TIP686: Big Tech Stocks w/ Adam Seessel
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You're listening to TIP. On today's episode, I'm joined by Adam Ziesel to discuss his updated thoughts on big tech companies. Adam began his career doing research for Sanford Bernstein, Barron Capital, and Davis Selected Advisors. After these stints, he started his own firm, Gravity Capital Management, in 2003, and since then, he's outperformed the S&P 500. But it hasn't been a straight ride up.

For the first decade, he implemented the traditional value investing approach of buying cheap and unloved securities. And then in the mid 2010s, his strategy started to fall out of favor and quit working. So he evolved his approach to what he calls value 3.0, which is outlined extensively in his wonderful book, Where the Money Is. Since transitioning to the value 3.0 framework,

He's back on track to outperform the market while also owning the best of the best businesses. During today's discussion, we cover Adam's key realizations as a value investor over the past 20 plus years, how the concept of intrinsic value can help anchor us in reality even though it's just a mental model we use to evaluate businesses, Adam's updated views on Alphabet and Amazon since he published his book in 2022, his approach to taking advantage of the AI wave without paying these hefty valuations,

Why progressive insurance is dominating the auto insurance space and taking share from Geico and so much more. With that, I bring you today's episode with Adam Ziesel. Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Playfink.

Welcome to the Investors Podcast. I'm your host, Clay Fink. And man, oh man, am I excited to welcome back Adam Ziesel. Adam, thank you so much for joining me here again today. It's really nice to visit with you again, Clay.

So for those who aren't familiar with you, Adam, or they missed your previous appearance on the show, you're the author of the very popular book, Where the Money Is. And it received high praise from legend investors like Bill Ackman and Joel Greenblatt. And I really can't recommend the book enough. And it's certainly one worth reading and rereading. So I wanted to start today's discussion, Adam, by talking a little bit about your career and your background, which eventually turned into this book.

You launched Gravity Capital Management in 2003, but you weren't the technology investor, let's call it, that people might think of you as today. So talk about some of the pivotal moments that you had throughout your career that helped shape who Adam is here in 2024. Adam Draper

Thanks again for having me, and I hope this is beneficial to you and your listeners. I started my career as a journalist, Clay. I was a newspaper reporter and then got into investigative journalism in my 20s and got people convicted of crimes and won national awards, which is all very exciting and rewarding. But

When I was turning 30, my wife and I were starting to expect a family and journalism, the hours were terrible. You're always chasing stories. I didn't think that was good for a family. The money was terrible. And this was in the mid 90s, even before the internet

I just said, "You know what? Let me take my research skills on to Wall Street." So I did. And I was lucky enough to get an entry-level position at Sanford Bernstein, a very good Wall Street firm. And they trained me up. I met some legendary analysts there like Weston Hicks, who taught me about insurance, and Warren Buffett. So then I sort of progressed onto the buy side with a couple of well-known firms, Barron Capital, Ron Barron, and then

Chris Davis, Davis Selected Advisors. About 20 years ago, I said, you know, I'm ready to go off on my own. I'm not a very good employee, pretty strong-willed and stubborn, so I thought it was better for me to start my own business. So I started Gravity Capital in 2003.

So generally speaking, it's been a good run. The record's been good, although it's really been three distinct records, which gets into your question about tech. Its first decade or so was excellent versus the S&P after my cut. I was investing sort of in the classic value way, old economy stocks, cheap valuation, and everything was going great. And then around 2014, my performance started to flag.

That continued into '15 and well into '16 and after two and a half years of bad performance, I said, "What am I doing wrong? Either I'm wrong or the market's wrong." So it was one of those good binary questions where either I was doing things wrong or the market was seeing things wrong and I decided that I was doing things wrong, that a lot of my old Ben Graham cigar butts just weren't working anymore.

Value investing is a great construct because there's a lot of discipline around it. But in the digital age, what I learned was there's no more reversion to the mean. A retailer who falls off the pace is not going to kind of come back like the way they used to because e-commerce is eating brick and mortar retail's lunch. You can spread that across all sorts of sectors, manufacturing, healthcare, financials. Those have all been poor investments. A

over the last 10 or 20 years, generally speaking, because the best years for a lot of these companies are behind it. So whereas before you could invest in a fallen, beaten down stock that was cheap and trust that it would come back, that's not happening anymore because tech has disrupted so much of the...

the economy. So maybe a little less than 10 years ago, I started what I call value 3.0 investing. Actually, I don't call it that. A friend of mine coined that term. I steal it from him. And so I'm investing in much more high-quality businesses whose best years are ahead of them. And a lot of those happen to be tech. So what I've been trying to do in the last eight or 10 years, and the reason I wrote the book is to try to codify or formulate

a way to think about tech in a value framework because tech and value investing historically haven't gotten along, but I think they can get along. So this is my way of reconciling or synthesizing the old school value concepts, which I learned, which are still useful with the new realities of the digital age.

Looking back, it really makes a lot of sense to go through the transition that you did. But one of the most difficult and important parts of investing is recognizing when you're wrong and figuring out how you can fix that. So I really deeply admire that you came to that realization and focused on delivering results rather than protecting your ego or protecting your previously held beliefs. Well, Clay, the two are related.

