Investing Unscripted Podcast 114: Getting It Wrong (and Still Making Money)

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Jason Hall: Hey, everybody. Welcome back to Investing Unscripted, where we ask and answer the hard questions about investing. I'm Jason Hall. He's Jeff Santoro. He is my good friend. He is the voice of the people. Hey, Jeff. Hey, how are you? I'm good. We're recording. This is a little bit different time than we usually do.

We usually record it in the afternoons, kind of [00:01:00] early midweek. We're recording this on a Friday happens to be August 2nd. And boy, oh boy, his August started off pretty tough for investors. 

Jeff Santoro: Yeah, as, as we're recording this, so I, it's about what time is it? It's about 10:20 in the morning. Yeah. 20 after 10, markets open and it is an absolute bloodbath, at least right now.

So when this episode drops in a four or five days, it'll be, it'll be fun to see what has happened since, but... 

Jason Hall: Yeah. 

Jeff Santoro: But after yesterday and today, yeah, August is off to a rough start. 

Jason Hall: And well, I think we'll talk a little, it's not, you know, it's, it's a little bit kind of ironic that the show that we're going to do today, a hat tip to our good friend, uh, Tyler Crowe at Misfit Alpha we'll put the link to his Misfit Alpha in the, uh, in the show notes.

But we have a, uh, a text kind of chat group with a few of us and he suggested this idea of when, when you own stocks and they go up, but not for the reason [00:02:00] that you was your thesis or that you expected. 

Jeff Santoro: Yeah. And I, I loved this idea immediately because these are the things that I talk about when I go through my portfolio.

And I think, Just generally about having less stocks, which I do. I don't know like every day. I I'm drawn to the bottom, right? I I tend to look first at the ones that have been losers for me But there are some times I look at the top at my winners and say to myself like even though this has been a winning Stock for me.

It's not for the reasons. I bought it Right. And I, and I asked myself that question of like, so if they were the other way, would I still own it? So I think it's a fun thought exercise and I'm looking forward to kind of talking through it. 

Jason Hall: Me too. So we're titling this episode, getting it wrong and still making money.

And I think that that that's like if I were to write a autobiography at some point, that, that might be the title. 

Jeff Santoro: Yeah, that's a. That would be a good autobiography title, especially for you. 

Jason Hall: Yeah.  

Jeff Santoro: You get it wrong a lot.  

Jason Hall: A lot. 

Jeff Santoro: [00:03:00] But here you are. 

Jason Hall: Here I am. 

Jeff Santoro: You've made it.

Jason Hall: Again, on my own.

Jeff Santoro: You've made it this far. 

Jason Hall: Going down the only road I've ever known. 

Jeff Santoro: I think, I think a good place to start, and this is one of those things that I understand now but didn't understand when I started. Let's talk about all the, the different reasons why stocks go up, because it's not always, there's not ever one reason, and it's not always for the reason you might expect.

So let's, let's start there. I think that's a good place to kick off the conversation. 

Jason Hall: I want to start with, like, the most objectively pure. Reason why stocks go up over the longest term and why they should go up. And this should be kind of the basic thesis for most of the investments. Most stock pickers are making make, and even if you're just an index investor, it should be the same thing.

And that's when you buy a stock, when you invest in a stock based index fund. You're [00:04:00] buying a little fractional ownership of a real business. And the goal of that business is to sell whatever it sells to earn money, to make profits, to generate cashflow. And over time you grow that the business is going to become more valuable because it's more profitable.

And if you look at stock market returns over the long term, it correlates directly with earnings growth, right? That's the purest driver. So if you think about, you know, owning a company is owning a percentage of those cash flows or profits as those go up. You know, the valuation stays the same or even normalizes lower, the value of the company is going to go up.

Right? That's the purest thing. It's you invest in a business, the business becomes more valuable, your ownership goes up. 

Jeff Santoro: Yeah. And what I think can, so what's hard about that when you're a newer investor is you don't always have that longterm perspective or [00:05:00] knowledge and you're looking at things in the short term.

So, and that can be day to day. hour to hour, minute to minute, or even quarter to quarter, or year to year, right? I mean, five years is a relatively short term. Yeah, right. If we're being honest. And so the flip side of that coin that you just described is that in the short term you can, you can have a stock that you bought for that very pure reason, right?

