The Exchanges

Q So go back to that story. So now you're an early, early bird in this world. You go through college and what then?

A So I moved to Austin, Texas in. And I was trying some entrepreneurial things straight out of college and spending all of my free time reading annual reports and doing my own common stock sort of personal portfolio research. And I thought about doing this Buffett model where Get a family partnership together, you know, with some friends and family money and started a professional career really early. But I made a very good decision at that time where I said, you know, I don't even know what the business looks like, but the infrastructure that is around being a professional investor, and it would be of me to get some experience in this area before I really outed myself as a professional investor. And so I just happened to be reading the Dallas Morning News in 96, and it described a guy that was Trying to build a quantitative model to pick stocks like Warren Buffett. And he was in Austin. He was relatively early in his growth as a professional investor. And so unannounced, I just sort of walked into his office and said, Hey, I kind of want to do this for a living. And I didn't have a resume with me or anything like that. And I just happened to hit the right person at the right time. And he said, well, we don't have any money to hire anybody, but I do need a lot of help. And I said, well, why don't you just let me start working here for free? And then you can pay me when I become i…

AI assessment note: “I was trying some entrepreneurial things straight out of college and spending all of my free time”

Q In the context of concentrated portfolios, there are times, and this is certainly one of them, when your investors will be paying attention to things like ESG factors and diversity and inclusion, probably the two most notable ones today. How do you think about integrating that when the number of companies you're investing in is small, the number of people on your team is small?

A Yeah. So we, despite our small size as a team and relatively small size, I mean, we're an institutional asset manager. We're five and a half billion under management today, and that's small by wall street standards, but it's a decent size firm. Now we have actually just become a signatory to the UN PRI. And so I think that that fits well within our research process because we're not precluding ourselves from really buying things that we would have otherwise. Uh, it's requires a little bit more documentation, but at the end of the day, I think it's where the puck is going in, in institutional investment management. And so we want to be good partners to our clients who are most of whom are also signatories to that. And so ESG is becoming more of a highlight. We are not advocates. We aren't taking activist positions and trying to change policies and things like that. But most of the businesses that are pre-qualified on our focus list are pretty compliant anyway. And so it's not a heavy lift for us. So that's a change. And in diversity and inclusion, one of the issues we've had is I think what's referred to in the industry is kind of a pipeline problem. Where we have made this effort for years to try and increase the diversity inclusion elements of the hiring process, but the hiring pool itself hasn't been serving up what we need, and so we have started an effort which targets furt…

AI assessment note: “we have actually just become a signatory to the UN PRI”

Q Why don't we get started with your initial background and interest in investing?

A Yeah, sure. So I'm from Omaha, Nebraska, which doesn't really matter much to the story other than there's clearly a interest in Warren Buffett that was peaked, and that was kind of late eighties, early nineties, before he became the international superstar that he is. My father was in the US Air Force, and so we were stationed outside of Omaha, Nebraska at Offutt Air Force Base. At the time, Nebraska had a Fairly robust effort to keep the top high school students in state, and so I was offered a full scholarship at the University of Nebraska, studied math and actuarial science, all the while was, you know, reading any reports in the evening and trying to hone my craft to the best of my own knowledge, and came across the Berkshire Hathaway and reports, opened up my own self-directed brokerage account, and started making all the mistakes that early investors do, but got those out of my system in my teens, and so it felt like I got a Relatively early start on my progression as an investor.

AI assessment note: “I'm from Omaha, Nebraska... there's clearly a interest in Warren Buffett that was peaked”

Q What teaching from your parents has most stayed with you?

A My mom is the most pious person that I've ever met. I grew up Catholic and she's a A very intense mass goer, and her expectations for us growing up were very high in terms of academics and achievement and so forth, but they were even higher for values, integrity, and that sort of thing, and it wasn't an aspiration to be an honest person. It was an expectation, and that was hugely influential in my life, and then my dad is a natural contrarian, which I love about him, because we talked about he buys stuff off the fifty-two-week low list, and he's an eye surgeon and an entrepreneur, and he never really cared whatever Anyone thought of him, and I love that about him in a good way, and so I think that gave me the confidence of 27 to go out and start a business despite having a bunch of doubters in my circle, and just to tune all that out, ignore it, and go for it, so yeah, I think that's, that's what I've learned.