And the other interesting point you made there is you're now looking to invest in companies where their best days are ahead of them, whereas it's just flipping this old approach on its head in a lot of ways where some of these old economy businesses saw their best days behind them. It's certainly not ahead. Robert Leonard

Yeah. I mean, the world has changed, right? I mean, in the '80s when Buffett invested in Coca-Cola, they had all sorts of great opportunities ahead of them. They had per capita consumption increasing in the third world. They had per capita increasing here in the States. New Coke was introduced and customers rebelled because they didn't want change. That's the best kind of business you can have, selling sugar water. And people love that red can or the glass bottle.

and the growth was ahead of them. But per capita consumption of soft drinks in the United States peaked in 1999. It's been declining. So, in their core US market, they have a real problem. And internationally, health concerns, concerns about sugar and diabetes is growing. But in other words, it's a business that used to be great and is no longer as great. And you can say that about a lot of classic late 20th century investments.

whether it's Wells Fargo or Exxon or Bank of America. These are businesses that used to be wonderful but aren't wonderful anymore.

On our call the other day, we chatted about your track record and how you've done since you started in 2003. And you explained how from a big picture, you had outperformed the S&P 500 over the entire tenure. But you were doing that anyways at the, say, the first decade or so. And then you sort of came to this realization when your strategy wasn't working as well as it once was. And it reminds me of Buffett in a way where he's had to evolve his strategy over time and adapt

So yeah, please talk more about that. Ben Graham was value 1.0. This is my buddy, Chris Begg's construct. Ben Graham was value 1.0, which was balance sheet based and very negative. He wanted to see what the liquidation value of a business was. That was Ben Graham.

It was great because it was a discipline, but it wasn't great because it didn't really care about what the business did in the future. One of Graham's old analysts used to say, if you ever started talking to Ben about what the business actually did, he would get bored and look out the window. He just wanted to know the assets and the liabilities and what it could be sold for. He wanted to buy below that liquidation value. That's the framework Buffett inherited and he revered Ben Graham.

But in the '50s, when Buffett was a young man and starting to invest, America was a very different place than Ben Grants a generation ago when it was in the depression and businesses were beaten down. In the '50s, you know, America had won the World War and we were ascendant and business was growing and stable and we had the Securities and Exchange Commission and generally accepted accounting principles. So, the rules were standardized and

You could understand financial statements and businesses had great growth ahead of them, decades of growth. Coca-Cola, Disney, Geico, all these wonderful Buffett investments. So I call that value 2.0. Buffett pivoted with the help of Charlie Munger away from his mentor's defensive, somewhat negative stance to a much more positive, optimistic view on businesses. So in many ways, value 3.0 is just a continuation of that.

except we're widening the aperture to include tech, which Buffett, aside from Apple, has missed. He missed Google, he missed Amazon, he missed Microsoft, he's missed all of them. And his performance has suffered as a result. So I'm just suggesting that just as he pivoted from Graham while retaining many of the critical variables of Graham's philosophy, we do the same with regard to Buffett and value 2.0.

Trey Lockerbie : So you recently pulled data on how much of the market's value creation came from tech versus non-tech over the past 20 years. What did you find on that?

This was a fun exercise I did with one of my analysts. And I've been saying, rhetorically speaking, "Hey, how much of the value in the economy going forward is going to be created by tech?" As opposed to say, industrials or retail or healthcare or any of the other sectors, financials. It's intuitive to me and I think to most people that most of the value

in the next 10 or 20 years will be created in technological or technologically related fields, right? That's where the value is being created on the margin. But I thought, let's quantify this. Let's go back last 20 years and say how much value has been created by tech. So what I did is I took, you know, GIX has these 11 sectors.

S&P or I think it's MSCI, one of the data services has 11 sectors for the stock market in the S&P 500. So I took the Gix information technology sector and then the Gix communication services sector where Google and a couple other big tech companies are. And then I put Amazon and Tesla in that bucket because they, for various reasons, have been put into the consumer discretionary bucket, but they're really tech company. So I said, who

Well, in 2004, the market value of those four buckets, the IT sector, communication services, plus Amazon, plus Tesla, represented 19% of the US stock market value. That was 20 years ago. And today, those same four buckets represent a little under half of the US stock market value. So 46%, to be precise. So the stock market over the last 20 years has gone from less than 20% tech to almost half tech.

which intuitively makes sense. The market cap of all US stocks was X, and then in 2024, it was Y. 60% of that delta was created by tech, by these four sectors that I'm talking about.

So that was interesting to quantify that 60%, maybe a little shy, between 55% and 60% of the value creation in the US market was in tech. And I think it'll probably be at least that much going forward because whether it's AI or driverless cars or virtual reality or quantum computing, I mean, pick the mega trend du jour, then they come in and out of fashion, which I find somewhat amusing.

But whatever the mega trends are, they're all tech trends. So tech is where the money is. Tech is where the money is going to be. So it's foolish for us as investors not to tune into the technology sector and understand how it works because it does function as a business and it functions just like any other industry. You just have to understand the particular ways it functions.