I, I believe in this company. I want to own a little piece of it. I expect profits and cash flows to improve over time and then the company will be more valuable and I'll own part of a more valuable company. But in the short term, sometimes none of those things are actually happening. And the stock is going up anyway, right?

So like there is that's the other way that stocks go up. 

Jason Hall: And, and, and the best way to think about that is, is multiple expansion. Right. 

Jeff Santoro: Right. So when you hear the term multiple expansion, that's basically what we're talking about. 

Jason Hall: And, and a lot of times, like we hear that and we kind of think of it as maybe kind of a bad [00:06:00] thing, right?

Because it's like, well, the business hasn't really quote unquote earned. The higher stock price, uh, investors are just agreeing to pay a higher multiple for it. 

Jeff Santoro: let's define multiple. So like that's a generic term for like all the typical valuation metrics you hear price to sales, price to earnings, price to cashflow, things like that.

Jason Hall: Right, exactly. So, so, and I don't want to get too deep in this, but basically the way that works is If a, if a stock trades for 20 times earnings, your investment today, if the company's earnings stayed exactly the same and they were giving a hundred percent of those earnings every year back to investors, which they don't, but this is just kind of the proxy to think about it, it would take 20 years.

For you to fully recoup your, your investment in earnings, giving back to you. Right. So that's kind of how you think about these price to earnings. And it's not literally in years, but it just works out that way. 

Jeff Santoro: Yeah. Um, another way I think of it, another way I like to think of it is I, I think as consumers, it's [00:07:00] very easy.

To think about getting something for a discount. So if I go to the store and there's a shirt for listed for 20 and it's on sale and I buy it for 18, I bought it at a discount. I like to think of multiple expansion and like the way the stock market works is sort of like the opposite of that. Almost like you go into a store, the tick, the sticker price for the shirt is 20 but you want it so badly or you're, you believe it's going to go up in value because it's like this cool shirt.

You're going to pay 25 for it. 

Jason Hall: Right. 

Jeff Santoro: And that's, that's kind of, cause you. We're always talking about positive numbers in these multiples, right? 20 times sales, 30 times sales, 10 times sales. That means you're paying 20, 30, 10 times the current value, or at least with the, so, because you're, you're assuming it's going to go up later.

Jason Hall: Yeah, no, that's exactly right. So, so the idea is, again, the lower the multiple that you can pay, On these valuations, the bigger bang for your buck you're getting, right? So multiple 

Jeff Santoro: expansion is when that number is growing. [00:08:00] 10 times sales is becoming 20 times sales is becoming 30 times sales. Right. But 

Jason Hall: maybe So think about this.

And I don't want to use sales. I'm tired of Earnings. Okay, fine. Let's say, let's say earnings. So let's say a company trades for 20 times earnings when you buy it. And a year from now, Their earnings haven't changed. They earn the same amount of money and the stock is now trading for 22 times earnings. The stock price just moved up by 10 percent assuming everything is the same, right?

This, the, the, the stock has moved up 10 percent in value because you know, 20 to 22 is a 10 percent increase. That's multiple expansion, right? The stock price moved up, but the business didn't do anything. To create additional per share value, right? So that's, that's, that's what we mean by multiple expansion.

Now, I want to say this, like I said, a lot of times we kind of think about that multiple expansion is maybe kind of a negative connotation. But I don't think that's always necessarily the case. A lot of times, like Amazon is a good example, the stocks down like 17 or [00:09:00] 18 percent the past few days.

They just reported earnings markets doesn't love their guidance and stocks down like 11 percent today. August 2nd, but it's up 92 percent over the past year. And now a lot of that is. Earnings growth, right? They've done a lot of efficiency stuff. We talked about it before, right? So they've, they've, they've, they fixed some stuff in their business and they've gotten leaner and they're growing more profitable parts of their earnings have grown a lot, but we're also still seeing some multiple expansion on top of that.

Right? So both things are happening at the same time where earnings are going up, but the multiple investors are paying is still higher than just that earnings growth. Right? So, but my point is Jeff. When, when we were talking about Amazon at the beginning of 2023 part of your thesis was some multiple expansion, just the market had discounted the business so much at that point, the market was discounting the management's ability to kind of write [00:10:00] the ship and start generating profits in some areas that had gotten ugly.

So. The multiple expansion that you've seen actually was part of your thesis, that it was, the market was going to more appropriately value the business. 

