ZIM - Small Cap Alpha Commodity Danger And Advanced Emissions Solutions With Courage & Conviction Investing

2023-07-24 08:50:00 ET

Summary

• Courage & Conviction Investing on small cap alpha and his 1st half performance (returns up ~46%).
• How capturing gains in RCM Technologies and TravelCenters of America exemplify investing strategy.
• Commodity supercycles and his top stock idea.

Listen below or on the go via Apple Podcasts or Spotify .

Courage & Conviction Investing on his 1st half performance and small cap alpha - returns up about 46% (2:00), how capturing gains in RCM Technologies ( RCMT ) and TravelCenters of America ( BP ) exemplifies investing strategy (7:50), why the macro picture is not worth following (34:00), commodity supercycles (42:40) and his top stock idea (51:40).

Transcript

Rena Sherbill: Courage & Conviction Investing, who runs an investing group on Seeking Alpha called Second Wind Capital , and I myself just got my second wind. So, welcome to the show, Courage & Conviction Investing.

Courage & Conviction Investing: Hi Rena. Thanks so much for having me. It's a pleasure to be here.

RS: It's great to have you on. Longtime fan. I'm super happy to have you on the show. And I'm even happier because you just released your first half returns . Wow, if people are looking to past performance as any kind of future indicator, they would be wise to look at your return. So, I feel like that's a great place to start.

We’re here on July 20, 2023. Really midpoint in the year, maybe a little bit passed. Do you want to talk about what your performance is looking like and what your viewpoints on that are?

CCI: Yeah, sure. Yes. So first half up about 46%. I'm a small cap value special situations investor. Deep, deep fundamental work, speak with management teams, synthesize conference calls, try to figure out the sector, the ecosystem, where you are in the cycle, what normalized valuation you're paying for businesses. And then you try to overlay that with a catalyst, right? That's kind of the formula.

And I'm 42, and I've been at this game for a long time. My dad bought put a $1,000 in Peter Lynch's Magellan Fund when I was like two. It did exceptionally well and he was into the stock market. So that's where my interest originated from. And I've just been obsessively following markets, reading, it’s just like it’s an addiction. I guess there could be worse addictions. But I'm literally up at 4:00, 4:30 in the morning reading conference calls, talking to different friends about ideas and the earnings seasons are incredibly fun.

Every four times a year you get, say 4 weeks to 6 weeks depending on the names that you're in, the sectors that you're in. It's just a mad dash. It's from 4 a.m. to till eight, really some days. If you’ve got multiple companies reporting and you're trying to synthesize faster, you try to be up to speed faster because you want to catch an inflection point.

And especially in small caps, depending on how levered the balance sheets are, I don't do a lot with really levered businesses per se, I'd have to really know the business well and depending on where you are in the cycle. If it's a commodity that can be different if you're at an inflection point, but I try to stay away from leverage. But my point is that in small cap land, companies can literally move 30%, 40%, 50% or 100% in a week. And so, you just don't have the luxury of tell, you know, get to it in a couple of days. And that's what makes it so exciting.

And the reason I love small caps is because there's so much alpha. The structure of the market is such that, the big buy-side money, pension funds, endowments and mutual funds, insurance companies, they can't buy enough of these equities, let's say sub a couple billion, and specialties sub 500 million, that they just can't size up a position even if the company doubles to make it worth their time and efforts, and it's just too hard to get in and out.

So you have tremendous pricing inefficiencies and with that comes a lot of volatility. But if you really know your names, if you know your companies and within the context of a portfolio, this is just a great hunting ground. And I don't know why more people aren't into this sector. My guess would be, it's really a function. They can't stomach the drawdowns because literally sentiment or negative report, or downgrade, a company can move 20%. Nothing is fundamentally changed about the business.

I run a pretty concentrated portfolio . I have about 15 names right now. The vast majority of the capital, that was probably in say the top 5 to 7 to 8, where the latter pieces are 2% to 3% sized. I try not to go above 15%. My conviction has to be very high to get to 15%. But I do regularly have one or two 15% names, usually one. And then I'll have a lot of 8% to 10% to 12% size names. And I've been at this so long. The key is really -- it's this game's about slugging percentage. So hitting for extra basis and within the context of a portfolio, if you have one or two really good winners, you get -- the returns add up very quickly.

And so this year, there's just -- it's just been, if you survive. January was fantastic. I had a big January effect portfolio that I put together. I got lucky that did really well. The Russell 2000 ripped in January. And then it got really tricky February and March with the banking crisis, Regional Bank, Silicon Valley ( SIVBQ ), First Republic ( FRCB ), the whole regional bank index just got destroyed, fears about the value of the security is not mark-to-market, like huge losses because the interest rates have gone up so quickly. And just a lot of fear.

Then small caps got completely dinged. I think the Russell swung from up 10 at the peak, maybe a little north of that. Actually, it was probably up maybe 12. And then I think it went to either flat or negative.

And so you just have to weather those drawdowns and know your names and have conviction in those names. But when you get those big drawdowns, that's really where you can make the money. It is sizing up names that you really, really know well, where just things get completely disconnected and you just take advantage of that. And really the returns were driven by taking advantage of irrational or logical selloffs. And I can give you a specific example I think that may be helpful just to explain my thought process or…

RS: Yes. Please do.