AI assessment note: “her expectations... were even higher for values, integrity... It was an expectation”

Q Where did that initial interest in investing come from?

A I grew up in a household that was fostering of academic and other achievements, and my father was an eye surgeon, but also an entrepreneur, and so he was starting all sorts of random things that benefited his medical practice, and he would drag myself and my two brothers to these meetings, and we would sort of absorb these high-level business conversations as youngsters, and so I think that Sort of piqued my curiosity. He would, uh, look at the fifty-two-week low list and the Wall Street Journal and pick stocks for himself, and that sparked some questions, and then, and then, I don't know, I think it was just a sort of a self-directed interest in business generally. I think I grew up in a, an environment of actually relative financial scarcity early. My dad was in medical school while I was growing up. I always thought to myself, I don't want to be in a situation where I have to have my freedoms constrained because my paycheck depends upon it, and so I think the entrepreneurial ambition That outed in Barrett's Capital was really driven by a desire for financial independence, and that was just sort of coupled with an extreme intellectual curiosity in the stock market.

AI assessment note: “He would, uh, look at the fifty-two-week low list and the Wall Street Journal and pick stocks”

Q sure there are a lot of people of that ilk who would love with a very small war chest to go in and be able to attract that capital. I'm curious, you know, you mentioned the product market fit, you mentioned that wave and trend. What were the other factors, you know, before we get into the investing itself that You think allowed you to win some of that business?

A Well, I think that allocators are always looking for something unique and differentiated. Unusual usually produces unusual results and concentrated microcap, I think was pretty unusual at the time. And for me, without transitioning fully at this moment into the basics of what we do, the recipe of concentrated and the qualitative approach to investing that we practice was a pretty unique recipe at the time. There's a great blog out there called Weight But Why written by Tim Urban, and he has one post about chefs versus cooks, and this is just a great mental model that I have layered on in all facets of my life, but it's particularly appropriate in business generally. The analogy is that a cook takes existing ingredients and follows a recipe and will produce a great tasting dish, but a chef looks at a table full of ingredients and tries something completely new with the existing set of Ingredients and makes something new and fantastic. I think in business generally, you get paid for being a chef a lot better than you get paid for being a cook. So I didn't invent the concept of concentrated portfolios. We did not invent the concept of qualitative research. We didn't invent the concept of being a small microcap investor. We didn't invent any of this stuff. We just put it together in a new way. And that new way was fairly unique at the time. And even today it's pretty rare. There ar…

AI assessment note: “the recipe of concentrated and the qualitative approach to investing that we practice was a pretty unique recipe”

Q So how did you evolve from this diversified quant shop to the micro cap focus on the investment side?

A Microcapit originally came from time scarcity and resource scarcity in my world. And so I literally started out of the spare bedroom, my condo in Westlake, which is a suburb of Austin. And I didn't, you know, as I said, with 21,000 dollars and paid in capital, obviously wasn't investing a lot in infrastructure and things like that. I had a laptop, some accounting software. Little known fact about my firm is for the first nine years, I didn't have an attorney. I was just so frugal that I didn't want to pay for one, which was, I do not recommend to people. I think it was completely reckless. Uh, course of action. And now we have great attorneys that we have great contracts and things like that, but our initial institutional contracts, I just negotiated myself. You know, I just thought I need to save every dollar I can, because this is survival. I burned the boats. I didn't have a plan B. This was going to work. Right. And so I had this laptop and this accounting software and this environment of financial scarcity, but also time scarcity. I had to do everything. You know, I had to do everything from balance account statements and charge fees and process this and that, and it was just me. And so if I'm also doing the investment I felt like I needed the best opportunity that I could have to, as a, just a single person to underwrite these ideas and feel confident about the work that …

AI assessment note: “Microcapit originally came from time scarcity and resource scarcity in my world.”

Q So one thing we really haven't talked about at all is price. These are, in your estimation, the best businesses in your universe with great management teams and great growth prospects. You might not be the only one who discovered it. So how do you factor price into your portfolio and assessment?

