Then in college, I had an internship at The Motley Fool, which was a great experience. In the last year of college, I did school and also worked at a hedge fund part time. And s,  really the background is a lot of investing and just business analysis.

When I graduated, I wanted to kind of do something a little bit different. So I had those two experiences at The Motley Fool. It’s a great business, but it’s really a publishing business, they have to get out a certain number of materials every month, because that’s what they promise.

It’s pretty hard for members to kind of create optimal portfolios just because there’s so much volume of recommendations. Then the hedge fund, they did a great job of portfolio management and allocations, but I thought the fees were a little bit high.

After college, we set out to kind of create this research service to combine the best of both worlds. I have been doing that the past two years and I really just love investing.

Robert Leonard  2:42

We’ll get into your strategy a little bit more later in the episode, but did you think the fees were high at the hedge fund because you might follow a similar model to what Warren Buffett had at his original partnerships or hedge fund.

Ryan Reeves  2:53

I think that’s a really interesting model. I believe it was like a 5% or 6% hurdle rate for Warren Buffett’s first partnership. Then he would take like 25% of the profits after that hurdle rate, which really just aligns the incentives versus charging 2 and 20, and you underperform for years and years, then you’re still just charging that 2% management fee. Then you’re getting 20% of anything, if you actually do have positive returns.

And so, I think it just really aligns incentives with Warren Buffett’s model. But yeah, that was kind of the thing, just talking about how you should actually get paid based on performance, not just the fact that, “Okay, this is the kind of conventional sort of thing that we’ve always done.”

Robert Leonard  3:39

When your teachers’ husband came into your class to speak to you, was he pitching stock investing in general or was he pitching a specific type of strategy? Was he a day trader, technical analysis? Was he a value guy? What did that dynamic look like?

Ryan Reeves  3:53

Actually, a good question. He might have been pitching something, but I knew so little that I might not even have caught on, but basically, he came in and was just talking about different businesses. Then throughout the rest of the year, we had several stock games where you’d pick a business and try to see who outperformed the most.

I think McDonald’s or something and really didn’t do that well versus some other person, the class pick the apple and just absolutely crushed me. And so, maybe it’s the competitive nature of I want to figure this out, since I didn’t do that well at the beginning, or something. But yes, I don’t think he had a specific tilt or anything.

Robert Leonard  4:32

The reason I asked that, was because I was curious if it led to the current shed that you’re using now. If it didn’t, how did you pivot from what he taught you to what you’re doing today? So what does your strategy look like today?

Ryan Reeves  4:44

I’ve had an evolution as an investor. Actually, after learning about what the stock market was, it kind of stumbled across Warren Buffett and started reading his investment letters and figuring out just what valuation was all these sorts of investment in concepts. Then over time, I eventually saw that these companies that I was familiar with kind of these consumer companies like Netflix and Amazon, I started seeing them do incredibly well. Here I was trying to figure out, like typing into Google, low PE ratio stocks, because I thought that was a good thing to do.

I kind of had these two ideas in my mind. On one hand, I see these stocks going up and up that are kind of very overvalued. Then my stocks really aren’t doing that well, but I’m  playing by the “rules.”

And so, just after wrestling with that for a long time, I eventually started slowly being interested in more growth companies. That’s a lot of what my strategy kind of represents nowadays. The thing is all investing is really value investing, even if you’re investing in companies that are growing, that doesn’t necessarily mean that you should willingly pay for a company that there’s no way it can grow into its valuation.

[Therefore], even though I invest in companies that really have high growth, I don’t just put valuation to the wind, I think about what are the assumptions that are priced in this company?

I think that’s a common thing that a lot of value investors, they’ll never pay up for something, but there’s also a limit to that. There’s not black and white, there’s definitely a lot of nuance involved.

Robert Leonard  6:24

It’s kind of funny that you said that at the beginning about how you’re just buying low PE stocks, because I did almost the exact same thing.

When I first got into investing, I was learning about Warren Buffett, I thought that I had already read everything about him. But I still for some reason thought that an undervalued stock just meant that it was trading at a low multiple and if my discounted cash flow analysis showed that it was undervalued, then I should buy it.

It was strictly on fundamentals. I didn’t look at the qualitative business. I didn’t look at the business model, any future prospects or anything like that. I had the same results that you did.

There was no reason for the stock to go up. There was no catalyst for the stock to go up or for the market to realize the value of the stock that I saw. And so, I continued to underperform and it got super frustrating.

Then as I continued to learn, just like you did, I started to pivot a little bit more to more growth, where I realized that growth doesn’t necessarily mean a low multiple. It means that even sometimes it’s qualitative factors of the business that are undervalued. That’s completely changed my investing strategy today.

I know myself, I love analyzing stocks, I love reading annual reports. But at the same time, I know that it’s a tough road, and academics and finance tend to look down on stock pickers a lot and show us that research concluding we’re as good as monkeys throwing darts at the Wall Street Journal stock section, right? So do you think you can analyze stocks and invest and beat the market?