CCI: There’s this company, RCM Technologies, ticker is ( RCMT ). I originally wrote it up behind the paywall for my investing group service, March 31, 2022. The stock was just under 10. And then by June, I think 6 or 8, the stock hit 29. It was a COVID winner, kind of pull forward, the earnings ramped dramatically. And then I kind of lost sight of it because it moved so quickly. I didn't capture all of that move, but I certainly did capture some of those gains. Then I just had it on my back burning.

I follow literally 300 companies just on my radar. I'm literally – and Seeking Alpha, by the way, has incredible tools for following news, following news, press releases. I literally follow 200, 300 tickers. And every morning from, I'm checking every 15 minutes press releases, new press releases because I don't want to miss anything. And the SA news team does an incredible job with finding really good pieces of news and information, a lot of times well ahead of like a Wall Street Journal, or Bloomberg, or maybe Financial Times.

Anyway, just to get back to RCMT. They had pretty good numbers Q4. And I said, okay, I'm going to put this back on a 10% position at 13.25. And within two weeks, the thing dropped to 10.22 on my face. I'm scratching my head and I got the CFO on the phone.

Lot of times, if you write a good note and explain who you are, the management team, especially the CFOs are happy to talk with you and he certainly was. I had a really good conversation with the CFO. He was in Ireland, on his way to Germany for a business venture. I was really impressed with him.

And then I'm scratching my head and I'm saying, all right, the stock is trading at 5x earnings at 10, balance sheet is fine. The CEO, Brad Vizi , owned 1.5 million shares. The share count was 12 million, but they have been aggressively buying back the stock. And they had this huge tailwind, because of the biggest K-12 schools staff nursing business.

And so post-COVID, there have been a lot of behavioral issues with students falling behind, having difficulty adjusting. And so they have these really specialized nurses that are really credentialed and that are a great resource for school systems to help children having issues.

I said, okay. The balance sheet is fine, trading at 5x earnings, management owns a ton of stock. They're buying back stock aggressively. The conference calls read incredibly well, the outlook is really strong. What am I missing? And I wasn't missing anything. So I bought more.

So I took it to 15% and I was literally singing from the mountaintops of my group. Every day there was a Kumbaya. I don't want to talk about anything else. I want to talk about our RCMT, right. I want you to get to 15%. If you have the – if that fits your risk parameters and it makes sense for you and you have the dry powder, you have to get in this thing.

And so sure enough, subsequent to the events happened and the management ended up buying back a lot of stock. They had a good Q1, that was ahead of consensus, gave a strong outlook, and then they actually bought a nice block of stock from some institutional holder.

So, once that got cleaned up and the supply and demand overhang was alleviated, the market said, you know what, this is exactly what we want to bet on. We want smart management teams, we want a good outlook, good balance sheet, that are buying back stock.

And when the stock hit 29, Brad, I think sold 100,000 out of 1.5 million shares. So 1.6 million shares times 30 that's a lot of money. And so for him to have that much confidence not to take more than that off, that spoke volumes to me. So, I'm largely out of it because the stock hit 20, my price target was 20. So, I don't want to get overly cute when the stock goes from 12 to 20 in three months. And I haven't even seen the Q2 print and seasonally it's more of a second half business because the schools aren’t in the session of summer.

But that is one example of the immense amount of alpha that is available. If you're willing to turn over a lot of rocks, if you’re willing to pick up the phone, talk to management, if you're willing to synthesize the conference calls, or you're willing to think about, what am I paying for this business, you go and take a step back and say, what is the outlook for this business. Is it going to be around in five years? What's the competitive advantage? What's its ecosystem? What's normalized EBITDA, think about all those things.

And so again, the market cap was just too small. Institutions don't care, very limited sell-side coverage. And not to be overly negative, but I'm on the call and I had written pieces about how -- because if you looked at the updated K, Q, you could see the change in share counts. So you could see how aggressively they were buying back the stock. But on the conference call, the sell-side was surprised that they bought back that much stock.

If you simply looked at the difference between the K and the Q, you could have worked out the math. Because again, the sell-side is covering 25 names, they're not doing any secondaries, there’s no banking relationships on the debt side. So they cover it. But it's not at the top of their list because they have other situations they're involved in. And again, if it’s not banking, that’s kind of – it’s not at the forefront of their minds.

That said, there are some very good sell siders. It's just really nuanced. It depends on the company. It depends on the industry, their experience and whatnot. So, I don't want to just broadly say the sell-side isn't good, but I think they are just a spread so thinly that they're not at the forefront per se to catch some of these inflection points. And that's where the serious money gets made, is the inflection points.

RS: I think what you're describing is a really nice example of something that you talked about in this article where you wrote about your first half returns. And you said something that time allocation is one of the most important things that an investor can have. I would add probably in life and not just in investing. Show me somebody that knows how to allocate their time wisely and I will probably show you a successful person.

When you're talking about uncovering all these rocks and doing all this due diligence, a) do you find that that's unique to -- not unique, but it's especially true for small caps as opposed to maybe mega caps or large caps, or more well covered stocks where the news is really out there in a more public way? And b) how long was the process before you honed the strategy that you're using today?

CCI: Yeah, I would completely agree. Bandwidth is so important and people that are the best allocators of bandwidth, balancing work, family, health, other commitments, friendships, trying to enhance yourself educationally, maybe doing some volunteer work. It makes you more well-rounded but there's certainly, it's like the Pareto 80-20, which I'm not great at getting enough rest because I'm up too early.