So you mentioned a bit earlier the reversion to the mean concept. And I've thought a lot about this. And one of the things I've learned is that the mean isn't a real concept that's actually out there in the world. It's something that we sort of make up in our heads. And I recall during our last chat, you explained how there isn't a mean that, as you mentioned, the brick and mortar retail, there isn't a mean that they're going to revert to when they're being disrupted by Amazon.

And with that said,

The intrinsic value is also a number that us value investors, it's a number we try and come up with and ensure we're paying below that intrinsic value. But like the reversion to the mean, it's also a number we kind of just come up with ourselves. And I guess there's not necessarily a law in the universe that states that a price has to revert back to that intrinsic value. And you shared one example in your book of a company called Avon Products. So you bought this stock at $12 a share below

believing that it was going to revert back to fair value. And knowledgeable private buyer offered $23 a share, but that ended up not going through, I believe, and the stocks slid down to $9. So how do you reconcile these concepts and mental models that are simply in our head versus just reality? Robert Leonard

Well, thanks for bringing up Avon products. That was one of my signature failings back in the mid-decade of 10 years ago. Always stings a little bit, so I'm going to use it constructively to keep me on task. But yeah, that was not my finest moment as an investor. I would say that intrinsic value is different than reversion of the mean in the sense that it's still a valid concept.

Let's just start with the very first principle of net present value, right? Like a business's value or any financial instrument's value, right? A CD or a loan or it's equivalent to the future values of all its cash flows discounted back to the present. You know, if you had a time machine and you could travel forward and understand what the cash that Amazon was going to produce from now for the next 20 years, say, you would have an excellent understanding of Amazon's

intrinsic value. As you say, we don't know the future and so we don't know what the intrinsic value of Amazon or any other security really is.

That's what makes it an interesting business. That's, as they say, why they run the horse race. But look, you can't be certain. So that's number one. But you do have this excellent framework of net present value because conceptually, it's true, right? It's not like reversion to the mean. It hasn't been disrupted by any business or economic or social force. A business is still theoretically worth something.

all its future cash flows discounted back at an appropriate rate. So then what do you do? Well, then what you do is you start looking for relative certainty, which is what Buffett did in Value 2.0. Disney in the 60s, how could it miss? Gillette has an 80% market share, men's razors, how could it miss? Buffett used to say, I'm only upset that Chinese and other Asian people have less facial hair. That's the only inhibitor of

Gillette's growth, they don't have to shave every day. We used to call these stocks inevitables because it wasn't 100% inevitable, but it was as close to 100% inevitable as you get in the business of probabilities, right? Gillette, Coe, Disney would continue to grow and compound value, would continue to grow their earnings.

And so, you could have a reasonably high certitude that the net present value of the future cash flows was high. And so, what is the current multiple but the current price versus the current earnings? So, if you have a high certainty, relatively speaking, of a lot of cash flow coming in the future, then you should pay a relatively high multiple of current earnings because the value is not in the current earnings, the value is in the tail, so to speak.

So, those things are still true, but then we say, "Well, let's get our heads into the early 21st century economy. What are the inevitables today?"

Amazon has 40% share of e-commerce, 50% share of the eyeballs on e-commerce, a delivery network that's second to none. They now deliver more packages on a daily basis than either UPS or FedEx, which is mind-blowing. So what's the risk that they're going to be disrupted? Now,

In other words, how inevitable is their continued primacy in e-commerce, number one, and number two, also in cloud computing where they have a 40% share, huge economies of scale, right? Huge first mover advantage. So those businesses to me look very much like the inevitables of the late 20th century like Coke and Gillette. They're not going to be inevitable forever, right? Coke was an inevitable until it wasn't. Disney was an inevitable until it wasn't. So I'm not saying forever.

But for a long-term investor horizon, 5, 10, 15, 20 years, that's how you get comfortable with intrinsic value. You get uncomfortable by business analysis and say, well, what's going to disrupt this? And if you can say almost nothing, then you can start to estimate with reasonable certitude your estimate of intrinsic value. You could be wrong, things could change, but that's how you do it.

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That's certainly well put. And we'll be getting to chat a little bit about Alphabet and Amazon and where they sit today. But I wanted to make one comment with regards to Buffett and Munger. So after Google was launched, and it really just came onto the scene in the 2000s, Buffett and Munger, they saw right in front of their faces that Geico was paying $10 or $11 per click and getting great returns from that very high spend for something that seems that...

just so minuscule. And Munger actually stated that one of their worst investment mistakes was not buying Google. And of course, they bought Apple and that was a home run play. But part of me still wonders if they just have really missed the boat on a lot of these big tech names. These businesses are some of the best businesses the world has ever seen. They arguably traded at pretty good prices back in 2022. I'm curious to get your thoughts on Berkshire having over $300 billion in cash, but the

But they've still never managed to buy any big tech besides, say, Apple, maybe like a little slice of Amazon, but nothing that really moves the needle for them.