Jeff Santoro: Right. It was almost like I expected the multiple expansion to bring it to a valuation that was reflective of what I thought the business could do. And I think that's the piece of it.

More reflective 

Jason Hall: of how the market has historically valued the business. Yeah. Because it wasn't. 

Jeff Santoro: Yeah, but I guess the way I was thinking of it too is like, stocks go up on the multiple expansion side of things, I think for kind of two reasons. One could just be exuberance and momentum, right? Because and, and, and we'll talk about short selling in a second, which can be like a version of this.

But like, if, if I'm excited about Amazon, I go buy it, that's going to drive the price up. And then you're excited because you see the price going up, and then you buy it. And then the next, you know, and then it kind of builds upon itself. So like, that's part of it. But part of it too, is people who are. are more sophisticated investors are doing all sorts of calculations and thinking and projections about like where they think the [00:11:00] company will go.

So like that will drive the value up as well. So sometimes when you see a very high flying high growth, at least on the top line company that people are excited about, some of it's just emotion, but some of it is like legit. I could see this company 10 X ing it's. It's revenue over the next five years because I have so, so much belief in this product and that'll drive the, 

Jason Hall: I can use two stocks that both have gone up a lot for multiple expansion reasons over the past year and a half for kind of both of those two reasons that you were just talking about.

So we talked about Amazon, but you could say the same thing about Metta, right? Metta was deeply discounted value play, where it was just trading for a really, really cheap earnings multiple cashflow multiple, you know, whatever you want to use because the ad market was weak and they were still plowing money into a reality labs here we are a year and a half later, they're still plowing money into reality labs, but they did get a [00:12:00] lot leaner in their operations.

And the ad market has bounced back and their growth rates have bounced back. Right. So that was a great value play. And then we could say the same thing about Nvidia, where this was never a value play, but two things happened. Number one, business boomed, right? All the AI stuff has boomed. And the market increased the value of the stock without multiple expansion, just because, well, your earnings go up that much, your business should be worth that much more.

But then we have seen multiple expansion on top of that. Cause everyone's excited about AI, right? Because of the momentum. Exactly. Right. Um, so, so it's never just one or the other. It's rarely just one or the other. Right. But over the longterm, over the very longterm, you think 10, years, earnings growth. And, and market values tend to go up kind of hand in hand.

So, so that's how multiple expansion can play a role. Um, and like I said, sometimes it can be part of the thesis, right? It's not always [00:13:00] just a bad thing. , 

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so let's talk about short, short squeezes because you do hear this in the news. Sometimes when a stock [00:15:00] really goes up in a short amount of time and people are kind of confused about why, like sometimes this happens, not even around earnings.

But if there's like a one piece of news that might trigger some excitement, you'll see this. So why don't we talk about what short squeezes are? 

Jason Hall (2): Yeah. So first thing I want to say is that I think, I think short selling is an important, um, and necessary part of a healthy stock market. You know, Andrew left, I'm sure most people have heard about Andrew left, uh, the guy behind Citron research, I believe.

Is he Citrin? I think he's Citron research noted short seller had a couple of, of a big short wins about a decade ago. He's actually the SC, I think it's the DOJ are charging him for market manipulation, like he's He's in trouble. Because a lot of the actions that he was taking allegedly yeah, he's, uh, 

Jeff Santoro: I, I Googled him to make sure that it was Citron research and it is, and he actually surrendered himself to authorities four days ago.

So, 

Jason Hall: yeah. Yeah. So it's, it's, um, yeah, he's been charged with some pretty, pretty big stuff, but the, the short version is a lot of times associate short sellers [00:16:00] with the Citrons and the Hindenburgs and you know, these bombastic, scary. they put out that are 95 percent things to scare retail investors out of the stock to send the stock price down.

And then they make a quick, a quick profit, right? Because they short it before they release their research. And then they close out their position and they make a profit. So a lot of times that's what, when people think of short sellers, that's what they think about and kind of the nefarious negative, but the vast majority of short action that happens.

Isn't people that are out there with a platform, it's just they, they, they look at the business and they say, well, this valuation is stretched. I think the, I think the valuation is going to come down. So it's multiple. They think multiple contraction is going to happen or they, they've identified some flaws with the business, right.

That they think are going to cause an issue. 