But you want to be smart and strategic about how you allocate your time and I don't run any quant screens. It's very much a -- it's an art. It's just reading a lot of news and it becomes like a spidey sense because I've been at this for so long, that you learn through your mistakes, your mistakes are the greatest teacher.

And what's so unique about investing is, if you strike out and you get hit in the slump, then you have to take a – get a step back and get really cerebral and say, okay, what am I doing wrong? Why isn't this working? How can I learn from this? How can I apply this differently? And how is this going to make me a better investor? And that's what's so unique about this business.

But I've also learned that you got to kind of be grounded and not get too swept up in the euphoria, 2020 was just fantastic. But not to get too far off tangent, but in Thanksgiving at 2021 when there was this omicron wave of COVID, that was the market ringing the bell at the top. And I was definitely really late because I think I had put up such monster returns in 2020 and that was up 80% first three months of 2021.

And I kind of got a little, took my eye off the ball and I got beat up really. I gave back 25% in Q4 and I totally missed the -- I totally underappreciated the inflation and I totally underappreciated how high the Fed would go and I totally underappreciated how that would totally change the narrative.

I mean, I could obviously understand the net present value and the discounted rates and access to capital and all that stuff. But that was definitely caught flatfooted in 2022 and I had a fight to be up 5% and it was a complete dog fight. How am I going to grind every day to keep my head above water? How am I going to hit singles, bunt singles, sacrifice the runner, hit a sac fly, field well, I love the baseball analogies…

RS: I know, I hope people following along are baseball fans.

CCI: Yeah, so I just think the biggest thing is I got so up in ’20 because I run money for my parents, and my mother is extremely risk averse. And I was up 93% in 2020, but on the actual managed capital, it was probably up 400%, if you actually look at the available capital. And so you just -- it goes to your head, right? You start thinking you can't miss and you start missing stuff and you get kind of sloppy and that was a really important lesson. And so through the school of hard knocks and you just have to, you have to change strategy and change course.

But I will say one of the biggest things that I've learned is and I love Buffett. Buffett's by far my favorite. I think he's the greatest of all time. Malcolm Gladwell has talked about how genius and success is really -- you need to think about longevity, right? You just can't be, you have a great stretch for five years. It's the people that can do it for the duration. And Buffett's record is just incredible.

But management teams are so important in small caps. Do they have skin in the game? Are they competent? Do they work hard? Are they aware of things? And they create the value oftentimes. And they can destroy value so quickly.

And that's, I would say, as part of my evolution and I'm literally learning every day. If you're intellectually curious, you want to get better every single day, iterate every day, every month, every year. And then hopefully that knowledge compounds, that wisdom compounds. And then if you get a little bit off course, you got to course correct. But I would say the biggest thing that I've learned is how good is management.

And that's an art. It's really a subjective valuation and you have to speak with them and you have to synthesize the conference calls and say, what can they control and how honest are they about what they said they were going to do and then what they did. When they start talking about the weather and making up all these excuses. That's not a good sign. When they don't own a lot of stock, that’s not a good sign, right?

I want to invest with entrepreneurial people that have skin in the game, that want to get paid, you think about John Malone, the billionaire. He hired a lot of brilliant people and he paid them mostly options, right? Out of the money, but long duration options, right? And he said, if you do well, you will get incredibly wealthy. If you don't, you'll make nothing and the relationship will end.

But I only want to hire people that have the belief in themselves, and the incentive, the ambition, the drive to want to go out and create something and to want to trailblaze, and to do something different, to disrupt, to build an organization that's better, that has better margins, and that's going to earn their cost of capital. Constantly learning, but that's one of the big, big things that I've learned the hard way.

Half the management teams are mediocre at best. And there are the few exceptions and those are the people that you really want to invest with.

So to give you an example, TravelCenters of America ( BP ). I wrote about this. Originally bought at $41 in September 1, 2021. Okay. So you have a Pilot and you have Love’s. So these are mostly -- these are truck stops that are diesel fuel -- they mostly sell diesel and then the business chronically underperformed under – like Love’s and Pilot, they own the Browns, right? They're billionaires and Love’s is just incredibly successful.

And so they brought in a new CEO. I think it was Jon Pertchik . I hope I didn't say his name wrong. He came from the hospitality business, okay, hotel business. And I said, okay. Here they put up their first good quarter in August 2021. And I said, whoa. And I went back and I read every one of his conference calls . I synthesized it. I read them twice.

I said, oh my God, this guy is incredible. And from the time he started, EBITDA was sub-200 million. It was maybe 180 million. And then by the time, BP bought them out for $86 in Feb 2023, so not that long, the EBITDA was almost 400 million.

But step-by-step, he got diesel margins from say $0.12 or $0.13 to $0.18 or $0.20. So you're talking billions of dollars, the difference between making $0.14 and $0.18, we're talking serious money. They had the best repair fleet in the business, right?

So he realized that he had to get better techs, he had to pay the tech’s better, he had to staff them because that was a key point of differentiation. He fixed the parking lots, he painted, he made the bathrooms clean, he made the showers clean. So, people wanted to actually stay there overnight. And then when you stay there, you would maybe buy something in the restaurant, you buy something in the convenience store, because that piece of the business is at 50% margins right.

