now paying more to borrow and the cost to replace is more expensive unless you're very talented at reserving for future capital events. And even if you are reserving for future capital events, that is diverting money away that could have been used for a dividend or stock bought back. So opposite of those types of industrial businesses. Now, you've got these businesses that are not only capital light, some of them are super capital light. So consider Microsoft (MSFT, Financial) or Adobe (ADBE, Financial), maybe Alphabet (GOOG, Financial) or Meta (META, Financial). You know, Microsoft and Adobe, they are subscription models and they, you know, they provide software as a service. My office cannot operate without Microsoft's office suite, you know, Word, Powerpoint, Excel, all of that, we use it on a daily basis. Adobe, similarly, the people that use it, they're deeply ingrained into knowing how that system works. But the cool thing is, is that any time those businesses want to expand or update that product, they simply provide an update to the product. And then anybody who has internet access immediately receives that updated product. There's no new factories that need to be built, there's typically no new money that has to be borrowed in order to facilitate that update.
In the case of Alphabet and Meta, you've actually got the same situation. But instead of it being a subscription type business, the users are actually providing the inventory and access to the product doesn't really cost the user a direct fee. Obviously, we know that data is being harvested, monetized and all that's under scrutiny, but it's a super low-cost business platform. So in the case of those businesses, you can just look at their financials, you can see that they consistently generate free cash flow and that tells us they don't need to borrow money to expand, they may borrow money for other reasons, but just for typical expansion and maintenance of their operating system, they're not having to borrow money. It also tells us that with that accumulated free cash flow, they can still buy back stock, they can issue a dividend or they can make other acquisitions. But while they are determining what the most prudent path is for allocating capital, they're now earning 5.5%, maybe 6%, on their cash holdings. That changes the profitability dynamic for these businesses that have a slug of retained cash on their balance sheet. So take, for instance, a business like Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), they hold approximately $150 billion in cash and float three years ago that earned Berkshire pretty much nothing because interest rates were as low as they could possibly get this year. Berkshire will probably earn another $8 to $9 billion simply because they're able to take those excess funds and invest them into high yielding treasuries. So without Warren Buffett (Trades, Portfolio) or Charlie Munger (Trades, Portfolio) having to incur any more risk, capital risk, certainly they're now able to generate $8 or $9 billion simply by having better reinvestment opportunities.
And that goes to identify there are some businesses that are free cash flow generative that now have this wonderful problem. They are benefiting from higher rates. But if you're General Motors (GM, Financial), if you're an airline or things like that, you're having to manage debt and you are constantly sweating bullets in terms of trying to figure out. OK, when is the next tranche of debt gonna come up? And how much are we gonna have to pay for it? How much more are we gonna have to pay for it? Certainly more than we have over the last 15 years and again, not to go down this road too far, but certainly during the pandemic, you realize that there were a lot of businesses that were in our mind, we call them zombie businesses. A lot of very heavily levered oil and gas-type businesses. They should have gone into bankruptcy. But because the federal government stepped into the capital markets and started buying the debt of those businesses, it gave them more of a lifeline than probably anybody ever anticipated was possible. Well, those lifelines are no longer available and, as a result, you're having to find true operating efficiencies to stay float. But again,a lot of those industrial-type businesses, they have predicated their entire existence on being able to consistently get debt and renew debt. Whereas there's a whole different class of businesses. Again, the super capital-light businesses, they will actually benefit from having the increase in rates.
SG: All right. Thank you. For the second part [of the question], you did kind of touch on what filters or metrics you would use to find these companies.
DS: Yeah, I think it's number one, a lot of time looking at not only debt, you know, the maturities as well as the rate, um but also recognize that leases are a form of debt. And so sometimes you can just look at traditional debt metrics and you can be deceived if you're not taking the time to look at leases. So we will typically annualize that out and take a multiple of that because, again, if you're Dollar General, for instance, and you lease most of your buildings, your landlord is not sitting there giving you a lease for six months. It's probably six or seven years. And, as a result, we recognize that we wanna own ongoing businesses. So you've got to try and figure out what's gonna be the cash flow obligation necessary to satisfy those debt obligations and cash flow obligations. Otherwise, your landlord is gonna kick you out of your building or your banker is not going to refinance your debt. Some businesses, older businesses, still have a traditional defined benefit pension. So obviously you've got to figure out whether or not that's overfunded, underfunded or properly funded. Because again, those can definitely be draws on the capital resources of a firm. And then you can also sort for free cash flow if you see a business that is generating positive free cash flow every single year for 10 years in a row. That's probably a really good indicator that they are a capital-light type business that operates very efficiently.