Jeff Santoro: Yeah. But so they were never. Yeah. Yeah. I've never shorted, but I've listened to podcasts and things where like short sellers are interviewed and stuff. And [00:17:00] yeah, it does seem like it's those two things. It's someone believes this is a fantastic business, but the valuation makes no sense and they'll short it.

Or they think, I think this is a fraud and they'll short 

Jason Hall: it or some combination 

Jeff Santoro: of the two. 

Jason Hall: And the way you short stock is you borrow shares. From someone and just like borrowing anything, you pay interest to borrow it and then you sell them short. So I could borrow a stock. Let's let's say it trades for 100.

So I borrowed the stock and I pay the interest rate, whatever it is to borrow that stock. But then I sell it for 100. I sell those 100 shares that I barred for 100. So now I have. Was that 10, 000 at some point? I'm going to have to give those stocks back to the person that owns them. Which means that I'm going to have to buy them back.

So the way that a short seller profits is I sell that stock short at a hundred and then it drops in value, right? So drops to maybe my target is 75 and it drops to 75 and I buy it [00:18:00] back. There's a hundred shares for 75. So I just paid 7, 500 to buy their shares back. So I've made a 2, 500 profit, less profit.

interest that I pay, right? So that's how shorts make, make their money. So the here's, here's the mechanics of a short squeeze, short squeeze is when a stock that is heavily shorted. And I would say a stock that's heavily shorted could be like 5 percent of the float, right? 5%. 

Jeff Santoro: And just real quick, you can see, if you go to any Website that has stock data like Yahoo finance.

It'll tell you what percentage of the shares are sold short. And sometimes it's even, sometimes you'll even see more than a hundred percent of the, of the shares are, are sold short. 

Jason Hall: and that's a like a mechanical glitch and the way a lot of these systems report the data, you can't actually short more than the float.

No, I know 

Jeff Santoro: that. But what I'm saying is that's an indication that it is heavily. Exactly. Right. 

Jason Hall: Right. So, but I, but again, it could take, you know, 5 percent or [00:19:00] less to cause a short squeeze. And here's the mechanics of a short squeeze. You have a fairly large amount of, of, of shorts and a lot of this is going to kind of come down to volume of, of stock.

Uh, trade shares that trade for a company. So you might have a small percentage of shares that are sold short, but if it's a stock that has a low volume it doesn't take much for that squeeze to happen. Um, you can have a larger percentage of the stock that turns over a lot of shares and it might be less likely for the stock to move as much with a squeeze.

Jeff Santoro: But can I, I want to ask a clarifying question. Yeah, I think this is where you're about to go next, but I think it'll. It'll help people frame it. So when you buy a stock long, right, because you think it'll go up, the most you can lose is a hundred percent. But am I correct in assuming that when you sell, when you sell a stock short, you can lose more than a hundred percent?

Jason Hall: Oh, many multiples of that. 

Jeff Santoro: So this is this first step of the squeeze. 

Jason Hall: Right, exactly. And that's, and this is what causes [00:20:00] squeeze to happen. It's like somebody screaming fire in a crowded, Auditorium. The panic happens and people try to rush for the exits. So Right, because if the, 

Jeff Santoro: because if the stock shoots up, you're watching Yeah.

Your loss go from here, 80 to a hundred to to a hundred. You're watching your loss go up. So here's the, 

Jason Hall: here's the mechanics, right? Here's the mechanics of how it works. And, and the other thing too, you can actually use options to do shorts, like kind of a synthetic short. So like, if you. You can buy puts, for example so you're, you're, you're long at a price that could be exceptionally higher now, but if you're buying a put your long, the puts, but what you've done is paid somebody to give them, you've paid somebody else for them to give you the right to sell them a stock at a set price, right?

So it's a way to be, to short a stock because you think the stock price is going to fall. Again, it could be the same thing. You could buy that put at a hundred dollars and you think the stock's going to fall to 75. Five. You could force, you know, you could, you could put those stocks to some of that stock to somebody else, right.

At that price. [00:21:00] So it's another way to be short. But kind of back to the point about the short squeeze, um, because this is the whole, like, you know, somebody screaming fire in a crowded room thing is that what happens is that when you have a lot of people shorting a stock, typically they're shorting it for kind of the same reason.