I think about this a lot, as you can imagine, as I call myself a value 3.0 investor or a new value investor. I have mixed feelings about it with regard to Berkshire. Sometimes I feel defensive towards them and sometimes I feel, as you're suggesting, more critical about them. Let's see, what do I start with? I'll start with the critical part. So, I mean, you're absolutely right that apps and Apple, they've missed tech. If you look, apps

Apple, they only started buying Apple when it became sort of a consumer products company, when it's, you know, jobs died. The risk of crazy moonshots was off the table. The new CEO was a supply chain guy. Very little imagination, good operator, keep the train running on the tracks.

massive capital return. Carl Icahn launched a proxy fight and got them lit a fire under their butts to start buying back stocks. So they're relatively unambitious in terms of how much cash they plow back into their future. So it became very much a sort of a value 2.0 investment, harvesting the cash. We got an iPhone. We're going to crank share up. We're going to raise prices on the phone. We're going to push the Apple Store services. It was kind of like Coke.

It does bother me that in 2017 and 2018, I was at the annual meetings when they said, "Gosh, it was stupid. We missed Alphabet and Amazon." See, I don't fault them for when they IPO-ed because the battle lines were still being drawn, right? And Buffett used to say, "I didn't know whether Google was gonna get leapfrogged by AltaVista and Yahoo."

But seven or eight years ago, when they issued their mea culpa, it was clear that Google was the winner and it was clear that Amazon was the winner. They said, oh, we missed it. At the time, I was like, you could buy it today. And those stocks have doubled and tripled in those seven or eight years. So, and as you say, in 2022 was another amazing buying opportunity. I do think that there's some validity to say that they have largely missed tech.

And it shows in the stock price. I mean, Berkshire Hathaway stock price has been not much better than average over the last 10 or 20 years. You can start contrast to, you know, from 64 to 2004 when it was just a loon shot. But in 2004 to 2024, it's been quite average. So I do think they could be faulted for having largely missed tech, even when, and perhaps especially when, they admitted that they missed it, like as if it were over.

and it wasn't over. On the defending them side, Buffett was 74 years old when Google IPO'd. Maybe I'll be forgiven for not missing the next trend when I'm 74. He doesn't use email, he didn't come of age in the tech era. I'm a little older than most but my college class was the first class at Dartmouth to be required to have a personal computer. So as a freshman, I was required to have a PC. So

I'm young enough to have kind of gotten tech. I was still forming when tech was nascent. He was forming when there was one newspaper in every market and it was a mint. Washington Post was a monopoly and Buffalo News was a monopoly.

He learned to invest in a very slow-moving, slow-changing economic environment to dominant businesses that could kind of grind out slow market share gains. He did not come of age and he is not programmed for a disruptive age where things are moving very fast and it pays to invest a lot of money through the P&L and depress your earnings. So if I miss a huge trend when I'm 74, I hope people will forgive me.

Robert Leonard : All right. So this brings us to chat more about Alphabet and Amazon. So you chatted about these two names in detail in your book. You still own both names in your fund. So I wanted to bring you on to give a bit of an update on these two names, especially. So 2022, your book was released and that was a broader bear market overall and Alphabet and Amazon were beaten down. And

When we look at January 2023, Alphabet was priced as if chat GPT was going to destroy its business model, which isn't necessarily true yet at least, and the stock's up 100% in less than two years since then. How about you share just broadly some of your updated views on Alphabet and if anything's changed over the past couple of years?

I mean, Alphabet, Google, Charlie Munger said himself, is the best business ever invented. It is literally the toll road on the information superhighway. Anytime people go to search the internet, they go through Google, it has more than 90% share. So if you're selling microphones or services as a divorce attorney or running shoes or plumbing supplies, you pick it. You got to advertise on Alphabet to be seen. It is the ultimate toll road.

People over the years have tried to take away their toll road just because it is such a wonderful business. So Amazon had a secret project called A9 and they hired the guy who wrote, literally wrote the first textbook on search algorithms, a guy named Udi Manber. So he hired him to start Amazon search business, tried for a couple of years and then quit, went to Google, leading Bezos to say, treat Google like a mountain. You can climb it, but you can't move it.

And Bing, of course, has been trying for two decades and has spent tens of billions of dollars trying to take away Google's search. And to me, the ultimate proof point of Google's dominance came in the period you referenced almost two years ago now when Microsoft took a big stake in OpenAI and said, "Come on, try Bing. It's now partnered with OpenAI. It's going to be such a better search engine."

and Google stock declined and everyone was wringing their hands. Since then, I tried it, I'm sure you tried it, and then we went right back to Google. Bing's share of search in the US market has actually declined.

since the OpenAI announcement, which is an incredible stat and not one that many people know. And the media certainly doesn't want to dwell on it because the media was wrong, right? So this is the very textbook definition of a business that has a moat where people come at it hard and not just any companies, but like huge smart titans like Microsoft and Amazon, they come at it hard.

and they can't dislodge it, right? That is the very definition of a business you want because talk about certitude and net present value, theoretically, Google has a moat, but let's put it through the ringer and see if it actually does have a moat, right? That'll test it.