SG: All right, thank you for expanding on that a little bit more. I appreciate it. In your published article "Becoming A Critical Thinker," you discuss the importance of critical thinking and the apparent lack of it in the educational system. Do you have any interest or plan to do something to influence the change of current K-12 education?
That's a very difficult problem, but I think it's actually a societal problem. And it's not something that's hiding. I think everybody recognizes that this is a problem. You know, for myself, I've taught on the college level since I was 28. So half of my life I've been teaching at the university level and the program I teach at Texas Lutheran University called Bulldog Investment Company is now in its 15th year. And I guess in observation, being in the classroom on a regular basis and also running an investment firm, so I'm a practitioner, it allows me to see what works and what actually helps teach fundamentals as opposed to theoretical applications. And I can just tell you that we don't use any higher order math. We are not a quant-driven hedge fund that's trying to day trade the market, but we recognize when we're breaking down a company, we know that our brains are like a supercomputer. It will run in the background while you're working on other things. And so you may work on a math problem or the financials of a given business and then it, you know, as you're going to bed at night and you're thinking through the day, all of a sudden something pops into your head, you'll find yourself maybe thinking about a concept or maybe looking back at a number, you recognize the power of your subconscious is still working on those math problems. And I know sometimes we'll sit there, we'll just look at a number back in the office the next day and go, “I don't know what's wrong with that number, but something is wrong with it” and that prompts you to take a step back and double check your math. And I guess that's just it, the fundamentals of math, they are just basic building blocks and whether you're a college student or K through 12, every American needs to be able to think through those types of things.
So addition, subtraction, multiplication and division. You've got to be able to do that in your head. You know, I may double-check myself, but just to keep those mathematical processes going, I will still run math in my head. Every student needs to be able to do percentages as well as the rule of 72. The rule of 72 is one of the easiest hacks any kid can possibly learn. But what you're gonna be able to do then is assess things like opportunity cost. So assume somebody, uh, wants to buy a $50,000 car today, but they could spend $25,000 maybe on a used car has similar utility relative to an expensive brand new car. And this is something that I do for myself and for my students: I make fun of a car buying decision I made back in the early 1990s.
So in this particular case, you know, I just always show my students if a portfolio grows at 10% per year over decades. And you spent 50 grand on a car, but you could have only spent 25. That means there's a $25,000 differential. And as an investor, you owe it to yourself to constantly run the math on what that decision is costing you. So the rule of 72 if your portfolio is growing at 10% a year, that 25 grand becomes a $50,000 boo boo in 7.2 years, becomes a $100,000 hiccup in 14.2 years, costs you 200 grand in 21.4 years and 400,000 in 28.6 years. So I made that decision when, in 1991, I bought a car, a race car and I paid $6,800 for it. I blew it up. I had no salvage value for it. And amazingly, I had the opportunity to buy Berkshire Hathaway A shares at the same time for $6,800. So anybody who wants to pull a quote, you can laugh at my own stupidity. That was a decision that I made back then. And it's cost me over half a million dollars. So I run that math every single year and I show it to my students because I don't want them to make the same mistake. That's simple math. It's very easy to run that and understand it. It's easy for me to see how much of my net worth that's cost me and what it could have done. So $6,800 30 years later has cost me over half a million bucks. That's real money for anybody. And I think, again, if I were sitting down with K through 12 kids, I would want them to be able to develop the mathematical skills to be able to do it again, the addition, subtraction, multiplication, division percentages, rule of 72. If you could do that and then you sat somebody down with a credit card statement and said, “OK, if you pay off your credit card every single month, it doesn't cost you anything. But if you leave a balance there, it's gonna cost you 24.9% or whatever it is today.” If you understand rule of 72, you know exactly how long that is gonna take for the interest component to double on a regular basis. That should be a lesson that really sticks with most Americans and would help them to better manage their money.