And they're looking for, I don't want to necessarily say a binary outcome, but they're looking for events to happen. That are going to drive the stock price down so that they can profit. And typically those things are going to be around earning season, because usually they're shorting a stock because they think that whatever the thesis is, is flawed and that there's things that are going to undermine it.

The business results aren't going to be good, whatever it may be. Right. And there might be in, there's some of it where like, where they think there's a fraud there. But the key is that whatever the event is that happens. Is the inverse of what the short thesis is. Maybe the ideas of companies revenues are going to start declining, and then they report a blowout quarter revenues, good generating [00:22:00] profits, and then they give really good guidance too.

So that's the catalyst that's, that starts the dominoes falling, where you have some shorts that try to get out quickly. So the way that you close a short position is you buy back the stock, right? So you buy back the stock to, Close the position and more shorts do the same thing. So they're putting in these buy orders to buy the stock and there have to bid up and keep bidding up to get their price.

And you can see a stock price go up 10, 15, 30, 40 percent in a single day. Sometimes when these events happen and it's not people that have a long thesis that are rushing into the stock. It's shorts that are doing everything they can to get out as quickly as they can to limit their losses, because again, you bought that stock at a hundred.

Or 10, whatever. And next thing you know, it's 12. Well, guess what? You, you, you've, you've already lost 20%, right? And [00:23:00] what I've noticed 

Jeff Santoro: is you, you tend to see it a lot when like the results are good, but not great. Like you're like, Oh, that was a good quarter. Nothing crazy. And then all of a sudden the stock's up 20%.

Jason Hall: Right, exactly. 

Jeff Santoro: We've talked a lot about all the reasons that stocks might go up. Um, I think the last one that we had on our little outline here that I don't think requires much conversation, but it, and it is just now we're in a world where the Yolo Redditors can drive a stock price up just because they decide they want to.

Um, fortunately, that's a handful of stocks. It seems like they're interested in. So 

Jason Hall: yeah, the 

Jeff Santoro: chances of you being involved in one of them are statistically low, so we don't have to spend a ton of time on it, but let's get back to the original sort of thought about this episode, which is around So we've established all the different reasons stocks can go up, but I think we've nicely distinguished between the short term non business fundamental, fundamental reasons, as opposed to the long term.

Long term and sometimes short term business [00:24:00] fundamental reasons. But what about the idea that sometimes stocks will go up for reasons other than what your thesis was? And let's stick to the fundamental piece, right? So let's put all of the crazy market, you know, shenanigans on the side for a second.

And just think about you own this company. It's really doing well stock price wise, but you're looking at the results going like, Okay. I don't, this is not why I thought it would go up. 

Jason Hall: Yeah. So, I mean, the classic example is like an Amazon that we can reference back to again, and anybody that bought the stock anytime in the, you know, through really through 2010, 2012, 2013, uh, your thesis is still based on e commerce and yes, e commerce has done well.

It has, and it's grown. But if you look at Amazon's business today, the first obvious example of a massive thing that you couldn't have been planning on a decade or more ago is [00:25:00] AWS, right? It's still, I don't know, what is a quarter of revenue now? No, it's still less than that. But it's a substantial sizable portion of operating income and cash flows.

It's the profit driver of the business. You, could you have possibly imagined them being a movie studio or a TV studio? Right? One of the things in their press release yesterday was, I don't know how many, like 25 Emmy nominations or something like that, and Fallout, one show, 16 Emmy nominations. So the, the ecosystem that they've built, um, how much broader it is than could have been part of the thesis is incredible.

So that's, that's the first easy example that comes to mind. 

Jeff Santoro: Yeah, I just put numbers on it. AWS revenue is about 18 percent of total revenue. Um, but it is, I'm not gonna do the math in my head, but on an operating income basis, it's a, let's see, 9. 3 billion versus North America, which is basically e commerce in North [00:26:00] America is, is only 5 billion, right?

So almost double the operating income coming from AWS, despite being 18 percent of revenue. 

Jason Hall: And if you look at, if you look at their guidance for the third quarter, it might actually be more than a hundred percent of everything else operating income, right? It's, it's, um, it's become a remarkable portion, portion of that business.

Is there a, is there a, you have a, you have an example? 

Jeff Santoro: Yeah, but I just want to add on to like, I think there's even a potential second act to the Amazon story that you're talking about, because for the last couple quarters, the fastest growing segment in terms of revenue has been AWS, but the second fastest growing has been advertising 

Jason Hall: advertising.