So, it's been long battle tested. Just think about, it'd be interesting exercises. How many hundreds of millions of dollars did Bing get in free publicity from all the media coverage of OpenAI? I bet you it's over a billion dollars of free advertising, right? Headlines and news reports, all saying, go try Bing, it's better, implicitly, right? This was free advertising and it didn't work. Google was again under some pressure because

No one in the marketplace can beat it, so the government's trying to beat it. So they had this adverse court ruling this summer where the judge declared Google a monopoly. And yesterday, you saw the Justice Department came out with their proposed remedies, which include not paying

Apple for search, divesting the Chrome business, divesting the Android business. So I find it kind of amusing because Amazon couldn't be beaten in the marketplace, so now the government's trying to beat it. I think we'll be fine, but it's under some temporary legal overhang.

So one of the things the Department of Justice is sort of pushing for is for Alphabet to sell off the Google Chrome segment in order to try and weaken their monopoly position and then make it so they can't just simply pay Apple to make them the default browser. Do you see any chance of any of this actually happening?

Well, sure, it could happen, right? Nothing's inevitable, right? This Chrome thing strikes me as a red herring. I can't see how the judge would agree to it because I read a funny comment by an analyst the other day saying that selling Google Chrome is like cutting off your left foot and trying to sell it. Like it's useful to Google Chrome, but it has no value to anybody else. Like there's no money to be made from Chrome. So I don't think that's going anywhere. Android, I feel similarly about.

Look, there is a risk that intelligent people who know Google well have laid out this intelligent risk case, which I find the most plausible risk case. So I'll just lay it out for you and then I'll tell you what I think. So the risk case is the judge agrees with the government, Google can't pay Apple, but other people can pay Apple. I've talked to legal scholars and that's completely consistent with antitrust law. Doesn't quite make sense to me, but fine.

So, then Bing ponies up whatever billion dollars and Satya Nadella takes another hard crack at search. So, if that happens, several things have to happen for Bing to succeed. One, they have to make a deal with Apple and pay the money. That's fine, they got the money. Second, they've got to make sure that a material number of people don't leave because I don't know about you, but I have my iPhone.

As soon as that deal goes through, it takes me 30 seconds to switch back to Google, right? Most other people will do that immediately because we love Google. But the bear case is enough people stay. They're just lazy or don't know what's going on, so they stay on Bing, say 20% to 25%. And the people I've talked to say that that conceivably could give Bing enough critical mass of search queries

to start training because it self-trains, right? It gets smarter the more queries it has. That's one reason Google has its dominance. So Bing gets better because there's enough people searching on Bing, right? It becomes a credible second player to Google. So instead of Google having 90% plus market share, they have 70. So that's the bear case. They lose share to a competitor, that a competitor finally comes through in the form of Bing on Apple's phones.

I don't think it's likely. I think it's possible, but I don't think it's likely because all these things have to happen. Google has to exhaust their appeals, right? First of all, the judge has to agree. Then Google appeals to the Supreme Court. That takes a few years. Then Microsoft gets on Bing, gets on the iPhone. And then, by the way, they actually have to execute, right? Which is no small task. They actually have to finally get Bing right.

Is it possible? Yes. Is it likely? I don't think so, which is why he continues to be a major hold-in.

Robert Leonard : So I have one other point I wanted to make with regards to Alphabet. When you zoom in, it's clearly an amazing business. So despite the narratives that people say, you look at search advertising, you look at YouTube, you look at the cloud segments, these just continue to grow and they're highly, highly profitable businesses. And we recently just did a deep dive on MasterCard here on the show. And when I was looking at Alphabet and revisiting it, it sort of reminded me of MasterCard in terms of just how

how much volume these businesses are doing. So listen to some of these stats. So in the trailing 12 months, MasterCard processed $9.3 trillion in payments. And it's just like, wow, how is anyone going to disrupt this business? And then I looked at Google search, they've processed 7.1 trillion results back in 2023. And I think that just helps put into perspective just how powerful the

this business is with Google search. But I say this knowing that behaviors can potentially change and technologies. And I'm almost curious what some of these numbers and growth metrics look like with chat GPT. And yeah, has that been something you've looked at and the queries that they're running over there?

I just keep looking at search market share. As I say, Google share is stable, maybe slightly down, but well into the '90s. And the one I was really concerned about was Bing with all this free publicity with OpenAI, and maybe they have a better mousetrap, and maybe they get traction because of all the free publicity. But Bing share is down in the US. So I don't worry too much about ChatGPT.

We can talk about artificial intelligence if you like on a very healthy skepticism towards it, I think. I think it's the hype du jour. Virtual reality, that was really hyped. That was gonna be the rage. And Mark Zuckerberg changed his company name to Meta. Now that's not doing too good. So I tend to kind of... I love tech, but this specific mania du jour, I tend to chuckle about.