Ryan Reeves  7:42

I love this question because if I didn’t believe that, there’s no way I would be in the business. The thing is, at the end of the day, the numbers don’t really lie. I have been keeping track of my returns for, I guess, over a decade now. If my returns are well below the market, I should probably sit there and think, “Well, maybe I should stop this and invest my time into something that’d be more productive.”

But at the end of the day, like there’s a certain end, that’s a tricky thing. Because okay, if you outperform for one year, is that luck or is that skill? For three years, five years, 10 years, like at what point is there really kind of a clear cut skill. A lot of people will study this and come up with, “Okay, only if you perform by a meaningful amount after 20 years or something, then you can chalk it up to skill.”

It’s like, okay, that that might be true. But yeah, my point is, at the end of the day, the numbers don’t lie, if you actually outperform, then okay, there might be some sort of merit to my process.

Then the other thing I’d say is, there’s a difference between the probability of something and then also the magnitude of the outcome if it actually does become true. Actually, I was looking at this the other day, I think these are the correct numbers. So if you put $10,000 in the market for 40 years, and the difference between 6% and 8% return, eventually is 1.2 million.

I mean, $10,000 is a decent amount of money, but pretty doable. Then the difference between 6% and 10% is like 3.3 million. And so, it seems like a measly 4%. But compounding really affects the actual amount of money that you have.

My whole thing is, okay, maybe the probabilities of you outperforming by a decent amount aren’t very high, but I think the magnitude of that, if you actually can do it, it’s probably worth it. I think the expected value is probably positive. That’s kind of just another thought on that.

Robert Leonard  9:50

Yeah, and the percentages also take into consideration it’s the same thing for expenses right? If you might have a great return, but if you net of expenses, that’s where that discrepancy can be really big on the other side.

To your point, it’s hard to know, like you said about when there is conclusive evidence that I can successfully pick stocks and at least keep up with the market, if not beat it? You could argue that forever, is it one year, three years, five years, 10 years, 20 years and some people will still say that Warren Buffett’s lucky.

I don’t think there’s ever going to be a specific time period in which you have to have certain results to be classified as successful. So, but that said, do you think picking individual stocks is a good strategy for a new investor? Or should they possibly just stick to diversifying through low cost ETFs?

Ryan Reeves  10:38

It’s a great question. I think there are two things that we should think about, or any new investor should think about if they’re actually interested in picking stocks. And so, that’s the first thing at interest level if you have no interest in business, or the stock market, but you like this idea of making money, maybe like this get rich quick sort of thing about the stock market, that’s probably not a good sign. So you have to be interested in it, because it’s pretty competitive.

If you don’t actually enjoy it, and if you don’t, if you’re not continuously learning, then that really puts you at a disadvantage.

Another thing is risk tolerance. So if you cannot withstand, I mean, Warren Buffett says if you at any point cannot withstand a 50% drawdown, then you probably shouldn’t invest in individual stocks, just because there is a lot of volatility. If you don’t know why you’re holding the stocks that you hold, you can easily get shaken out of them.

So I think those are really two things that people should ask themselves, if they are interested in picking stocks, like do I really even care about this and care about learning about this? Then what is my risk tolerance, because those two things, if you can get them right, will really set you up on a clear path, even if you’re not necessarily good at it at the start.

Robert Leonard  11:51

Let’s assume that someone has an interest in stocks, they know they’re interested in it, they know they’re ready to put the time in. They’re not experts by any means. But they know they want to try picking individual companies, how do they know when they’re ready to actually start doing that and get away from ETFs?

Ryan Reeves  12:07

I think that’s a really good question. That’s the thing, you won’t be ready. But that’s also kind of the point, it’s a little bit like anything that you’re learning that’s new. A good idea is just to get involved.

If you are always reading about investing, but you never actually do it, you kind of miss a lot of context. It’s kind of like writing, wanting to learn how to ride a bike, then all you’re doing is just reading about riding a bike. At some point, you actually have to do it and understand even the emotions that are involved with it.

You see that your stock has something called enterprise value, and you look up what that means, and then you start learning piece by piece just as you do it. And so, I think just jumping in, and just starting with a small amount of money will really prime you and really give you a context for the beginning of the investing journey.

Robert Leonard  13:00

If you’re like me, you have friends and family members that tell you investing in the stock market is gambling, and that they don’t want to gamble with their money like that. How do you handle these types of conversations? How do you explain to someone that might not be in the investing world that investing in the stock market isn’t actually gambling?

Ryan Reeves  13:18

I’ve gotten those conversations, I think so first of all, if somebody asks me a question, but it’s not really a question. It’s more of a statement and they’re trying to get me to agree with them, like you can’t really beat the market, right? Then I’ll just kind of laugh and not really take it seriously because it’s really hard for somebody that is not open minded. It’s really hard for you to completely change their mind about something.

And so, I won’t go to bat and absolutely try to convince them of every little point, I’ll just kind of try to be unemotional with those people and just let them kind of have their own viewpoint because it’s probably not worth my time to try to convince them because they’re not in a state of even wanting to be convinced.

But for somebody who’s actually open minded and asks a genuine question about what do you think about investing, I’ve read this study where people can actually beat the market. But I mean, what are your thoughts on that?