Yeah, 

Jeff Santoro: right. So an advertising is still only, let's see. 9 percent of total revenue, I think. So it's still, you know, it's growing, but it's only 9%. But still, it's the fastest growing piece. So let's say a decade from now that grows to be 18, 20 percent of revenue. You know, [00:27:00] again, that's not something that necessarily that you that you saw coming.

Um, I don't know that I have a specific example where something in my portfolio where something went up for a reason that I, other than why I bought it. Although I guess if I was going to say pick two, I think I would talk about, well, I want to talk about cyclical stocks in a second because I think they can, they can go up for reasons you're not expecting, but I think it's a little bit different.

We'll come back to that. But the two that popped into my head Arista Networks and Broadcom, and I've talked about them a bunch of times in tandem because I feel like they have just rode the AI. Tailwinds. But I think you could almost broaden it out for anyone who's invested in the, in the semiconductor or related semiconductor space in the past 18 months.

You probably did not have AI on your, on your thesis bingo card. And if you did, it, it was maybe just. Oh, and they also play around in AI, not like, oh, AI might be the primary [00:28:00] business driver for the next several years. 

Jason Hall: Right. 

Jeff Santoro: And yeah, so I think like, if you're looking at it from the standpoint of like, why did I buy this stock and why is it up?

That could be a huge disconnect because there was, there's some big transformational thing that happened is morphing, if not changing the thesis. Here's another one that just popped into my head and it's similar to the Amazon example, but how about Microsoft? 

Jason Hall: Absolutely. 

Jeff Santoro: Right. If you bought Microsoft in the eighties.

Or early nineties, you bought it because if you 

Jason Hall: bought it in 2010, 

Jeff Santoro: I was fine. Yes, same thing. But you bought it for windows, right? Like you bought it for windows and for, you know, Microsoft office in Excel. And now I think the biggest part of the thesis is forgetting AI for a second is the cloud business, right?

That's. They're they're second or third for cloud infrastructure. I mean, I would go 

Jason Hall: even even further with Amazon than that or with Microsoft than that, because they've become so deeply embedded in the enterprise broadly, 

That they, [00:29:00] yeah, 

Jeff Santoro: but that's still driven by, but that's driven by the original stuff, isn't it?

Like, 

Jason Hall: I mean, yes and no. I mean, I think large. Yes, yes, but There have been kind of cracks in the armor there with, you know, like some of Google's tools and other things that have been developed serve a lot of those same purposes. But the fact that it's kind of this integrated, you know, for fully, you know, vertically integrated Offering across everything that they do is so, so powerful.

And you know, you're, you're a Mac fan. You can do everything that Microsoft offers on a Mac too. And it feel, it can feel just as integrated. That was not, not the case a decade ago. And it's becoming more of that, but I agree with you. I think the cloud has. It's been a big part of that. It really, it really, really has.

Here's here's one. Go ahead. we've already mentioned it here, but I mean, I think Nvidia is about as classic an example as you, as you can get, and we don't even have to talk about the AI stuff that's happening [00:30:00] now, but think about how big it is. Important Bitcoin was in the prior decade to Nvidia's sales for mining.

Uh, that was 

Jeff Santoro: the last sort of boom and bust that they went through prior to the AI stuff. 

Jason Hall: And, and they generated a massive amount of cashflow from that, that funded further investments that have led to the, the, the, the investments in CUDA and, um, their GPU hardware for, uh, for AI. So I think that's another really good example.

Jeff Santoro: All right. So let's, let's talk about. When a stock goes up and it's, it's entirely because of. multiple expansion. And I want to first talk about cyclical industries. And then I want to, and then I want to talk about 2021 because it feels like in 2021, almost everything was because of multiple expansion.

And I made a lot of stupid mistakes because that happened to coincide with when I was still a [00:31:00] relatively new stock investor. But I want to know what you think about cyclical industries, because Texas instruments is a stock that. jumps out to me for this. All of the results for the past several quarters have been bad in terms of things trending in the wrong direction.

Revenue growth is slowing, profitability is getting, is worsening, cash flow is decreasing. Like pretty much any metric you'd measure If you chart it over the past, whatever year to six quarters, it's heading in the wrong direction. Yet at the same time, the stock continues to go up. I believe it recently in the last couple of weeks, it hit an all time high.