Robert Leonard : Transitioning here to Amazon, this was another stock that got hammered around the same time Alphabet did and has come roaring back. And I think the narrative with Amazon is actually a bit different. So they went through a CapEx cycle that depressed their free cash flow in '21 and '22, and they've since shown their highest margin and profitability levels ever. So it's interesting that Alphabet and Amazon today have roughly the same market cap at around $2.1 trillion. So

I'd like to just open it up to you to share any updated thoughts on Amazon that you might have. Well, I mean, Amazon, the various narratives make me laugh, just like the AI narrative, virtual reality narrative, the alphabet narrative. My wife is from North Carolina, which has one of the best state mottos ever. It is Latin. It's esse quam videre. I don't speak Latin, but...

I looked it up. It means to be you rather than to seem, which I think is a good motto for life, but also in the stock markets. You have the appearance and then you have the reality. So a good investor always wants to go for the reality. And to the extent that the appearance distorts the stock price in our favor, then that's great.

So, Amazon's stock price is frequently distorted. It went down by over 50% in 2022. The review of my book in the Wall Street Journal was horrible because 2022 is a horrible year for tech because the rates were rising. And he said the book should have been called Tech is Where the Money Was because it's over, basically, he said.

It was written by a hedge fund guy and it really irritated me because like, wait, I'm talking about a 20-year generational period here. You're talking about one year. Okay, tech's having a bad year. But as you say, the stocks have come roaring back and everything's fine.

Amazon is funny because it can publish whatever profit number it wants. After Google and Facebook, it has the biggest advertising business online. I mean, it's really kind of funny because it's a $50 billion business, but the operating income number that Amazon reports for just its e-commerce business, X, the cloud business, is like $10 billion.

So, where did that $50 billion go? Because it's extremely high margin business, right? Like, let's say you had to employ $5 billion worth of engineers to administer the ads business. It's not anywhere close to $5 billion. But even if it were $5 billion, the profit margins would be 90%. They should be making $45 billion a year on advertising.

but it doesn't show up in the P&L. So where is it going? It's going into all these other ambitious projects. They're reinvesting through the P&L. They could publish a ton more earnings than they do, but they don't. But in 2022, the pandemic was a huge shot in the arm for e-commerce. And you remember Bezos and company decided to double the size of the infrastructure network into the pandemic. And demand grew, it turns out, 90% to 95%.

So, they slightly overestimated the demand growth versus the capacity growth. And I don't know if you remember, but they were crucified for, "Yeah, I'm sorry people, but e-commerce secularly is growing 10 or 15% a year." So, like they over expanded by less than one year of capacity. In nine months, the capacity was filled up. So, one analyst had a funny line. He said, "This is the easiest problem ever in history to correct."

Because if you expand by 100 and demand goes up by 90 and your underlying demand is going up 10 or 15% a year, you fill that capacity in a year. But you would have thought that they had committed murder for over-expanding. So these narratives, they just get exaggerated both on the negative side and then on the positive side. So the flip side is AI is way hyped, in my opinion.

So Amazon is terrible. Amazon is terrible in 2022. Oh, I guess it's not so terrible stock double.

And I think we're in one of those moments now with Alphabet. It's just almost always not as bad as you think it is. And it's also almost always not as good as you think it is. So, this is a good old value investing trope, which is buy when people are fearful, buy when the narrative is bad. In some ways, it's not that hard. You just have to train yourself to be on the other side of whatever narrative is being told.

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All right, back to the show. Robert Leonard : So in your book, you actually stated that you believed that Alphabet has the better set of businesses than Amazon, and you primarily pointed to their business model being more capital light and software-based. And in recent years, we've actually seen the capital intensity of much of big tech to be higher with these investments in infrastructure and AI and whatnot. Has your opinion on the business quality on a relative basis changed between these two?

It actually has, yeah. I mean, people ask me sometimes what I would change in the book. I said, "Not much." But my estimation of Amazon's business quality has increased relative to Google because capital intensity is bad in the sense that you have to plow your profits back into cash flow. But it's good in the sense that it's very hard for people to dislodge. Just take search, for example. The reason people can take a shot at search is because it's not capital intensive.

So, like, you can never imagine a judge saying, "What's the remedy for Amazon's dominance in its infrastructure in e-commerce?" They sell your e-commerce. It's much harder to disrupt the e-commerce network that Amazon's built than it is to disrupt Google's search network. And the cloud, AWS's cloud

infrastructure is likewise much harder to disrupt because of the economies of scale that they have. So I take your point. I think that Amazon's business quality is as good, if not better than Google's. Preston Pyshenko The last time we spoke, you didn't own Microsoft and Apple, and you still don't today. So I was curious if you could share some of your general thoughts on why you aren't attracted to those businesses.

I respect those companies and I'm happy to say that I've missed them. I don't mind admitting that I wish I had owned them because their performance has been as good if not better than Amazon and Google. I mean, Microsoft I missed because I just always thought it was kind of boring office tools.

I missed how deep they have their claws into the large American and international enterprise, large business, and how that would allow them to parlay that into a great cloud business. And I also missed what a great executive Satya Nadella was. So, missed that one.

And then Apple, as I told you, Amazon versus Google, I've always been predisposed more to software asset-light businesses than asset-intensive businesses. And Apple obviously is a hardware business. But I miss McShift as they sold more services. I miss their pricing power. I admire both businesses. And unlike Buffett and Munger, I'm keeping them on my radar screen because I would like to buy them at one point.