SG: Yeah, it's definitely an important point. And I agree with you. There's lots of people who don't know what they're doing, especially when it comes to spending money and like the debt, getting into debt, and that gets them into trouble. So I definitely think that those could be some valuable skills learned early on in life. Um, all right. So what are some of your favorite stocks currently? And why?
So we already talked about Brown-Forman. Uh, you know, very early in my career. I had a guy tell me, “Give me a one line sentence on what to look for when investing.” And it'll cover a couple of these, but relative to Brown-Forman specifically, this guy said, “You know, eat them, drink them, smoke them, go to the doctor and look good when you get there.” And so it was your food companies, your beverage companies, whether it be alcohol or other things, um, smoke them. He said, “I don't smoke, but if other people want to invest in cigarettes, that's fine. I'll put that in a portfolio.” Go to the doctor. So health care-related companies and then beauty supplies and things like that. And he said, “If you'll focus your attention on those types of things, you'll never be the popular kid at the party with the latest greatest technology, but you also won't blow your clients up.” And so when I think about that and I think about the need to just let your portfolio compound for long periods of time owning an alcohol company, a spirits company can be a wonderful cornerstone of your portfolio. So again, Brown-Forman, you got the fifth generation of the same family running it. They run it very smartly. They continue to show that they are thinking about long term down the road. And so if a really good spirits company, whether that be Brown-Forman or maybe even Diago; we've owned that in the past too. If they stub their toe or for some reason they become out of favor for a short period of time, those are really easy assets to own.
Another one that, I shared this with my students and I had a little GuruFocus exercise for my students, I went and I pulled up the interactive charts and I just went through all the valuation metrics on Dollar General (DG, Financial), but I covered the name of Dollar General up and I just showed my students slide by slide and showed them what the 10-year chart looked like on all the different valuation metrics. And I just said, just assume this is a predictable, inconsistent company which typically is, but you can see just how out of favor Dollar General is right now. And I think there's a couple of reasons for that. So, you know, the free money era of the pandemic is over. So things like surplus SNAP benefits are no longer there. And we know that the bottom 50% of Americans are starting to have higher delinquencies on auto payments on credit cards, on revolving credit and things like that. But at the end of the day, the things you're buying at Dollar General, they're not, um, they're, they're not excessive type things. They're the things you need to get through the day in the week and they're nestled into a neighborhood. So people are shopping at Dollar General before they're going to go shop anywhere else. Uh, be that as, you know, maybe for a $7 latte at Starbucks or something like that. And so even though there's a lot of bad publicity about Dollar General right now, we think long term they're gonna continue to do fine.
Another one that falls in the eat them, drink them, smoke them, go to the doctor and look good when you get there is Ulta Beauty (ULTA, Financial). Beauty has been another one that I just laughed during the pandemic when they said, “Oh, well, you know, uh, everyone's gonna be at home and nobody's ever gonna wear makeup ever again” and you just realize that even if you're on a Zoom call, you know, especially all of those of us that are in a professional capacity. If I'm on with a client, I'm not gonna just roll out of bed in sweatpants that have, you know, cheese down the front of me with my hair going every which way. You still have to look the part even if we are doing distance meetings. So, Ulta Beauty is another one that uh we like quite a bit.
S&P Global (SPGI, Financial) is one that we continue to hold. And like when you think about the debt rating, so again, think about how much more scrutiny there is going to be on debt now in a higher interest rate environment. So S&P is one of the main credit underwriting institutions, very dominant. And Moody's have a very good footprint there as well as all the S&P indices and things of that nature.