Then I’ll just go into the kind of reasoning that I had earlier.

I think it really comes down to what’s the difference between gambling and I mean, it really comes down to risk as gambling, the idea of risk is kind of thrown to the wind, you’re not really thinking about what are the probabilities in bets?

I mean, somebody can actually gamble in a smart manner. People do poker, and they are actually really good poker players, statistically, they can do better than average. Okay, sure, that’s gambling, but kind of, as I said before, the numbers speak for themselves.

I think it’s really being able to take the emotion out of it. Just like poker would be considered gambling, but people can actually make a lot of money from that if they make the right decisions unemotionally. That’s kind of what I would go through, but it’s really hard to convince people if they’re not even looking to be convinced.

 

Robert Leonard  15:06

I know you’re pretty concerned with investor education, you’ve thoughtfully pointed out in your website that people deserve financial education that’s simple, interesting, and not in a slimy manner. I totally agree with you. That’s exactly what we’re trying to do here on the podcast. So how can listeners become better educated in this industry?

Ryan Reeves  15:26

I’m a big fan of investor letters. There’s actually this great website called Mine Safety Disclosures. If you just typed in hedge fund letters on Google, you can find it. But this guy has kind of compiled all of these investor letters, like hundreds and hundreds of them. I think it’s a great way because these are professional investors who’ve been doing it for a long time. They have people that trust them with their money, and they do this for a living. So they’re constantly thinking about this stuff.

And so, if you just read through some of these, if you come to a concept that you don’t understand at all, you just Google it. Investopedia is a great resource where you can just find a ton of different concepts, and just start to piece together concepts and ideas. So I think that would be a great place to start reading investor letters.

Then anytime you come to something that you don’t understand, just start Googling it and digging in and try to figure out the context. So I think these letters are a great place to start.

Robert Leonard  16:24

Is there anything in particular that a new investor should focus on when they’re first starting to learn about these topics? If you could go back and maybe think about when you were just starting, did you waste your time studying certain things that didn’t really matter and now if you could go back and do it again, you focus on specific things and learn those first?

Ryan Reeves  16:41

It’s actually a really good question. It’s tricky, because as an investor, there’s certain investor things like a certain foundation that you need to have like a little bit of accounting, just knowing what the cost of goods sold are and being able to kind of speak the language of business.

I think accounting is actually a really helpful tool just to have a solid foundation. Then a lot of it is just business fluency. I think in investing, there’s a huge focus on financial fluency, but a little bit less focus on business fluency.

Looking at what’s the marketing of this company? How is it stronger than this other company? What’s the company culture like a little bit more of the qualitative aspects? Because I think those have longer life spans. So if you understand kind of the core, what makes a good business.

I’d say that those concepts have a longer shelf life, then figuring out what the like earnings per share of this particular company will be next quarter. So I think like what that said, there is a certain, like accounting fluency that you that you should need.

I would say that one thing that is maybe not particularly helpful is like the minutiae at the beginning. Like if you come across something that you really just can’t understand. For instance, goodwill and amortization write offs, like you probably don’t need to understand the minutiae at the beginning. If you get really big concepts and understand the main value drivers of a business, I’d say, it’d be pretty well served understanding those first.

Robert Leonard  18:21

Yeah, I think understanding the qualitative side of things is so important. We talked about this a few minutes ago, but that was a piece of my investing that I missed early on. I think in today’s world, it’s probably one of the most important pieces, understanding the fundamentals, the financials and things of that nature are important as well.

But in reality, there’s technology today that hedge funds have and other wealthier investors have that they can deploy. If there’s any discrepancy in value based on just strictly fundamentals, that’s going to be taken away almost instantaneously by these high frequency trading, these super fast computer models that these people have built.

So it comes down to finding value in the qualitative features that a lot of people are missing, because they’re not seeing the business or understanding the business in the right way. I think that’s where a lot of undervalued picks can come in. And so, I think that’s great advice. Like I said, it’s something that I missed when I first got started.

Ryan Reeves  19:16

I’ve one thing to kind of touch on off of that point. So it’s really interesting as an investor, if you think about trying to figure out the value of a company, so the value of any asset is the present value of future cash flows.

If you think about a DCF model, the input of the DCF is the financial metrics of the company, how much is the top line going to grow? What are margins going to be all of these things? So that’s the input, right?

Then the output is the value of the company, you run it through the present value calculations, all that so input financials, output is the value of the company. But if you think of it from the entrepreneurs point of view, the output is the financials and input is all the hard work they do thinking about the strategy and thinking about company culture, all these small decisions that they make every day are the inputs of the eventual outputs, which are the financials.

So it kind of creates tension as an investor. Your input is actually an entrepreneurs’ output. I think it’s an interesting way as an investor to kind of focus on the inputs. I think that’s a little bit of the difference between quantitative and qualitative, like a quantitative investor focusing only on the outputs of a business, aka the financials versus a qualitative investor might focus on inputs of the business and all like, what’s the customer value proposition? How is pricing affecting demand, like all of these sorts of soft factors that eventually create the outputs?