A Yeah, we want to be disciplined about what we pay and we want to pay for less than what we think the business is worth. Unfortunately, we have been subjected to the torture and it has been torture over the last 10 years of watching the most expensive names on our focus list. Outperform the cheapest names by a long shot. I mean, if you are value factor focused, you have had a very, very difficult run over the last 10 to 15 years, and I'm not saying anything earth shattering there, I don't think, and so the good news is that the qualitative framework that I just described does allow us to make these qualitative convictions that are as or more important than the price to value disparity, and so we have bought 85, 90 cent dollars where we were just super convicted in the quality of the business. And that has paid off for us and is one of the reasons that we have probably better numbers than people that are more value factor focused. You know, and I hate it when people ask us, are you a value manager, growth manager, whatever it's like growth is part of value equation. We are value philosophy because we want to buy stuff for less than it's worth, but we are not value factor investors. I think if you look at the Fama French three factor model, price to book has just stopped working. And some people say, well, we're ready for the ultimate mean reversion there and comeuppance is going …

AI assessment note: “we have bought 85, 90 cent dollars where we were just super convicted”

Q And then how did you think about within a concentrated portfolio, what you were looking for, what types of businesses and stocks?

A Yeah. So to move a little bit into what we currently do, the two differentiators for the firm are the level of concentration, which is still pretty concentrated, even by concentrated manager standards, but also this idea of qualitative research. And so if we just sort of step back for a second, it's, it's a often forgotten concept, but it's very basic and everybody should keep it at the top of their mind that stock prices are simply a reflection of internal Compounding of business value per share, right? Absent distributions and dividends and multiple expansions and contractions, your experience as a common stock investor will mimic the per share business compounding that happens at the fundamental level, right? And so if you're looking for above average stock price performance, you necessarily need to be looking for above average business compounding. And above average business compounding isn't available everywhere. Uh, we're in a competitive marketplace and microeconomic theory, one-on-one would dictate that if you're out earning your cost of capital, I'm going to open up shop across the street. We're going to compete on price until we earn our cost of capital over the cycle. Unless one of us has some unique competitive position and that can take all sorts of forms, borders by forces and network effects and all these sorts of things. And so we try to study these qualitative …

AI assessment note: “those generally fall into three buckets, we think, which are moats... Management”

Q So before we get into the portfolio construction, when it comes to maintaining the focus list, At any point in time, I'd imagine these are the 30 companies in your universe you think are the best businesses, and then another one comes up. Do you just drop off the 30th to keep it at 30?

A Yeah, so it sort of slinkies around 25 to 30. I mean, if a business gets acquired or something like that, we don't immediately, your market for replacement. So we try not to be penny wise, pound foolish here. I mean, it's just, it's a, just, hey, what are the 30 best companies in the space? It's kind of a mental model. And then if that number is 32, or if it's 29, that's fine too. But the interesting thing is after 20 years, it's just getting harder and harder to qualify for the focus list, right? I mean, and that's a symptom of us doing well, right? And it's kind of frustrating. If you think about it, it could be the perfectly rational byproduct of a process well executed that an analyst comes and works for us for three years and doesn't get anything advanced to the focus list, right? I mean, that just could be, hey, you know, you're doing your job, and every rep is part of the process, even if those reps are not accretive to our focus list or ultimately the portfolio. The flip side is also true, where you'll know what pressure is when you are a junior analyst for us, and you've come across the idea of a lifetime, it gets advanced to the focus list, and all of a sudden, we have a 20% position in the name. That is very possible. It happens all the time, and that is a fair amount of pressure for, you know, somebody who's 23, 24 years old. I wouldn't have it any other way, and th…

AI assessment note: “Yeah, so it sort of slinkies around 25 to 30.”

Q As you go through this process, there are a lot of aspects that other types of managers would, the proverbial lose sleep at night, you know, owning a 150 cent dollar or things like that. When you get nervous about What might be to come? What are the aspects of your process or the portfolio that tend to give you the most angst?