Kind of going along with the debt theme, Visa (V, Financial) and Mastercard MA). Again, the pandemic showed us that we really don't want to be touching gross grimy dollar bills and passing them around. Instead, we'd rather just swipe our cards and I know that there's always new legislation that we're gonna cut back on exchange fees and on debit card fees and yet, Visa and mastercard continue to make our lives easier. They are something that benefits from inflation. You know, there's a general offset directly off that total value of goods and services that are purchased with Visa and Mastercard. And more and more as governments around the world recognize that paper money is very expensive to produce. It is the preferred method for people that are wanting to avoid taxation. Governments want to get away from printing paper currency, they want everything to be held digitally because, again, it's much more efficient to produce and distribute whether that be pension checks or welfare checks or any of those types of things. And ultimately, that allows them to monitor taxable dollars that need to be collected somewhere in the world. So with Visa and Mastercard continuing to benefit from coordinating buyers and sellers on their, on their rails and that being digital in nature, that's a wonderful tailwind for both Visa and Mastercard.
Then the last thing I would say, you know, again, this is kind of a corollary to Dollar General if you've ever shopped at Ross Stores (ROST, Financial), some of our clients love it and some of our clients think it's just, ugh, they hate it. But if you've ever been into a Ross Stores, it looks like a clothing cannon went off in there; just clothes all over the place and it's always different every time you go in there. But you know, Ross is very open about saying it's like a treasure hunt because what they're doing, Ross goes to Macy's and Dillard's and Kohls, all those front line retailers and they basically say, “Hey, if you've got something that has a bit of a flaw in it or if it's last year's inventory, it's something you can't sell and you wanna get rid of, we will buy it from you” and they buy everything from stuff that might be a little ratty to stuff that really looks quite good and they'll buy it for a dollar, they'll resell it for $15 or $20 sometimes $30, $40 or $50 depending on what the item is. But like the other day, I was at Ross and there were some Hoka shoes. So, I mean, normally those were selling for like $200. They were selling at Ross for 60 bucks. And I'll tell you, like, my dress shirt I bought. Every dress shirt in my wardrobe has come from Ross and I don't think I've ever paid above $20 even for a nice Ralph Lauren-type shirt. I have never paid more than 20 bucks. So to me, Ross is not only a, it's basically a financial intermediary in the clothing category. They provide financing and liquidity to the front line retailers that may have a slowdown, something may have been out of favor or the pandemic happened and Ross was able to step forward and say, sell it to us. We'll provide you immediate liquidity, we'll store it away, but we will eventually sell it. And so it's just, it's a very interesting business model. Even if you don't like shopping there, just understand what a great business it is.
SG: That's great perspective. I had never thought about that. That's awesome. Let's see, are there any particular sectors you are avoiding?
DS: You know, the older I get, the more I say, we will never do something. And I guess the airline industry is a really good one. Prior to the pandemic, the airlines were getting religion and they were starting to consolidate and gates were being controlled and pricing was being controlled. And if you'd asked me 10 years ago, I would have said absolutely not, we will never invest in the airline industry. And you just realize that even the best intentions are being, you know, people are having their feet held to the fire, you know, good intentions are fine, but you're gonna have to be more profitable.
That said, things like again, the airlines, the auto manufacturers, those are really tough businesses because they are constantly changing. So airlines got punched in the nose with the pandemic, the auto manufacturers. I mean, every day that Elon Musk wakes up and says, “I think today I'm gonna, you know, go to space,” when you've got people that can upend an entire industry. I think it's better to say not that I'm necessarily gonna avoid something, but I'm gonna recognize that it's constantly changing. However, if it's more capital intensive, if I have to borrow a lot more money, I recognize that the underlying business model is more at risk and there are possibly easier decisions to make. So I can make my life easier, make our clients' lives easier by recognizing some investment decisions are just a lot harder to pull off. So take a step back. Nobody said you had to invest in everything. I find that smart people love to beat their head against the wall and really challenge themselves with lining up all these variables of this is gonna happen. Then this, then this, then this and when all those 10 variables all stack up just perfectly, the airlines are gonna work great or the auto manufacturers gonna work great, or I can just go own Brown-Forman and Ross, and so taking a step back and making things easier on yourself, I think actually delivers better performance and it avoids you from being sucked into that really seductive story of all the airlines are gonna consolidate. There's only gonna be four major players and all the gates are gonna be consolidated and it's gonna normalize pricing and all of a sudden the airlines are gonna be these, you know, very profitable, very consistent businesses. I just recognize that that's true until something exogenous happens in the world such as a pandemic and then your entire thesis gets blown up.