But I think you can kind of get a layer deeper that as you’re talking about, especially with computers, and just like machine learning, and all these things, that kind of arbitrage in a way, the actual financial differences and inefficiencies, I think you can kind of get a layer deeper if you start looking at the inputs from an entrepreneurs point of view.

Robert Leonard  21:02

Let’s dive into a few specific stock picks and how you’re analyzing those companies. Let’s start with a company that you already own, and that you still like to this day, what is that company and how did you find it?

Ryan Reeves  21:14

This is the company that voted for a while called Roku. Roku is a company that I first found in college actually. In my dorm, there was a Roku TV setup, this tiny little Roku remote, and so it kind of primed me. Then it IPO-ed not that much after I started familiarizing myself with what the Roku operating system was and all this.

So then IPO-ed and I started looking into it more. There’s some pretty interesting growth and then it was a little bit of a broken IPO. Actually, it kind of ramped up and then had a bad quarter, and stock kind of fell off a bit.

Then I started really looking into it. The interesting thing about Roku is compared to Amazon, Google and Apple, who have pretty much the same sort of product, Roku has really thrived.

I think the value is that Roku is a neutral platform. And so, let me just kind of back up. So Roku’s main value add is for the Smart TV manufacturers. A lot of these companies that make smart TVs, they could have a whole team of in-house software developers that make the operating system for their TV. So you can try out different subscriptions and just kind of navigate your TV.

What Roku does is it allows the Smart TV manufacturers to license their operating system. And so, just like windows and PC manufacturers, Roku really does that for smart TVs. Now it’s sold in like every one out of three newly sold smart TVs. It’s really created massive scale last quarter. I think they reported 38 million active accounts for Roku.

What this does is it begins to allow Roku to have leverage over different players in the ecosystem. For instance, Disney Plus did a ton of advertising on the Roku system as they launched. Apple TV does the same thing.

Roku is kind of this aggregator of demand and eyeballs. Then they can kind of leverage that to sell advertising to content creators and actually brands. And so, the fastest growing part of Roku’s business is their advertising on demand. Brands will come to Roku and say, “Okay, you have 38 million eyeballs of tight, highly targeted traffic.”

So the difference between Roku since it’s connected TV, is that they have really high granularity into different people’s backgrounds of watching TV and the habits versus linear TV where they really don’t have as much granular data.

The ROI for Roku platform is much higher for advertisers as well. And so, I think the value of the neutrality is also important because if you think about Amazon’s Fire TV Stick, if you’re a brand like Walmart that’s wanting to advertise with nonlinear TV, but instead Roku, one of these other players, you’re probably not going to use Amazon because there’s obviously big conflicts of interest.

Roku is removed from all of that. They are just this neutral player that’s kind of a platform that really enables advertisers to get higher ROI spend on a lot of eyeballs.

 

Robert Leonard  24:29

Admittedly, I don’t know a ton about Roku. I have looked into the company a little bit when it went IPO not too long ago. And so, I was digging into it. There’s actually as we record this as a Roku TV sitting above my head on the wall here, but so I’m familiar with the product and the service.

I think what a lot of people miss on the IPO at least was that they thought they were a hardware company. They didn’t understand how the company was fetching the valuations that it was being a hardware company whereas it’s really more of that SAS model or the more that subscription software model where they are licensing it out, like you said.

Then using advertising as well, which of course fetches different valuations for the company and different multiples. So that’s definitely an interesting dynamic to the company.

Do you see the space that it’s playing in as a zero sum game? The reason I asked that is because you mentioned some pretty heavy hitters that that company is going up against, right? It’s going up against Amazon, Apple, companies that have a lot of money, a lot of weight behind them.

If it’s a zero sum game, they might get squashed by those two companies. Roku might get squashed by those two companies. So is it a zero sum game, or is there room in this market for everybody and Roku could be successful even with Amazon and Apple playing in the same field?

Ryan Reeves  25:43

A big piece of the thesis is just a general tailwind from linear TV to streaming. And so, for watch times, I can’t remember the exact statistics off the top of my head. But for all TV consumption, it’s something like 25% to 30% has moved from linear to streaming.

But in terms of ad dollars, it’s only 3% of total ad dollars that are on streaming. I then think there’s this natural tailwind of kind of just the continual degradation of the cable bundle.

So I think there’s a lot of excess room for different players, but I think Roku has the scale right now, and is kind of capitalizing on this tailwind. It will probably be a winner in most markets, but I think there’s also room for players just because this streaming market is gigantic. It’ll continue to have growth just because of these dollars that are going to be flowing from linear to streaming.

 

Robert Leonard  26:48

How did you find this company? How did it get on your radar? I mean, there’s 1000s of different companies to analyze or look at or invest in? How did Roku show up on your screener? Or how did it get on your radar? Honestly,

Ryan Reeves  27:01

I remember just seeing the Roku TV and wondering what Roku was. I’ve never heard of this and then it sort of primed me. I think I stumbled across an article about Roku IPO-ing. That put another kind of signposts in my way.