And then he worked on a small fleet business which was underutilized. Then he ramped up the franchise business, underutilized. Very profitable. Right. It's 250 million to 400 million in EBITDA. He bought some strategic pieces to complete the portfolio. And they had 280 sites, and they owned 50. They own the land free and clear.

So, I'm like, okay, the land itself and the debt was 8%. It was baby bonds, but it was expensive to call it. So he's like, I'm too busy trying to turn on the business to worry about calling this debt at 104. And so, but methodically step by step by step, this guy brought in the people and he literally did it. He turned EBITDA from 180 million to 400 million. So I went from $41 to $86.

And I was scratching my head. So during that ride, the stock went from $41, it hit $64, it wasn’t a seller. Came in to, I don't know it, I think it got as low as $33 and I'm scratching my head. I bought more, like this is nuts. And he just created incredible value. But there was a huge margin of safety because you owned 50 of the sites and TravelCenter sites are 20 acres. So you have the whole EV piece of it. But we're talking the land and the site.

So, I'm saying, all right, I'm buying in this company at $33, at a negative enterprise value. And the rents were 10-year fixed. So it was just like, it was one of the best value situations that I've ever seen. Obviously did really well with it, but in retrospect, it should have been my number one position. And it was number five. But that is a really good example of how a good management team creates value.

And the thing is, there’s a lot of people looking at rearview mirror that the company is terrible. The management is terrible. It's, no guys, the -- they switched to the guy who totally cleaned the house. But the perceptions and -- and so by the time the street figures it out, the thing's getting bought out, oh, how did I miss that? Because, well, you weren't in the weeds.

So, that's a good example, but most of my returns have been really high conviction bets. I've had some strikeouts too. I've definitely had some strikeouts. Again, it’s about slagging percentage and let's keep it honest. I've had some crash and burns, Lottery.com ( LTRY ) which was complete fraud . They published a 10-K that turned to be complete fiction. I've never seen in the US, like a 10-K where you say where the cash is wrong, the cash was blatantly wrong. And they report adjusted EBITDA, it didn't match the cash. I was, what the heck am I missing?

But the CEO was an incredible salesman, but had I done better diligence, the team was a bunch of jokers, they didn't have the resumes. They went to the Silicon Valley Gold Rush. They did well and they got some equity and all of a sudden these guys are management teams. But they weren't seasoned and it was a big oversight on that one. I took a pretty big loss there. But it's par for the course. You dust yourself off. Well, what are you going to learn from it? You get back on the horse. You don't give up and say, oh, I can't do it. All right, I made some mistakes. I'm not going to do that again. And I've made others too.

So to hit for high slugging percentage, you're going to make mistakes and you're going to have some strikeouts and it's just kind of par for the course. But within the context of a portfolio, again, if you're not getting above 15%, 10%, if you have something, I mean, it's bad. You have 10% in hand and you lose 80% it hurts, or like a 5% in hand and you lose 80% it hurts.

But if you're hitting for multi-baggers, or 100% on some of the other winners, then those kind of offsets themselves. So that's just kind of the way the math works. But I think a lot of people shy away from small caps just because the drawdowns are intense and they just can't stomach it. But if you really -- if you want to make the returns, you got to go where it's -- you got to traverse the rugged terrain.

RS: Right. It’s pretty clear to me how you got the name, Courage & Conviction Investing. Is Second Wind Capital, it that kind of dusting yourself off and being able to come back with the second wind for being dissuaded from a thesis? Or can you explain where the second wind comes from?

CCI: Yeah, so, all right. So just a quick background. So, I went to UMass Amherst. I did major in finance. I was so passionate about markets. I wanted to land in Boston as an equity analyst, a junior analyst. And my senior at UMass, there was a guy, John Mark Britto that came to visit. He was a UMass Music major.

And this guy, Rena, was the most incandescently bright guy I've ever met. He was a portfolio manager at Wellington. He ran 4 billion. And he handed out his card and I just kept calling this guy. And he's like, I love your persistence. I love your passion. This guy was a partner at Wellington, right. It's the most elite firm besides Capital Group on the mutual fund world. Wellington and Capital Group are, Templeton, those are like the cream of the crop.

And so here's a guy that has incredible responsibilities, international equities. And he said, you know what, I'm going to work with you because you have the passion and we're going to trade emails. You're writing us to get better. Your writing is not really good. And if you want to make it in this business, you're writing us to get much better. And so for a year, year and a half because I was kind of -- I couldn't get - I couldn't get a seat in Boston. And he worked with me and I've been lucky because I've had some great mentors.

I have another mentor that runs a $600 million family office and he's got a -- he was exceptionally helpful and we're friends and I've been lucky with that. But in the equity world, especially in Boston, maybe more so, it's less so in New York. New York is more of a meritocracy. But for -- my wife who’s two years younger and I didn't want to move to New York. I had an opportunity at Goldman Sachs, but on the operational side. And so it was literally kind of being in the wilderness and trying to pursue the dream and you couldn't really do it and kind of hope -- to keep the hope alive.

And I forget when I discovered Seeking Alpha, but, yeah, this is - I think of like a singer songwriter and, you're really good, and you know you're good. But there are thousands of people that are really good. And you go to Nashville and you wait tables and you kind of wait for your break and it doesn't happen. So you got to go back and say, all right, well, that didn't work. So what are you going to do? You’ve got to reboot, and you’ve got to still live. Well, you’re doing that.