And I also wanted to touch on NVIDIA as well. So many investors are likely feeling FOMO with this one over the past year or so, or if they do own it, they aren't sure what they should do with their shares. So Jensen Huang, he was on record for saying that the unofficial model of NVIDIA is that they are always 30 days from going out of business. And that attitude in business is why they're

such a successful company and dominating their field. And the way Morgan Housel put it on our show is that he thinks that their management team wakes up terrified every morning, and that's why they're so successful. And I can just imagine the alarm bells going off in your head as I say this. So did you ever consider NVIDIA for your portfolio?

Never. And I'm proud to say that. That's one that I do not regret missing. I watch the stock, but as I've said in my earlier comments, I'm more than a little skeptical about the AI craze. And more specifically, I hate the digital semiconductor business.

I like the analog semiconductor business. I own Texas Instruments. The digital semiconductor business was pioneered by Gordon Fairchild and Bill Shockley and Gordon Moore, who coined Moore's Law, which is that computing power doubles every two years while the price halves.

That's great for the economy, great for innovation, great for the world, but horrible for a business because every two years, there's a new product cycle, every 18 months to two years. So Intel for decades was the beast.

They ruled the roost. They had every product cycle. They nailed it. But yeah, I mean, Jensen Wong's comment about 30 days going out of business is directly descended from Intel's CEO's comment when he was on top. He wrote a memoir and it was called Only the Paranoid Survive.

very similar to Wong's comments and waking up terrified because the product cycles change. So, I know enough about digital semiconductors to know that they probably have more than 30 days. They've probably got a good five to 10-year window. But one day, they're going to wake up and they're going to be, have been outflanked through product innovation. They're the big dog now. They displaced Intel. Fair enough.

But I have no conviction as to how long they'll be on top. But my conviction is 100% that they will be superseded at some point, which, you know, go back to the net present value, right? It's not an inevitable. NVIDIA is an inevitable for 5, 10 years. It's inevitable that they will be disrupted at some point by someone who figures out the next better digital semiconductor. So I'm very happy to have not owned NVIDIA.

Robert Leonard : So an audience member passed along to me a number of questions related to the impact of AI on these big tech companies and how Fortune 500 companies will change their spend towards big tech. What are some of the major shifts you see in the next, say, three to five years with regards to AI? Perhaps its AI agents will be made available by big tech, or we'll see these companies have all the AI infrastructure and AI highly becomes commoditized, or maybe it's something else.

Yeah, I have no idea. People ask me, "What's your AI strategy?" And I say, "I have no AI strategy," which is actually a little disingenuous. My AI strategy is as follows.

As I said earlier, tech is where the money is. Tech is where most of the innovation and economic value will be added over the next 10, 20 years. So how do you play that? So broadly speaking, you can play it two ways. You can try to find the next open AI or anthropic, which hats off to you if you're an early stage investor or VC guy, good luck. But that's not... I play in probabilities, right? I play in net present value and inevitability, relative inevitabilities. So to me...

It doesn't matter what the mega trend is, whether it's AI or driverless cars or quantum computing. I asked myself, "Well, who's gonna benefit from these trends? Who's in a position to exploit and monetize these trends?" And it's the big platform tech companies. It's the big guys that we've been talking about. I did another stat. I did a talk recently at the University of Virginia.

So, OpenAI's latest valuation mark was 150 billion. And Anthropic, I saw Amazon took another stake in it today, but pre-today, it was 40 billion.

So let's just say that's 200 billion combined. Let's say OpenAI is valued today at 150 billion and Anthropic at 50 billion. Now, if you bought it at a million or 10 million or 100 million or a billion, you're doing great and hats off to you. But I couldn't have figured that out. Anyway, now they're established players in the AI race. Their market cap combined or their valuation because they're not public is 200 billion. Well, that's 6% of Microsoft's market cap alone.

And further, why is OpenAI and Anthropix selling stakes of themselves?

Like, if they're worth a trillion dollars, what are they doing selling at 150 billion and 50 billion? So, there's only two answers. One, they're complete morons, which I don't think is true. Or two, they need the resources of big tech to get to the next level, right? The reason Sam Altman sold to Microsoft was not because he's a moron or a good guy, it's because they needed Microsoft's cash and they needed Microsoft's engineers.

and cloud infrastructure to help them get to the next level. And the same with Anthropic and Amazon. They're partnering with the big guys because only the big guys can monetize these trends. Cloud computing, only three guys can monetize cloud computing. Only three guys have the resources to build these huge data centers, right?

Driverless cars, only a couple of people can monetize driverless cars, right? There are going to be a couple of driverless car startups, but Waymo is going to be the leader in driverless cars. It's almost inevitable. So you just go down the list of mega trends. If you think the metaverse is going to do great things, then Meta is your company.

There's going to be lots of good little startups, but I can't pick those. But I know almost to a certainty that these mega cap companies are going to be the ones that are going to be exploiting these trends. Even if they don't figure them out, they're going to be the ones funding the guys that have figured it out and taking big stakes.