Then I can’t remember exactly why I started looking at it again, but that’s the thing. Finding stocks is a very random process. I will do pretty much anything like some people say that they’ll never screen. I’ll screen sometimes. But a lot of the ideas I find are from sometimes internet forums or just talking to smart friends in the industry or new IPOs. There are so many different ways to find a name that it’s kind of like a treasure hunt.

Robert Leonard  27:52

Yeah, that goes back to a book that Peter Lynch wrote called “One Up on Wall Street,” where he talks about how you are able to find investment ideas, just from the different products you use every day. Roku here is a perfect example of that for you.

Now, once it showed up on your radar, you decided you were interested in it, you wanted to start analyzing it, what specific things were you looking for? How did you know that those were the right things to look for?

Ryan Reeves  28:15

It is a really good question to start analyzing and it’s something that I’ve kind of created, it’s not really anything special, but I call it the three drivers.

And so, the three drivers are kind of what would be the main inputs for eventual company’s value. I really think it comes down to being, especially when you’re looking at these companies that are growing fast, the top line, the bottom line, and then competition.

So if a company can grow its sales and then grow its margins will have more profit, and therefore the company will be valued at a higher rate. Therefore you’ll make money on your investment, as long as you don’t pay too crazy a multiple for it.

And so, those are the first two drivers: just simple top line bottom line, kind of figuring out what are the trends, is revenue growth just falling off a cliff or margins really eroding? Is there a potential path to profitability because Roku is not fully profitable yet on a GAAP basis?

Then the other thing is competition. I spend a ton of time analyzing competitors and understanding the value chain of the industry. I looked a lot into all the metrics of Firestick and is Roku growing faster? Why is that talking to people, talking to customers, talking to employees of the company? It’s really important to kind of understand the competition, because if there’s a crazy amount of competition, and there’s no barriers to entry, a lot of people think that that’s the case for Roku.

However, I think that the real value is the partnerships with these smart TV manufacturers because they’re solving a real problem for the TV manufacturers and a lot of people are viewing it for the consumer lens like, “Oh, I have so many options to watch TV as a consumer.”

I think they’re really missing who Roku is solving the problem for. And so just really understanding deeply the dynamics of the industry, especially the competition, because the competition comes in and starts undercutting you and starts offering advertisers better ROI, then obviously, that’s really going to kind of limit the profitability of your business. And so I really tried to look into those three things and understand those deeply: top line, bottom line, and then competition.

Robert Leonard  30:26

Now let’s talk about another company. This time, let’s talk about one that’s on your watch list that you’re interested in and you want to buy it, but you haven’t actually pulled the trigger and purchased it yet. What is that company?

Ryan Reeves  30:38

This is actually a tricky question for me because if I’m really fascinated by a company, and, but here’s where a lot of people probably differ, if they see a company that they really like, but it’s a little bit expensive, they’ll put on the watch list and wait for the company to kind of fall to a price where they think it’s reasonable for them to buy in.

I view it a little bit differently. If I like a company a lot, I’ll put a very small amount in just to start kind of having some skin in the game. If the company keeps performing well, and the stock price goes up, I have no problem just averaging up. And so, that’s what’s kind of happened with a lot of winners in the portfolio, just continually averaging up as the thesis of the investment plays out.

Honestly, there’s not a company on my watch list that I think I really wish I owned, because I will buy a little bit of it. It might not be a huge position, but I really just like that methodology because it kind of evolved over time.

I used to have this watch list where I would sort of be arbitrary because this price point would kind of represent a certain forward return that I could expect, based on my analysis and based on all the numbers.

However, what I found was that it was a little bit arbitrary, because let’s say the price point was $70. Then the stock would get down to 71. It’d be like, “Well, it hasn’t hit my price yet.” It’s like, “Well, that’s actually 1%. It’s a very small amount, 71 versus 70, what’s the difference?”

And so, it’s really hard to kind of have a specific price point, because the stock itself has no idea what that price point is. It’s not like it’s going to hit that and say like a blinking light and tell you that you should buy me now.

Another thing is, when a stock really falls a lot, it takes a lot of conviction to buy it. Because most of the time, stocks don’t just fall randomly. There’ll be like a coherent narrative of competitors coming in, and all this stuff is happening.

So if you don’t actually know the company, and you just have this price point, it’s really hard to even buy it on the way down. And so, I really just try to focus on the absolute best businesses that I can find. Then if the valuation is not super attractive, I will buy a little bit, and then continue to learn about the company.

I guess kind of like a counterpoint to that is where it might get me in trouble is I will dilute quality a little bit. So I stay pretty concentrated, I think the portfolio right now is like 13 names, but I think that a lot of investors that I really respect who have outperformed, they stay even more concentrated. They will only buy a company if they’re willing to risk like 10% of the portfolio or something.

So they really keep the quality of the name super high, but I think that it’s just another way to look at it. Right now, the way that I’m doing it is kind of what I sell down, but always trying to understand how I can improve and what would be a better way of doing things.

Robert Leonard  33:37

I actually do something similar ever since the trading commissions went to $0. I’ve done something similar, I still have a watchlist and I don’t buy every single stock that I’m interested in, or that might go to my watchlist.