SG: Definitely something to think about. All right. Moving on to a trendy topic, AI has really taken the market by storm this year. What are your thoughts on its prospects and impact on the market? And are there any aspects of it that give you pause?
DS: I wish I had special insights. I think this is, you know, the fun discussion of the day. It's just really hard to tell how this is gonna work. So just as a conversation with my students, you know, we've helped them to understand, they understand that right now AI is taking large-language models and is assessing mathematical numbers to different words such that when you type in a query, it is able to figure out. OK, which word is most likely the one that we're looking for here. And sometimes it's pretty amazing because you ask it for a factual answer and it has a little bit of creativity to it. So obviously, you've got to be careful about how you're using it.
I actually encourage my students to use AI, you know, whichever one they want to because I think it forces them to sit there and say, “Does this actually make sense? Am I able to verify the types of things that AI is telling me?” And I know that going back to how we started the conversation, that profit margins increased, going back to the 1980s to now from 4% to about 12%. It won't surprise me, if AI, once it gets refined, allows us to supercharge another leg up in overall profitability. So I can see private margins go from 12% to 15% or 12% to 18% or something like that. Just because when I look at our firm in the practice of breaking companies down, the ability to do so quicker and to see trends more quickly and the relationship of one company to another AI has the ability to do all of those things pretty quickly and it will allow our firm to continue to grow and do a credible job managing assets. But without having to hire lots and lots of people and the cost of technology continues to come down. So I can see a lot of really good aspects.
But again, going back to my conversations with my students, right now, a lot of AI is large-language models and those large-language models are populated by people using the internet. It doesn't mean that everything that's on the internet is factual and the more that it gets used, there's a lot of misinformation, disinformation or just flat out wrong information that's out there. And so I think AI is gonna have to constantly be refined to be able to sift through the good information versus the bad information. For us, when I think about like reading 10Ks or going to SEC.gov and pulling different financial data, I think there's gonna be some neat improvements for a firm like ours to be able to go and really pull data directly from those databases and then figure out how do we refine them, sift them, sort them and make it meaningful. But I still think that we're a ways off.
Remember, you know, this just is a bit of a tangent. We have been told that we were gonna have truly autonomous driving for several years now and it remains elusive. And so I think some of the technology works very, very well, but it's just not as refined as we hoped it will be. So I guess that's my very long-winded way of saying that I'm excited for what AI brings to the table. I don't think it's gonna be a cure-all for everything. But I do think, you know, if you're trying to do research into cancer, for instance, these days, it takes a long time for somebody to do the research and then publish it in a journal for internal medicine and then for other people to read it. You know, there's often three, four, five, six years of lag time between when something is published and when it is broadly accepted, if not longer, and I would be hopeful that AI would allow medical practitioners and people that are doing other types of cancer research, for instance, to be able to read the latest research and then be able to draw correlations that might help supercharge the advancement of that type of research.
SG: I am definitely in agreement with you with the, you know, speeding things up aspect of it. But yeah, definitely gotta be careful about what it tells you exactly. What is your outlook for the economy and market for the rest of this year and heading into 2024?
DS: If I knew that I would be on a desert island, living the life of luxury. You know, it's fun. All of our clients want to discuss those types of things and, for a variety of good reasons, you know, sometimes they're trying to make hiring decisions, they're trying to figure out should they ramp up inventory, should they borrow money for an expansion, So I think there's a lot of good reasons for looking at those types of things when it comes to actually managing investment portfolios. I'm not sure I have any great clarity or, you know, there are no nuggets of wisdom that are just gonna blow everybody's minds, but it appears inflation is calm, but yet employment remains pretty strong. And I think that's part of the discussion that most people are missing right now. The economy is doing much better, GDP growth in the third quarter, still 5%. I mean, when I look at the rest of the world, the United States is the envy. We should be so thrilled and pleased with the growth that we're having. But yet inflation is calm.