And so Seeking Alpha was such an oasis for me because I had all this intellectual curiosity. I had all these ideas and I wasn't quite ready yet to, good enough to land. I interviewed Fidelity and all these places and I just couldn't land. And so it was my sanctuary. I would moonlight at night and I'd write these thesis and it was a platform where I could share my ideas and I could put that out there. And so it really helped my evolution.

But I did work in investment grade bonds for five years, a $50 billion portfolio. I worked with analysts and PMs and it was a really good experience. But it was a great pathway to make a great living, vacation, but it just didn't blow my hair back because it's investment grade bonds. And so it's fine and if you want to make a living and support your family, it's great. It's just it wasn't that -- it wasn’t enough of an intellectual challenge for me.

So talking about a journeyman, to switch sports metaphors, you love the journeyman that is 45 and loses his tour card, has some issues and still pursuing the dream, still on the tour, keeps this card. And then he breaks through at 45 and he wins, and maybe it's the Hartford Open, or it's some lesser tournament, the John Deere Classic or -- you’re not a premier tournament per se, but that stick to it. And it’s that persistence, that passion that says, I am going to put four good rounds together and I'm going to do it. I know I can do it. I've never lived up to that potential, but I'm going to do it and they do it at 45.

I mean, it’s easier to see in sports because of the -- this is like a pure meritocracy, but the Second Wind Capital is, it's an ode to the wanderers that, you failed your first time and you come back and you try to do it again. So, I mean, that’s what it is. That’s it. It’s just – it can be universally applied to life.

RS: Yeah. So much of what you just said resonates really strongly with me. From the writing, learning to become a better writer. I think people that don't have a deep understanding of the investment world don't know that about the investing world. I spent a lot of time covering hedge funds letters in my time at Seeking Alpha, and I was completely blown away by the level of writing and the nuance of thought. And you used this turn of phrase, incandescently bright. That's a beautiful turn of phrase.

And so many people, not so many, but there's a handful of people that strike me as that. And also how you describe kind of the unique alpha , I think that Seeking Alpha affords people. There's just people that I never ever would have been able to read and I think there's people that would have never thought about writing if a platform like this didn't exist. So, I appreciate that and also just on a really personal level, a lot of what you said, just resonated very strongly with me.

I'm curious, you mentioned towards the beginning of our conversation, this notion that some of your investing thesis was thrown off by the more macro elements of the picture, the Fed. And you don't spend a lot, you wrote this article about Peter Lynch saying, if you spend 13 minutes a year on economics, you've wasted 10 of those minutes.

CCI: Right.

RS: You don't spend a lot of time on the macro picture. And a lot of people we talked to on this show, do. I'm curious why you don't and how you would, I guess, caution the average retail investor about the macro picture in addition to this whatever stocks they're covering?

CCI: If you take a step back, if you've read David McCullough , the great historian, he died a couple of years ago, but he was just a brilliant writer and thinker. The American experience, that experiment is so unique. It's just such a dynamic country and the probability of beating the British was very unlikely and you had the right people in the right places and you had luck and you had Washington, you had different events. And France comes into it and they just outlasted the British because they had to - the heart to be the underdog.

And so you just don't bet against America. Okay. If you look at history, if you read Buffett, it's incredibly dynamic people. They are very smart, ambitious people. We have the best system. You can argue that, but I think it is. And it's a pure meritocracy and really bright people from all over the world come to our universities. That's what kind of makes Americas so unique that the college and graduate level and the PhD programs like, Google, they're from Stanford Grad School. And there were a number of those success stories, right? So this is literally the streets are paved in gold in America. And that's my view.

And I had a great mentor, Rodney Thomas that I met on the golf course in high school and we became great friends. He died at 47 of diabetes, just the most charismatic, great guy, my first mentor in business. And he said, you just don't bet against America and it hasn't paid to bet against America.

And I get all the great arguments about how interest rates have come down and the debt's done this and the growth rates aren’t as high and all this other stuff.

But the American ingenuity, and just the system where if you come up with a great idea, you will find capital, you will find pools of capital and you can create these companies out of garages like the Steve Jobs, some of the ecosystems, like the clustering of Austin, of Silicon Valley of, you know, before it was like Rochester with Eastman Kodak and Xerox and Polaroid and just been countless companies and different waves and different industries.

But it's just not a good bet. So it's incredibly complex and you have these people that are PhDs from Chicago. It's always the same five schools, right, in Chicago, or Harvard, or Princeton. And it's the clubbiest of clubs and these are like 165 IQs. And they get paid ridiculous amounts of money and they can't predict the market, right? So if a PhD from Chicago that's been working at Goldman for 20 years can't predict the market, why would I think that I could predict the market?

And so my time going back to bandwidth is not, I can't add any value. I don't have any edge trying to think about the market. And so yes, I got caught flat footed. Yes, I underestimated the Fed. Yes, I made some allocation mistakes, but that's once every 10 years. And so the mistake that I made, just to take a step back is, I had my parents 100% in cash in ‘07. Right? And so we were early, the market crashed in ‘08 and ‘09. Right? And so I felt like a genius. The S&P goes from -- I don't know, I think 1,400 to 666 or 661, or whatever the lowest were. Right? Okay. Great. We sidestepped it.