But now I do buy a lot more frequently. I do buy one or two shares of a company that I’m interested in that might have just sat on my watch list just because now that I have skin in the game. I’m a lot more bought into it, even if it is just one or two shares.

Now I want to actually get in and research that company and decide if I want to allocate more of my portfolio to it. It sounds like you’re doing something similar.

I think you raise a really good point about the psychological aspect of a falling share price. That’s so hard for people who want to buy the stock and see it fall maybe 10-20% to get to that price that they want to buy at. How do they know that that’s going to be the bottom? That’s a really hard thing to do and try and buy just because it hit an arbitrary price target that you set, how do you know that that’s going to be the bottom and a good place to buy? I think that’s really hard for a lot of people to do.

Ryan Reeves  34:35

That’s a super good point because yeah, like I said, the stock has no idea what price you’re looking for and it’s going to just move how it wants to. You have to make the decisions based on the information that you have.

Robert Leonard  34:48

Are there any companies that are on your hypothetical watchlist if you will, maybe you own a couple shares, small position but you think you might want to scale it up bigger you just haven’t done so yet?

 

Ryan Reeves  34:58

Actually the company that recently reported earnings that I have a small position in, but I’m pretty excited about his company called Livongo. So Livongo is a fairly recent IPO.

What the company does is really at the core, it’s a data company, but it creates and has a bunch of different partners with companies that allow them to cater to people with chronic conditions.

So the main offering they have right now is diabetes offering. What they do is create relationships with self insured employers. For instance, Amazon has 300,000 employees or something and they strike up a deal with Livongo. Amazon can send out a blast to other employees saying anybody that has diabetes who suffers from this can use Livongo service. So these Amazon employees will enroll in the service and usually about 30% of total employees will enroll, based on who has the chronic condition. They’re still trying to increase the enrollment rate, but these employees will enroll, and then Livongo will send them a health kit.

It will be the instruments where you can see your blood sugar and all this. As you’re taking your blood sugar, that data will automatically go to Livongo. If your blood sugar is too high, it’s called a health nudge.

Actually, somebody from Livongo will reach out and say, “Hey, were you aware that this affected you?” And they’ve moved out the platform to hypertension and weight loss management.

It’s really how you create the value out of this data out of all this healthcare data, and the company is growing over 100%. They’ve added a lot of members, because they’re striking really good deals, like they just created a partnership with a company called Dexcom, which makes really high end, continuous glucose monitors.

And so, Livongo can now send these continuous glucose monitors that people don’t have to constantly pick themselves. Just that data will constantly be flowing to Livongo. They can create these health nudges and certain strategies so that these people with chronic conditions can sort of not always be going to the doctor and just kind of cut some costs out of the whole healthcare system.

Robert Leonard  37:16

As you’re explaining that company, and what they do and what they’re trying to accomplish and how they’re trying to cut costs out of the healthcare system, I can understand how that might be an attractive investment.

However, the other component of it was a circle of competency. For me, that’s outside of my circle of competency. I don’t think I could fully wrap my head around that business or understand it to a point where I’d be comfortable investing in it.

So what do you think about that dynamic? Is that a company that you are? Is it in an industry or does it have a business model that is within your circle of competency, just straight from the beginning? Or was it something that you kind of had to learn as you started to learn about the company?

Ryan Reeves  37:55

It’s a really good question. So the circle of competence is huge. If you don’t understand the industry and don’t understand the business model, then you have no idea when something changes and then if you should change your mind.

It was actually a pretty long process of just studying healthcare companies. Also, because it’s really at its core, it is sort of a SaaS model where they have subscriptions. It’s kind of like a per month per participant per month sort of deal for these employers.

I kind of could understand the business model. For every employee that enrolls in the program, the employer pays this much. But then the big piece was okay, how do I understand how Livongo actually sells these employers, and kind of a middleman in the healthcare system is something called a PBM, pharmacy benefit manager.

It took a long time to understand what those are. Can Livongo eventually circumvent them? How much do they actually add to the system? So like, all of these aspects of the healthcare system that are a little different from just like a normal technology company?

Yes, I spend a lot of time trying to understand what competition looks like. Does Livongo really have an advantage versus some of the other competitors who seem like you’re doing really the same thing? What are the partnerships like so yeah, it took a long time. I wouldn’t say that I’m fully a healthcare expert or anything, and that’s why it’s still a small position. But yes I think that is a super key aspect that you bring up.

Robert Leonard  39:29

uWhy is it still a small position in your portfolio? Is it strictly just because you’re still trying to understand the industry in the business more or are there other underlying reasons as to why you haven’t scaled into that position more?

Ryan Reeves  39:43

Kind of going back to the three drivers of competition is a key aspect. Now, I don’t feel like I have a full understanding of the competitive dynamics. There’s a few other companies like this one called Gluco that seem to do the same thing. It’s not a public company, so I can’t see any of the growth rates or anything like that.

And so, without any kind of real conviction around competition, it’s hard for me to put a lot of investment dollars into a company. Yeah, another reason is just, it’s a very new company. It’s hard to kind of get a sense of any of the trends because it’s been growing over 100%. It seems like everything’s on the right track.