A Well, your listeners can't see, but I have a head full of gray hair. I get nervous about everything. I get nervous about making sure that we have the right clients, that we have the right people on the team, that we have the right investments, that the right investments are, are fit for what people are paying attention to, that we truly have variant perception. I worry about all this stuff. So this is a business that is not only overwhelming because every day you wake up and you're drinking Through a fire hose of information, but it was also an endless stream of worry. And so the big worries for me are making sure that we have the right team, that that team is excited and incented to get up and work every day. And that we have the right investor partners. I have friends that, you know, ran funds that through oh eight, oh nine had Lehman brothers as investors and it sank the firm. That's a huge piece of this is just making sure that you have the right partners.

AI assessment note: “the big worries for me are making sure that we have the right team”

Q So circle back to that origin. There are so many people that would love to start their investment firm and very few of them come to where you are today. What were the key Success factors as you look back that you recommend to other people if they're going to try to give this a shot on their own?

A Yeah. So, you know, the interesting part of my story is that I'm kind of an outsider. You know, I didn't have a stint on Wall Street. I was a state school person, never lived in New York. And so I actually do attract a fair amount of unsolicited phone calls that said sort of, I want to do what you did. How did you do it? And so I think there's a kind of interesting story of we don't have any outside capital. All the capital that was ever put into my firm is 21,000, but 195 dollars and 14 cents is all the paid in capital. I mean, the barriers to entry in our business are not financial, as everybody knows. The hurdle to getting to success in investment management are things other than the starting capital for the management company. But I've touched on a key point, which is you need to have some frugality early so that you have the scratch to be able to make a go of this for a couple of years. You need to have a fairly extreme amount of self-confidence, which I just happen to have at that fairly young age. And so, You know, there are all sorts of people who are doubters who are going to tell you this isn't going to work. And then furthermore, most people say, I'll make a go of this. I'll use some friends and family money and I'll start clocking performance, but I won't, I won't start talking about myself to people until, you know, three to five years in and I have a track record …

AI assessment note: “you need to have some frugality early... fairly extreme amount of self-confidence”

Q People talk about moats all the time. How do you define what you look for in a moat?

A Yeah, we don't have a ton to add to the canon. I mean, this is a super hot topic and has been for five or 10 years, and there are people that think about this all day every day that probably have a Library of information that they can spot off the top of their head that could rival what we think of internally. What I can say is that anything that would allow a business to out earn its cost of capital for a sustained period of time and keep competition at bay is interesting to us. We want to understand it. And so as we present companies internally, and by the way, we present companies solely on the basis of these qualitative factors. We're looking for exceptional, the best companies run by the best people with the best prospects for growth. Independent of price. So everything that we pre-qualify for purchase is done without any knowledge of what the stock price is or has been. And then once it's qualified for purchase on what we call our focus list internally, at that point we do appraisals and we conviction weight in the concentrated portfolio, our highest sort of total return prospects. So in terms of the, just the moat specifically, it's just like management or underappreciated sources of growth. We're just trying to do a deep qualitative analysis on what makes it special and exceptional. And that can be some traditional source of mode, like importers, five forces, they could…

AI assessment note: “anything that would allow a business to out earn its cost of capital”

Q and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. I'm kind of curious about how this process works in such a concentrated portfolio. So you don't have screens, your people are out meeting companies all the time. How do you digest that information to figure out what's going to be on your focus list?

A Yeah, great question. So we have a rotating stable of junior analysts. So we hire people and put them to work and then tell them in three years, I got to go find different employment. Part of that is because we have a capacity limited set of strategies and that capacity limitation has actually included returning capital back to investors. And so there's an element of Expense management to what we do within our business, and that includes not having an upward path for everybody at the organization, right? And so that gives us fresh eyes on what is a relatively static opportunity set after 20 years. You know, it's dynamic and there's additions to the universe all the time, but it's helpful to just have fresh eyes of smart people looking at the stuff all the time. So we're constantly mining the existing universe plus any new additions or changes to the universe. And we're looking for those buckets of qualitative exceptionalism. And part of the fun of the job for me has always been the treasure hunt mentality. And I give our analyst team pretty much carte blanche to look at what they want to. And so there's much more detail in the work. If you underwrite a position yourself and you have some confidence in that position, rather than if I said, go look at XYZ corporation, you know, the, there's this bureaucratic question about, okay, does Brian want me to Write up something good abou…

AI assessment note: “I give our analyst team pretty much carte blanche to look at what they want to.”