But then I was too pessimistic and so then the market ripped in ‘09. It absolutely ripped. I was in B school at Babson at night and I did a great work on Chipotle Grill ( CMG ), and I built this model that was really good. And I'm like, the stock's incredible. I forget where the stock was and like, no, I can't buy it. I'm negative in the market. The macro is too challenging and all these different superficial things. Right?

Well, Chipotle is up, I don't know, 20x or something from there. And so, yeah. Okay, great, I sidestepped it. But then I missed the huge leg up and I missed the 3, 4, 5, 6, 10 baggers, right? So, I can't add any value doing that. Yeah. Look, the market ripped from 19, 2021. So coming into 2022 valuations were very high, there were definitely threats in the horizon and a lot of people made a lot of money short.

But again, I'm a value investor and so I'm not -- I'm buying businesses for 4 to 8 times the EV to EBITDA, what I think is normalized EV to EBITDA. So I'm not playing whiz-bang tech trading at 40 times sales and say, I think it's traded 45 times sales or 20 times sales. I should trade at 30. That's not the game that I play.

So I don't really care about the macro per se because I can't predict it. It doesn't really add any value. And I think what really hurts a lot of retail investors are, they think they can jump in and out of it and they can time it and they don't have an open mind to a great opportunity. I mean, you have 3,000 companies publicly-traded, maybe north of that. But in the Russell 3000 there's a -- I hate that I don't really like Cramer.

But there is a bull market somewhere and there are opportunities and so whether it's, if certain things are out of favor, maybe energy will do well, or commodities will do well, or ESG will do well, or -- and so I just -- I don't see any value in doing that. I don't see any value in trading futures, contracts and leverage and doing all this crazy stuff. Like you don't need to get that fancy and take that kind of risk in my view where if you do old school bottoms up fundamental analysis and you pay the right prices for businesses and you're reasonably good at it, you're probably going to outperform the market.

And so notwithstanding an Armageddon scenario or God forbid something like nuclear event or something. But at that point, it's not even going to matter because the world's not going to exist. So it doesn't really matter what your stock account is worth. So, I just, I don't see any value in it, notwithstanding once in, out of 10 years, where you have an event like the housing crisis in a way which I did see, I saw it two years ahead.

But then like I said, then I missed the huge leg up from ’09. And even in 2011, like the banks, BofA ( BAC ) and I remember -- I specifically remember calling my dad. We bought Wells Fargo ( WFC ) preferreds at, I don't know, 11, the par value was 25, and these were the Js of Wachovia. I think the Js. So 8% coupon. And then I remember at BofA, and they were $0.20 on the $1 and he's like, I don't know, you just had me in the equity and we lost 50% and I was, I know, but we're buying the preferreds at $0.20 and BofA makes it.

The sentiment was so fever pitch negative that the world was going to end. And sure enough, lo and behold, David Tapper steps in. He's the only buyer of BofA and Citi ( C ) preferreds. And he swooped in and made billions. And he said some days when he was buying this at the, the pinnacle of fair, it was like in Feb ’09. There was no -- he was the only one buying it. It's how many of these you want.

And when I was in -- on the investment grade bonds, I was -- I had a front-row seat to the financial crisis because I did the research, but we also did some trading and I remember talking to Goldman, talking to Lehman, talking to all these places and there was no bid for GE Capital paper, the finance. I'm talking about debt, I'm not talking about the equity. It's no bid.

And so anyway it’s -- I just don't see any value in the macro, once out of 10 years it makes sense. But there are all these great companies and I think you can get, if you just focus on businesses and paying the right prices and getting the right management teams, I think over the course of the career, you’re going to generate vastly superior returns to people that think they can predict again the unpredictable.

RS: To this point, you wrote this article about commodity super cycles and this prediction you made when commodity stocks were on fire in 2022. Is that something that you're going to continue to pay attention to?

CCI: All right. So, this is like the humbleness and I kind of like, I should be worth $25 million because I've had so many stocks that have gone up 10x, 20x, 30x, 40x. But I never quite get the timing right. So let me just take a quick step back.

So when I launched Second Wind Capital, my top three ideas were Kirkland’s ( KIRK ), the home furniture store and I really liked the CEO and they refinanced the debt. And we bought at 1.75, I was out at 12. It hit 34. And then we bought Signet ( SIG ) at 9 and it hit 113, but I was out too soon. That's partly because my investment committee and my parents that were up 100%, they want to sell.

But the third stock was a company, ( AMR ), Alpha Metallurgical coal. They changed their ticker. I think it was Contura back then. And then a natural gas company end up taking that ticker on the name change. But we were in this, speaking of commodities, we were in the stock – we got 4000 shares. I didn't have as much capital back then. And the thing went to four in our face or something.

And for whatever reason, I had to sell it. I had spoken with the IR guy. I was on the calls. I remember like the debt analyst, they had 600 million of debt to equity. It was 100 million. And lo and behold, there was this massive super cycle on met coal and they were the biggest metallurgical coal company, it was a post bank reorg.

So a lot of the debt had gone away and they were producing like 10 or 11 million metric tons of, I think that's actually probably short tons of met coal. And their cost structure wasn't bad, but the equity was so low because you were at the trough of the cycle. So prices were bad and kind of like breakeven, can they cover the debt? Well, met coal goes parabolic and this thing goes from 5 to 180.

And I missed the whole thing. I was in it. I had the thesis, spoke with the management, kind of forced to sell because I had to pick one horse. I picked Kirkland's. We did extremely well with Kirkland’s. But if you get the timing right, you can make ungodly amounts of money in commodities.