And so that would be an, that would be an example in my mind, where if you weren't looking at the business and just looking at the stock price, you'd say to yourself, Oh, they must be crushing it. And then you go and look at the business and you're like, what? I don't get it. Now, my best assumption as to why this is happening is because everyone who [00:32:00] Knows this industry knows it is cyclical and that we are in the down cycle, but people think maybe we're at the bottom just past the bottom and it's trending back up.

So I think the multiple expansion you're seeing despite the results is because of exactly what we're talking about earlier. People are seeing the future right there. They're projecting that this too shall pass. They'll be back to their dominant position. The numbers will improve and the stocks being priced as such. What do you think about that aspect of it when it comes to cyclical industries and multiple expansion? 

Jason Hall: Yeah, no, I agree. I think Texas instruments is a perfect, perfect example. So just for the uninitiated Texas instruments their primary business is making analog semiconductors which are important broadly for I mean the entire tech, tech industry.

'cause if you have, you know, a a, a chip and a smartphone or a computer, you need analog semiconductors to get power in and to connect digital devices and information to the real world. That's kind of how they describe the business. [00:33:00] So that part's actually that, that part of the semiconductor industry, like most parts of the semiconductor industry that are not AI, have been in a cycl cyclical downturn.

Uh, demand is industrial, demand is down the auto industries. Kind of down right now too. Um, so demand from there is weak and those are major, major markets for Texas instruments. So going back to July 1st of 2022, so close to two years ago operating cash flows down like 28%. Stock stock's up 22%, right? 

So that is clearly a case of, of massive multiple expansion on the cash flows basis, right? Because people are paying 22 percent more for 29, almost 29 percent less cash flows. And this, 

Jeff Santoro: and this brings up an interesting point, because you know, you, you said earlier, that people sometimes when they hear multiple expansion, they think it's a bad thing, right?

They think like, Oh, this stock must be, you know, getting bubbly or it's, it's, it's, it's detached [00:34:00] from its fundamentals. And I think that's the case. And again, we'll talk about that when we get to our next topic, which is 2020 2021. But in the case of a company like Texas Instruments or something in the cyclical industry, I don't think it's necessarily a bad thing.

It's an, it's a realization or a, or the market sort of understanding. Like if you don't 

Jason Hall: follow, if you don't follow the company. And understand the industry that they're in and where they are in the cycle. And like the long term tailwinds or headwinds, depending on the industry that it's facing, then it's easy to just say, yeah, the market's become detached from reality.

This is dumb. It doesn't make any sense. But Texas Instruments, like they, they're spending billions of dollars in capex to expand their capacity and also doing some things that are going to drive. production costs down and, and, and add margin, like a lot of margin to what they're, to their, to their bottom line.

Jeff Santoro: So, but the danger though, the danger is now they've set a certain level of expectation for when the market, when the cycle swings back up. [00:35:00] 

Jason Hall: Right. 

Jeff Santoro: Right. This is what I think about in terms of like, do I want to add to my Texas instrument position? And I haven't because it's priced like it's at the top of the cycle, even though it's at the bottom.

Jason Hall: That's why I was pounding the table about. Texas instruments two years ago and, you know, kind of late summer, early fall of last year, call it nine or 10 months ago when the stock price was down, right? When the market was. not betting on the future as much. 

Jeff Santoro: Right. And now it's me. And it's dangerous now, because like, this is the way I'm thinking of it.

You can tell me if you disagree. Now they have all this expectation built in and the numbers have not started to even tick back in the right direction yet. Right. So now it's like, okay, so let's say. When they report this next quarter, it starts to, but let's say we get to like the top of the cycle in another, whatever, 12 to 18 months, and they're not quite living up to expectations.[00:36:00] 

That's a recipe for stock price disaster, you know, so I 

Jason Hall: mean, that's the thing, and that's the, that's why when you think about these cyclical stocks like that, like this is where valuation really matters. Because you do, you do want to be hopeful that you do get a little bit of multiple expansion if you buy the stock, right?

Right. If you, if you know the industry and you, and you see, and again, the bottom line is like the valuation, even when Texas Entrepreneurial stock was, You know, 30, 40 percent cheaper than it is now. Based on the prior 12 months during the downturn, it still looked expensive. So when you think about the multiple, you have to value the business based on kind of the midpoint of the cycle.