Yeah, it's a great point. I mean, Meta itself is a great example of a company that made these big purchases and these companies ended up being the behemoths they are today. And then Alphabet, for example, buying YouTube and it becoming much, much bigger over time. I wanted to be mindful of your time here, but also get to one more company. You don't just invest in big tech, obviously. And I wanted to touch on Progressive today. It's been a part of your portfolio for a number of years and

may even be, say, a technology play, so to speak. So when I visited the Berkshire meeting back in May, one thing that stood out to me was that it seemed that Geico had been underperforming and it was delivering this lackluster growth in recent years. And then on the other hand, you have a company like Progressive, which is a stock you own, and it's had significant market share gains in auto insurance. And Buffett highlighted it during the meeting that Progressive is better at matching the insurance rates to the risks that they're insuring.

And my friend Alex Morris at the Science of Hitting blog, he covers this two companies well in his writings. And he stated that Progressive is just running laps around Geico in recent years. It's funny because insurance is just typically a very, very tough business to be in. And it's just so difficult because insurance to a large extent is just a commodity. To the consumer, it's just which company has the better rate. So what is Progressive doing differently than their peers? Robert Leonard

So I love progressive and I love talking about progressive because it ties into a lot of themes of new value investing or value investing 3.0, value investing in the digital age. So I've actually owned progressive only for a year and a half, Clay. I bought it last summer when it was under pressure because their profitability was suppressed because COVID-related inflation had depressed. It was making them pay out more money than they thought they had to for claims.

And I thought, well, they'll figure this out. This is easily remediable solution. They'll just raise prices and get their profitability back in order. And sure enough, that's happened. So the stock's doubled, I think, in a year or so. So it's been a great investment for Gravity. The reason I invested in Progressive was not because it was temporarily depressed. Because remember, reversion of the mean doesn't exist anymore. But precisely what you said, it's got the better mousetrap versus Geico.

which is an incredible story and goes straight to the heart of Buffett not getting tech terribly well. Geico was always the low-cost producer because it had no agents to pay, right? So, if you look at Geico's selling costs versus progressive selling costs, progressive selling costs are maybe 500 or 600 basis points higher because half of progressive's business is through agents. So, they have to pay commissions to the agents so their cost structure is higher.

So Geico was a great company because their cost structure was lower. But what Progressive has done has become actually the de facto low-cost producer of insurance because in the commodity business, the low-cost guy wins, right? That's a rule. Geico used to be the low-cost producer, but what Progressive did maybe 25 years ago was say, "Well, hold on. Our administrative costs or selling costs are maybe 20% of our revenue.

but 70% to 75% of our revenue is the actual loss costs that we have to pay on vehicles and medical bills and so forth. Let's use tech to underwrite better." And so, they did. And now, as Buffett has said, their loss costs are maybe 1,100 basis points lower historically than GEICO's. So, even though their administrative costs are higher,

their loss costs versus GEICO are even lower. So they now write insurance at a much more profitable rate. They are the low-cost producer. And as a result, they're taking share. That share gain accelerated

into COVID when first of all, people weren't driving, then they were driving a lot. Then we had inflation. We had a lot of body shop inflation, medical inflation, and poor Geico, which had not invested in its IT, which they have said they have 700 different IT systems, was like a pilot in a storm, in a fog with no instruments. Whereas Progressive had that same vehicle in the same storm, but

but had an incredible heads-up display. We read out and they knew how to price the risk. So Geico has lost 20% to 25% of its policyholders in the last few years, which is incredible. Whereas Progressive has added millions. So Geico, which doesn't have the tech to match risk to price, has lost policies and Progressive has gained policies. And Progressive is now the number two auto insurer. They've overtaken Geico.

So, they have this better mousetrap, tech-enabled mousetrap, which is what I look for. Half the companies in my portfolio, 50% of my portfolio is tech and the other half is not tech. Those companies tend to be like Progressive. They're using tech to beat the competition. So, Progressive is a wonderful company.

Yeah, that's a great point. I'm reminded of other companies like Copart or Old Dominion Freight Line that was one of these early movers in investing in these technologies. And then some of their competitors don't realize until 10, 20 years later that, hey, they're really behind the curve on some of these investments they should have made long, long ago. Yeah, it's very hard to catch up as GEICO is discovering.

Like I mentioned, I want to be mindful of your time here, Adam, and just thank you for joining me here again today. So please give a final handoff to the audience on how they can get in touch with you if they'd like or learn more about the book.

Well, I always appreciate your interest, Clay. You're always asking good, cutting-edge questions, so thanks. Investors, feel free to hit me up on LinkedIn. And by all means, one way to get to know me and my investment style better, either because you're interested in me and my firm or because you're interested in learning how to invest in a disciplined way in technology, please buy the book. It's Where the Money Is by Simon & Schuster. And as I say in one of my slideshows, it's a

available on Amazon or any local bookseller that Amazon hasn't already killed.

Wonderful. Like I said at the top, I mean, I really can't recommend this book enough and I always enjoy picking it up and reading a chapter from time to time when I get the chance. So Adam, thank you again. Really appreciate the opportunity. Enjoy the clay. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. The

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