I did a lot of good work on the free-side on Antero ( AR ) and Range Resources ( RRC ). I was in touch with Range Resources and I think I wrote a piece about Antero, like a $1 and I was in huge at $2. And so when the stock goes from $2, I probably started buying at $4. And I bought some at $3 and I bought - loaded up at $2 and then it's alright, $0.70 in your face. And I got a call, why do we have so much in this thing. We're down, you've tripled down and now the stock is $0.75. I said they're going to make it, it'll be fine.

But you're so mentally exhausted at that point and when you're -- it's not your capital, when you have a drawdown like that. And then so I think at $5, we were out, well, lo and behold, the stock goes to $48. We were buying Range Resource bonds two year paper $0.70 and they were the low cost producer. The Marcellus balance sheet was fine. The bank debt got reaffirmed and the freaking sell side, was putting out sell notes in the equity 3. I'm talking to management saying, your bank debt just got reaffirmed, yeah, I'm like, okay. And you have the lowest cash cost structure in the industry. You own Great Rock.

They made a bad acquisition in the Haynesville that dinged credibility. But I was like, these bonds are money good, right? What am I missing? They're yeah, we're buying them too in our PA. But so, okay. And so Range absolutely ripped. But I didn't fully take advantage of it.

And again, AMR thing goes from 5 to 180 that's a 36 bagger. You don't have to have a lot of money in a 36 bagger. But you got to let those winners run. So you can make a ton of money in commodities, but you have to get the cycle, right. And so, if you buy these things to trough earnings, they look very, very expensive. They have no earnings. But if they're a low cost producer and they own good assets and they can survive the cycle. The returns are incredible.

But what I kind of noticed then was just a sentiment observation. I was seeing people that were writing on technology stocks that were covering commodities. I'm like, okay, this person is a tech writer and now they've given up tech and they're writing in commodities and everyone was bullish.

There's a company ( UAN ) which I wrote up at 27. It's a fertilizer company. They make ammonia, which is used in fertilizer and natural gas is such a big piece of that. And ag was doing really well and so to enhance the corn crop, they would do this and the market just got really tight and it was like a complete supercycle. But I think I was out at 80, there was a -- the guy publicist that did a, he did a great piece and he's a smart guy.

I mean, don't get me wrong, but it was like a cult following. There’s 20,000 comments on this article. And everyone says 300, all right, we bought it at 27 and it's a commodity business and it's not even -- the assets aren't even that good. There's tons of competition. You got overseas competition and you got lucky because of the Ukraine war that spiked natural gas prices.

So 30% of natural gas goes into the input to make this stuff. So you had all this. And then there was a drought in Brazil and commodity prices were good. Literally this perfect storm. But it's, all right, wait a second. I was in at 27. I was out at 80, and people are betting their life savings on it at 180, this doesn't make any sense. It was as much a valuation, but really it was just a sentiment and just kind of the art of -- the time was a little bit lucky that everyone was in the boat. So if everyone's already in the stock, there's no one left to buy it.

And then lo and behold, the cycle changes and these things get cut into half, or they go down 80%. And so, what I see a lot of which is kind of dangerous that we've talked about the macro, which I think is really dangerous because you miss the upside and it's just tough to do that. But it's really dangerous to have all your money in commodities. I've come across way too many people that are just in energy or just in commodities and, okay fine if you don't have a 20% or 25% allocation, really you know the space exceptionally well, maybe you want to have, I don't know, 35, 40. But you can't be 100% in commodities. It's just not, how do you do it?

And I think people just get so swept on the euphoria, the recency bias that they don't get that these are fragmented businesses that don't have any meaningful market share and you're subject to the supply and demand. And if either the demand comes on or the- sorry demand abates or gets anaemic because the macro or various factors, the supply comes on, well, guess what? You're buying these things at peak earnings.

I mean look at - totally switching gears and J Mintz is a really sharp guy. He's done very well. I'm a fan. But it's like he was really early in ZIM ( ZIM ). So, he bought it at the IPO, the stock rips. It pays all these dividends. But a lot of people, if you didn't get out, then the stock , even if you include all the dividends, the stock is still going to crush.

And it's, okay, great. If you got it early, you did great. But you're really late. Cinderella is going to turn into a pumpkin. Whereas if you're buying different types of businesses that have a moat, they have different industries, there's definitely cyclicality, structural situations, but commodities are so boom and bust. And if you don't know the patsy at the table, you can get run over. And I think that can be a big blind spot with a lot of people, unfortunately.

I mean, look at Cathie Wood , who's had all this success and she made an incredible call on Tesla ( TSLA ). It was just an incredible call and she held it and then whenever it went up 20x or whenever it went up, and she attracted all this capital. But then she had no place to put it and was making really bad investments, trading 20x, 30x times sales and on a -- I think she had 30 billion at the pinnacle.

So if you were in early, you did great. But most of the money that got invested, people net-net lost a lot of money because they chased crazes, they chased trends and I don't blame her. That's her tune. She has to sing it. People paid a lot of money to go to the concert, you know, like a Taylor Swift concert and you have to sing that music. You can't say, oh, I'm Cathie Wood and I'm going to start talking about REITs. That’s not why you signed up for her. You want whiz bang tech, you want the flying spaceships or whatever the heck she's invested in.