But for a while, really, the bottom line was improving that much, and kind of assumed that they weren’t doing efficient business operations and marketing and everything.

However, the last quarter in particular, they had some huge operating leverage, and margins really increased. And so, that was kind of an interesting sign, and kind of going back to the inputs and outputs, that’s an output of the business, the financials and all this, and then just checking those things. Okay, this financial metric happened, and then figuring out what is the input and figuring out how management is thinking about payback period and thinking about all these things.

It’s kind of like a big circle. So you check the financials, and then you find out what the inputs are, and then you rechecked the financials and kind of it’s this circle of kind of figuring out the qualitative and quantitative aspects of the business.

But yes, it’s kind of a combination of all these factors that don’t understand healthcare completely, just the space not super familiar with it, and then kind of the competition and this other factor. That’s kind of why it’s a small position right now.

Robert Leonard  41:35

What do you think about overall portfolio allocation? When you have multiple different stocks you like, or maybe even different asset classes like real estate? How do you allocate your capital appropriately?

Ryan Reeves  41:49

I think for other asset classes, it depends on your circle of competence. So if you work in the real estate industry, and you’re really comfortable, and you think there’s an amazing deal, then you’ll probably have a much higher allocation of real estate than I do, which I don’t really know that much about real estate.

So for me, just to kind of focus on stock  allocation is something that I think about a lot, because there’s definitely an art and a science. You can look at it very mathematically and figure out, okay, this is probably on a risk adjusted basis, the ideal allocation that I could have. However, it’s pretty hard to do that when you have a qualitative bent.

I think of it kind of on two vectors, one is conviction, and the other is kind of upside. And so upside would, it’s kind of qualitative, quantitative, right? So upside would be more of the financial aspect, looking out five or so years, what are the assumptions that I need to believe to kind of get a certain return that I think is respectable?

Then on conviction, it’s after looking at all of these aspects, looking at all these inputs, and talking to management or reading a ton, this holistic sense, what kind of conviction do I have in this business? And do I believe it’s going to be more profitable in the future? Then kind of based on these two vectors that kind of create an allocation.

[Though] I think one interesting thing is that it’s important to have a gold star. Gold star is a company in your portfolio, that any company that you’re adding to the portfolio has to be better than each incremental dollar that you add to the gold star. And so, I have a gold star in the portfolio, and it’s  a big position, but I don’t want to scale it up anymore. That’s why I started this smaller position in Livongo.

Though basically, you need to have this gold star, because let’s say you’re interested in kind of ratcheting up the gold star, but you’re adding other positions in the portfolio, you’re adding extra complexity. I think it’s important to kind of have a benchmark that you kind of look at everything else through that lens of should I buy more of this or more of this? It’s kind of just having a benchmark to understand what’s the best way I can position myself.

Robert Leonard  44:08

Yeah, I think portfolio allocation is so hard. I think it’s something that not as many people talk about, I think they talk about how hard it is to find individual companies and it is, but that’s really only one piece of it, right? You have to get that piece right.

But then you also need to make sure you allocate appropriately because if you have the best company in the world that nobody else sees, it’s super undervalued, and it quadruples in value in a year, that’s great. But if you only had a 1% of your portfolio allocated there, it doesn’t really do much for your overall portfolio.

Whereas if the other 99% of your portfolio was in a company that tanked, of course, your returns for the year overall are not going to be great. And so, that’s why I think portfolio allocation is such a big thing that I think a lot of people, especially new investors that we’re talking to here on the show, need to really take into consideration.

Now we’re experiencing an interesting time in the market right now as we record this. It’s early March 2020. Last week the market had its worst week since the last financial crisis. The Coronavirus concerns are continuing to rise. How do you handle investing in this type of environment?

Ryan Reeves  45:11

We talk a lot about the structure and all the things you need to understand as an investor. But really, a huge piece is your emotional stability. I mean, if you can kind of hold your head when everything else is going crazy, then what good does it do to have the best companies in your portfolio if you just sell them at the bottom.

However, I think that it is also like a self enforcing or reinforcing loop. So the more that you learn about a company, and the more that you understand the industry, and the more you understand the inputs of the business, you really spend so much time understanding this business, and the valuation and you think that it’s undervalued stock, and all of a sudden, the markets tanking, you’re probably going to have the conviction to least hold on, or if not buy more.

And so, I think it’s this reinforcing loop that the more you learn, the more emotional stability you have. Then the more emotional stability you have, means that you can spend more time just focusing on research and focusing on learning about business.

But I mean, hey, if you’ve done all that research, and you still can’t hold your stocks when things are going crazy, then maybe you have a slightly different risk tolerance. Maybe you have to hold more cash in your portfolio.

So just thinking about it like that is really important, just really understanding why you’re holding the companies you hold, if you don’t know them, then you’re much more likely to just sell out when things go bad.

Robert Leonard  46:43

Yeah, that kind of reminds me of a few years ago, I forget what year it was. But Bitcoin was trading around 1500, I want to say and I bought one Bitcoin, just because I wanted to try it. And I didn’t understand it by any means. I’m super risk tolerant, I love risk. I run a very concentrated portfolio. I use options quite a bit. I do more risky type real estate, in a lot of cases.