I don't want to say that we've won and inflation is 2%. I mean, it's still somewhere around 3.8% to 4.1% depending on how you wanna calculate inflation. But GDP has remained remarkably resilient during that time period. So maybe that allows the Fed to kind of pause, as they have said for the time being and just wait for more time to go by. So they can kind of digest. It's also naive for any of us to not be clued into the fact there's a presidential election in a year. Unfortunately, I don't think that we could have much worse candidates, but yet, despite the lack of leadership from Democrats and Republicans, capitalism still works. And that's one thing that our clients really struggle with because they watch the evening news, they watch too much of it and they automatically translate high inflation is gonna lead to, you know, bad things, slow economic growth and that's not what's happening. They see a lack of true leadership from our national leaders and they think this is really bad for the economy. I can tell you there is not a single business owner, whether it be a private business or a publicly traded business, that wakes up and says, “Well, my candidate did not win the presidency and therefore I'm shutting the business down.” Everybody who plays the capitalism game shows up every day ready to do battle regardless of the circumstances in the political environment.
And so I would just say, don't ever count capitalism out. Capitalism is undefeated. We may have a recession once every seven years, but capitalism still finds a way of marching forward. It's just truly amazing. I also think, you know, the situation in Ukraine and Israel, they're both very unsettling and, you know, not to be kind of blunt with our clients, but I say we are either going to march forward and deal with the situation and if there is a nuclear event, it's not gonna matter because we're not gonna be here. So you might as well keep marching forward as if life will continue to grind forward. It is always a grind, there's always something to worry about, but our economy continues to be the envy of the world.
Employment. I mean, everybody who wants a job has a job. We continue to be the land of opportunity. So many people want to move to the United States and so many of those immigrants are wonderful capitalists. I love hearing stories about people that moved to America to start a business and employ people and circulate cash through our society. So when I think about all that, I'm pretty positive about the the rest of the world. It's just a matter of dealing with all the circus on the side.
SG: Yeah, that's a really encouraging perspective. Thanks for that. It makes me more hopeful as well. But speaking of that geopolitical environment you touched on the situation over in Europe and the Middle East. Are there any international opportunities that you are think are appealing given the geopolitical environment?
DS: Yeah, and I guess just as a matter of clarity when we are looking at investment opportunities, we don't necessarily sit there and say, oh, this is an international stock and it fits in one category and this one's a domestic stock and it fits in a different category. You know, to us, we really think that that is something that academics and consultants have wrong about the investment business. You need to look at the business model and you need to look at where the sales are actually derived.
So one of my all-time favorites is Weatherford (WFRD, Financial), which is an oil and gas services company. All of its manufacturing is done in Texas and Louisiana, but its headquarters is in Zug, Switzerland. They sell zero product in Switzerland. So I think you really need to spend more time looking at where sales and profitability come from as opposed to where the legal domicile is.
That said, a couple years ago, we recognized when the vote for Brexit happened, there was disruption in the European market. Diageo (DEO, Financial) sold off hugely. We took that as an opportunity to buy Diageo and once people realized, OK, well, maybe some contracts are gonna be redone, but the underlying businesses themselves, they're gonna keep selling spirits throughout the world. That aspect of Diageo had not changed. That to us is the type of opportunity we would love to find in which you've got a wonderful multinational business selling into all sorts of countries around the world. There is a distraction in the way that we're going to account for our sales, but it really had nothing to do with Diageo itself.
Fast forward to today. We had owned Lockheed Martin (LMT, Financial), the largest of the prime defense contractors. We sold it earlier this year, though. Um, the Ukrainian situation gave that business a temporary boost, enough to where we kind of in our assessment felt that the next five years worth of sales and earnings and cash flow were already accounted for. So we sold it at about $470 a share, which fell all the way back down to $400. Uh, I haven't looked at it this morning, but it was back around $440 or $450. That's the type of situation we would look for. Recognizing that it's a very, very good business and we would embrace the opportunity to own any of the prime defense contractors under the right circumstances. They can be very good businesses. The situation in Ukraine and Israel, they have reminded everybody in the world for the need to have a good national defense. And sometimes that is a matter of buying the latest, greatest and making a massive investment in that type of defense. Other times, it's a matter of going to Lockheed and saying, I know that the F-16 has been in production since 1980, but we would like to place an order for eight or 10 of them. And if you're a smaller country like Finland or Estonia, you're right down the road from Russia. But you wanna make sure you can put planes in the sky just to push back on Russia and let them know this is not gonna be a cakewalk. You will have to take this by force and we will take you on. There's also another underlying thing there too, Finland, in the entire Scandinavian countries, all those Baltic countries, they are very nervous about what's going on in Russia. And by them buying product from a U.S. prime defense contractor, there is an unspoken but understood relationship that the United States will defend our business partners, our allies. And that's another part of the geopolitical environment that I think a lot of people probably don't quite understand.