RS: We want our favorites, I like that analogy. Courage & Conviction Investing, I really enjoyed this conversation. I think there's truly a lot of unique food for thought here. And I think also just a lot of compelling advice for investors. I really appreciate you coming on. Anything that you want to share with listeners before we go.

CCI: Yeah. No, I appreciate it. Do you want me to share my best top idea?

RS: For sure.

CCI: Yeah, so Advanced Emissions Solutions ( ADES ). Okay. So, I've been on this trail for a long time. And in this business, you have to know when you're wrong. And I don't think I'm wrong and I wrote a recent piece that we’ve tripled down. But I've done a lot more work on this company and I'm going to -- behind the scenes I've talked to expert, through a Wall Street friend, he hired an expert.

We had a conversation for an hour. There's a lot of great stuff going on here. So just high level. This company is in the environmental space. So they make powder activated carbon, which is used to take out the toxins in coal-fired plants and coal-fired plants are kind of going away. They do have some industrial and soil side, but they're in the middle of upgrading their plant. So they have this $400 million plant that they bought from private equity because private equity in ‘09 made an incorrect calculation that coal-fired generation would stay at 50%, and now it's 20%.

So they bought this asset that cost $400 million for $80 million through Apollo, it was a private equity firm. And the capacity utilization was really low and they had all these bad legacy contracts and yada, yada, yada. And they had this great tax credit business with Goldman Sachs and that sunset and that made a lot of cash flow. So the company had a lot of cash. And they announced a strategic review and I thought that they were going to sell it because you had one asset, you had all this cash, you are $5 in cash and you had this good asset. And so I thought, and I invested in it and I wrote on, and I thought this thing is going to get taken out at eight.

And after 15 months, lo and behold, they did a merger with this company Arq, which is really interesting. Founded by Julian McIntyre. He is a serial entrepreneur that’s made extraordinary success. We have a couple of Goldman Sachs partners. But the market hated it because everyone was in this for a deal and the stock crashed, right, it crashed from $6 to, I don't know, it got as low as like a $1.20 recently.

Because they have all this cash and because they bought Arq, they have a 30-year supply of bituminous coal, which is the big feedstock you need to make this next generation product which is granular activated carbon. And they're in the process of upgrading their plant to get to 60 million pounds of granular activated carbon. So the name plate is 150, but you lose some of that to go to GAC and long and the short of it is they have most of the money on the balance sheet to do it. The average selling price is much higher, but I'm going to be working on a piece.

But just as a little preview, there's this big EPA policy changes in flight that were published in March of 2023. Okay. And no one's connected these dots and I've read the policy paper and so this is called, PFAS which is the forever chemicals. And 3M ( MMM ) just paid $10 billion to settle this. The EPA is going from 70 parts per trillion to 4 parts per trillion. I don't want to give away the whole plot here, but this policy is in motion, this bipartisan support is going to happen. And so, they're going to have 60 million pounds of granular activated carbon, which in the EPA report is the optimal way to treat these PFAS chemicals. Okay. So you have a huge catalyst. A new CEO that got announced this week that just bought $2 million worth of the stock. And he took a $50,000 salary. This guy is extraordinarily wealthy.

So for him to, just take on day one puts up - and above the market puts up a 1.8 million, and he want to get paid in equity at $3. So I would argue this guy's in this for 10 and whether or not they can execute and do it, who knows? And there's always risk. But no one sees, no one's even -- has even connected the dot on the EPA PFAS, where they're going with GAC and the equity 70 million. So it's by far my biggest position and I think it's wildly undervalued. That said they do - there’s certainly risk, you do have to successfully upgrade the Red River plant to be able to process on the front-end side to make the granular activated carbon.

But the market has not worked out this PFAS angle and if you just kind of do the math, and as a quick aside, so Calgon is the biggest player in the United States and they're owned by Japanese chemical company, Kuraray. It's a $3 billion company in Japan. And there’s a privately held company.

So ADES is the only way, or one of the only ways to play this massive catalyst of EPA policy change, the papers -- it's already in the public domain and it's in the public comment section process and you have a 70 million market cap that has most of the cash that they need to get this thing to production. And they brought him, a CEO, as an operator who just put up $2 million and he's getting paid $50,000 in salary and taking his compensation at $3 strike price.

So this is ridiculously asymmetrical. That's by far my biggest position and if they can pull it off, I think the stock goes materially higher. So I haven't even written on this, I'm still working on it with a couple of people. So I haven't been able to do all the calculations. But if people took the time to listen to it and you took the time to reach out, I'm sharing something that I did that’s kind of a rabbit in the hat.

RS: We like it. We like it. Advanced Emissions Solutions, ADES, you wrote about them in late June. So I guess that's kind of a prelude or an addendum depending on how you're looking at it to this conversation.

CCI: Yes.

RS: Yeah. Appreciate you sharing that with us. I have no doubt that listeners will appreciate a rabbit in a hat. The ones that do will. Courage & Conviction , really enjoyed talking to you, really enjoyed listening to you, really enjoyed this conversation. I hope it's the first. I hope you come back soon and we're going to be reading your stuff in the meantime. I certainly will be.

CCI: Great. Thanks so much Rena. I appreciate it. Thanks for thinking of me. Be well, talk to you soon.

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Small Cap Alpha, Commodity Danger And Advanced Emissions Solutions With Courage & Conviction Investing