I’m not necessarily scared to risk but I just didn’t understand Bitcoin. It laid with my head psychologically, and I sold the next day, and then over the next couple weeks, it went to 20,000. I was completely okay with that, because I knew I didn’t understand it. It just didn’t feel right. I wasn’t able to sleep well at night.

So I think weathering things like we’re going through right now is a big piece of that is understanding what you own understanding why you own it, and understand where you think the business is going over the next 5 to 10 years rather than just over the next month, six months, even a year when this type of situation is going on.

The other piece of it too, is that a lot of the listeners are probably relatively young, like you and I. They’ve likely only ever invested in a bull market, and arguably one of the strongest bull markets we’ve ever seen in history. So for a new investor that’s listening to the show that hasn’t experienced this major volatility or economic issues, it’s probably a bit of a shock, but it’s probably also a good way for them to get their feet wet for a potential recession that may be coming in the future.

Ryan Reeves  48:09

One underrated thing would be to start an investing journal. So anytime that stocks pull back, like this week, and I just write in the journal, what sort of emotions that you’re feeling, and what decisions you’re making. Then when you face a good time, and your emotions are completely different, you look back on that investing journal and say, “Wow, there’s no way that I could have felt those emotions. My mindset is so much different now.”

Then when you’re in the next crisis, in the next little pullback, you look back at the journal and see how the results have played out since then. Then that can kind of give you a foundation for making decisions with a fair amount of emotional stability.

Robert Leonard  48:56

So as we wrap up the show, I want to talk about your biggest losing position in your investing career. What was that position and where did your thesis go wrong?

Ryan Reeves  49:07

A little bit ago, I bought GoPro, which I thought had a stronger brand than it actually had. I think I really overestimated how important the brand was going to be in terms of the value of the company they had. This thing was like the new GoPro 4 was coming out. I thought that could be like a good product. I heard good things about what that product is going to be. I think I really underestimated how important software is in terms of a software hardware ecosystem.

I mean, if you look at Apple, okay, yes, it’s a hardware company. They sell phones, but really, it’s the software that integrates everything that creates the stickiness and really creates the brand of that phone versus GoPro. There’s not really a software ecosystem that has any switching costs at all.

And so, competition came and really demand wasn’t great for that product. I just kind of made a mistake of anchoring to a high point and said, “Okay, GoPro is off 40%? How much further can it go down?” But that is really a dangerous way of looking at investing. Because this once again, the stock has no idea what price you bought it, it doesn’t matter if it’s 40% off, all that matters is the future of that company. Is it actually getting stronger as a business? What are the financials looking like?

So I think anchoring to a 52 week high and saying,” Okay, this company is down 50%” is kind of a dangerous way to invest. Sometimes we’ll catch a right, sometimes it will turn around. But I think that I really put too much focus on the price versus actually thinking about the competitive advantages of the business.

Robert Leonard  50:49

Yeah, it’s interesting that you brought up GoPro. We hadn’t talked about this before. But GoPro I almost made the same investment. I’m big into the actual camera type space. I love photography. I also ride their bikes, race, motocross, things like that. So I’m super into the total ecosystem of action cameras. I just wanted to believe in the company.

Thankfully for me, I never pulled the trigger and I never bought it. Honestly, the biggest reason was I felt the same way about you as the brand. I thought they always had the best products, I thought they had the best brands. I thought that that was going to get them through and I thought the valuation was really attractive. Then I bought a 50 or $60 camera off Amazon, that was the exact same thing and it worked amazing. And maybe GoPro was a little bit better. But it was good enough, right? For most people who are not professional photographers, such as myself, it was a good enough product.

For me, that was the point where I just told myself, I couldn’t buy the stock. What I think is interesting is that it circles back to our conversation we had earlier, whereas if we just bought on fundamentals, I would have bought that stock because it was attractive.

But when I started to look at the qualitative side of the business, I started to look at the long term and say, do they really have a sustainable moat with a brand that they can defend long term into the future? Also, can that act as a catalyst to bring back the value in the stock that the fundamentals might be showing?

For me, the answer was no. So I feel bad that you had those losses. But we learn from it right? I’m sure you learn from that mistake and I’m sure you’ll make more money from that mistake than you lost from that trade.

Ryan, thanks for your time. I’ve really enjoyed this conversation, I think the audience is going to get a lot of value from it. Where can the audience go to learn more about you and just all the different things that you got going on?

Ryan Reeves  52:25

Thanks so much. So the website will be a great place to go. So that’s investingcity.org. I’m sure you can find a ton of educational resources for free there. Also, I have a research service and a lower price newsletter where the tagline is like reading a 10K, but infinitely better. We just break down different businesses.

Robert Leonard  52:54

Yeah, absolutely. I appreciate your conversation that we provide a lot of great content, I’ll be sure to put links to those different resources. In the show notes. I’ll also put different links to the topics that we talked about throughout the show, as well as some books that relate to those topics.

Outro  53:29

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