So I don't know if that really answers your questions on international opportunities to the political environment. I think it's really sad. I think not, not to take too much of a tangent, I think there's more opportunities for charitable giving into Israel and also into Gaza. There's just a lot of innocent people that are probably hurting in that situation.
SG: Yeah, I definitely agree. And I just thank you for that perspective. It's always good to hear different opinions, especially, you know, in this crazy world. On a lighter note, what advice do you have for individual investors?
DS: You know, it's funny. I'm gonna butcher this quote, but Warren Buffett (Trades, Portfolio) has often said that the biggest impediment to people becoming rich over the long term is their ability to focus only on the short term. You know, businesses don't wake up and say, “Well this week we're gonna be really profitable and therefore you can trade that outcome.” Great businesses are great businesses, especially over long time frames. And again, to quote like Morgan Housel, you need to find an investment platform and plan that you can stick with for the longest time frame possible. Compounding works best when it can be left alone for extended time frames.
But I think people really struggle with how to build a portfolio. They understand that OK, I'm gonna be a long-term investor, but how do I actually build a portfolio to do that? And it is strange, but the best investment to start with is not Microsoft or Adobe or anything like that. The best investment to start with when you're building your portfolio is cash and emergency money because that allows you to deal with emergencies that are gonna come up in the middle of the night.
So if the air conditioner goes out in your house in the middle of August in Texas, you're gonna do whatever it takes to cool your home because otherwise it can be 120 degrees in the house and you can't inhabit it. If the transmission falls out of your car, you have to be in a position to replace that. Otherwise you can't get to work, can't get to the grocery store, things like that. So the first investment is one of the easiest. You've got to allocate enough emergency money to be able to deal with those things that go bump in the middle of the night. If transmission falls out of your car and you're having to liquidate Microsoft to pay for that, you will inevitably liquidate Microsoft at the worst possible time. So first build your emergency money and leave that there.
Once you have done that, then you can start working on the longer-term aspects of your portfolio. One thing we've realized is if you break your money down into different blocks and allocate them based on different time frames, depending on the time frame, different assets have unique but predictable return and volatility characteristics. So having cash and liquidity, you can earn 5% plus off of that but still have tremendous short -erm stability. So you don't have to worry about, “Oh my gosh, did my cash devalue by 50% overnight?” Once you've got that stability portion of your portfolio, then you can start thinking about, “OK, what am I comfortable leaving alone for five, 10 or 20 years?” Five, 10 and 20 years will allow you to compound for an incredibly long period of time.
The news media seems like we need to be making decisions based on where we want to be in the next five minutes that will just blow you up. You need to be thinking conceptually about what is a business I'm comfortable owning for a minimum of five years, if not 10 or more and then leave it alone. If you'll do that, your portfolio will perform much better. So while Wall Street and all the crazy hedge funds and the quant guys, they are all super-focused with what's gonna happen in the next three months, nobody is focused on the long term. When I say nobody, I mean, there's a few characters, but if you're managing your own portfolio, you're in control of that. Focus on where you wanna be long term, there's less competition there. It's easier to play that game.
SG: That's great advice. Thank you! And finally, for the fun question, could you recommend three books and three movies for our listeners to check out? Please share why you like them and, obviously, they don't have to be investing related but just ones you enjoy.
DS: So on the movies, I have shown snippets of “Moneyball” multiple times to my students. And if you want to have a follow up of Moneyball study, the Chicago Cubs and the year that they won the World Series because Theo Epstein, who had been the general manager at the Red Sox, he really embraced Moneyball. Uh the Moneyball mentality of the data analytics of thinking about what really matters in baseball and it's so applicable to investing and just the world around us. If you can quantify things, you can start trying to measure what matters and what doesn't. So “Moneyball” is a great primer in just how to think data focused.
“The Big Short.” You know, 2008, 2009 was not that long ago, and yet there's a whole new group of investors that are coming into the market that have a vague recollection that something really bad happened once upon a time. But it's probably a lot like it was for me trying to understand World War II. My dad or my grandfather may have talked about it, but conceptually, it's just never the same as experiencing it. With the “Big Short,” I would just say that you need to be super careful about how you use debt and if others are using debt, you need to be even more careful about what the ripple effect is going to be to the entire market. People will always borrow too much money and it becomes, in a more and more sophisticated manner, via the use of derivatives that are extremely complicated. And a lot of times you don't really know what counterparty risk you are entertaining, and so making investments simple and in things that have higher liquidity, better balance sheets will definitely improve you.
Third movie is one about entrepreneurship and overcoming long obstacles and family dynamics and people telling you you're not smart enough. The movie is called “Joy.” It's about Joy Mangano. She was the lady that invented the continuous weave cotton mop and figured out how to keep that all together and then be able to squeegee off all the dirt that was in there. She went on to QVC and ended up becoming just an immense success since then. She's come up with over 100 inventions. I just love her story. I mean, true underdog story. Anything that I could see uh where an underdog is able to prove everybody else wrong. Corollary to that might be like James Dyson with the Dyson vacuum. There's just so many great stories in America about people that were told you're stupid, you'll never work, it'll never happen. And through grit and determination and having a vision and sticking to it, they're able to make it work. So that's three movies.
On books, I probably have more than that, but, I mean, obviously read all the Buffett books and the annual reports.
A business-related book that is more of a fictional novel is called “The Testament.” It was one of John Grisham's early books and is by far one of my favorite books of all time just because it has to do with behavioral finance, family dynamics, money, estate planning, how we pass money from one generation to another. And for some reason, I think because of the more technical nature, it wasn't as popular.
There's a book out right now called “Build the Life You Want” by Arthur Brooks. It's actually co-written with Oprah Winfrey. I just love Arthur Brooks. Brooks used to be the president of the American Enterprise Institute. Any time he is on CNBC or any time he's doing a podcast, I'll always take the time to watch it because he's such a positive and uplifting person about what is right in the world as opposed to everything that is wrong in the world.
Pat Dorsey's “Little Book That Builds Wealth” does a great job of breaking down competitive advantages and moats. Another book that's a little bit older, “What's So Great About America.” It was written by Dinesh De Souza; another wonderful immigrant story, went on to be a university president, worked in Ronald Reagan's cabinet.
Then lastly, the “Millionaire Next Door” and “The Millionaire Mind” are just wonderful books for those who really have wealth in our society. It is not the people that are out there showing the bling and driving a Lamborghini. It's the people I have as clients. They are truly straight out of “The Millionaire Next Door.” They are hard working, they're entrepreneurs, they often own a machine shop or an oil field services business, something of that nature. And you also realize you don't have to be the sharpest tool in the shed. You don't have to have a, you know, perfect score on the SAT or 4.0 GPA in order to be successful in capitalist society, but a lot of hard work and a lot of tenacity will help pay off. And I guess I'll round that off by suggesting “The Psychology of Money” or anything that Morgan Housel writes. He's just a very insightful man about how the human mind works and the relationship we have, the very complicated relationship with money.
SG: Well, thanks for all those great recommendations. I'll be sure to check some of those out that I haven't seen or read before. But thanks again for joining us, Dave. It's always a pleasure to have you.
DS: Well, thank you for including me. You know, guru focus has been a wonderful part of not only my professional world but also my students world for as many years as I can remember. And we just appreciate y'all being providing such a wonderful platform to educate everybody.
SG: Well, thank you so much. I hope you have a great rest of your day.
DS: Thank you so much.