Like what, what are, it's like it's true earnings potential in it during a healthy part of. The, the, the business cycle. And that's, and that's where you have to put in the work, right? You have to imagine, well, okay, here's where the earnings are going to be, or could be, here's the cashflow per share could be, here's where the stock price is now, does this stock price make sense based on what I think its earnings will be when [00:37:00] the cycle turns.

And then you have to be patient, right? You have to wait through everything while still focusing closely on the business, because like in a case of Texas instruments, it's not just the cycle turning it's, you know, the, I don't know, call it 20 billion through this part of the cycle that they will have deployed into growing their capacity into making these, these process improvements.

So they're ready for the upturn. What's that before the upturn, right? But then it's execution risk that, that, that is on top of the market turning. Right. So, you have to have expectations that earnings are going to be much higher in the future than they were at the peak, the prior peak, because of all the money that they've spent and because of the semiconductor industry's growing.

You know, the tailwinds that are driving it over the long term. So you're paying this higher multiple today, this higher price today, you don't have that margin of safety.

Jeff Santoro: Hey everybody, we'll be right back, but first, a word from our sponsors. Earlier in the show, you heard us talk about investing platform Public.com. That's where you can [00:38:00] trade options with no commissions or per contract fees, and you get a rebate of up to 18 cents per contract traded. NerdWallet recently gave Publicfive out of five stars for options trading.

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All right. So I want [00:39:00] to talk about 2020 and 2021 and what kind of happened in the market then as it relates to multiple expansion and that kind of a thing, because the core question we're answering here is what do you do when a stock goes up for reasons you weren't expecting or are not related to the business?

And I think everybody faced that to some degree during that time. year to 18 months and Here's my Summary of of that time and you can tell me if you think I have it nailed down So I think there was kind of two things happening One is there was just a lot of excitement and a lot of companies that had no business coming to the market and or being bid up were.

And I think of all the SPACs, I think of the pre revenue companies that came public that really had nothing to show for themselves other than like a good story and some excitement and hype. There was like a lot of vibes multiples going on. But then, you know, Because we were in that world of low interest rates, the market seemed to really value top line growth [00:40:00] and customer growth.

So if you were a software company on a subscription model, and you were posting 50, percent revenue growth and customer growth, it didn't matter what happened below the gross margin part of the income statement. It was like, that could be a sea of red, and Yeah. It didn't really matter because you could go borrow as much money as you wanted for 0 percent and wait two decades to grow into profitability and the market was willing to pay for that.

But to your 

Jason Hall: investors with lots of cash that we're looking for some sort of return, we're risking on because where else were you going to get any kind of return? Risking on defined as. Buying stock in a company and being, being a part owner in the company where you're at the bottom of the capital stock, you're the, you're the last person to get paid when things go wrong versus buying debt, which is, is the best place to be.

Cause you're the first person you get paid before everybody. Right. 

Jeff Santoro: Yeah. And then going back to, I think one of the very [00:41:00] first points you made when we started recording about basically. You as the investor wants profitability and cashflow like that's that's your stake to the business and that's what it grows over time and makes your ownership in the business more valuable.

That was the piece that was missing for a lot of these companies in 2020 and 2021. So people were willing to pay high multiples for top line growth with nothing that actually benefits shareholders, at least in the short term because of. Vibes and hope and dreams and YOLO and rocket ships. So I think it's a very good encapsulation of what can happen in that kind of a bubbly frothy time and how it can really lead to some bad investing decisions.

Jason Hall: The two examples that stand out to me is like, so I can understand a lot of. Software as a service cloud, like all, a lot of that stuff got bid up, um, [00:42:00] because the growth rates for so many of those businesses were, and a lot have been exceptionally high. And like their basic business model is super duper high margin.

Like you get 60, 70, 80 percent margin, gross margin, and like your base operating costs are growing at, you know, 10%, uh, a year, 15 percent a year, and your top line's growing 30 percent a year. You're going to get to operating leverage fast. Uh huh. Where you, you go from a sea of red to just cash raining from the heavens.

Right. 

Jeff Santoro: And then you just print money forever. 

Jason Hall: Yeah. Yeah. Um, and well, until, until Delta airline sues you because you cause them to cancel 8, 000 flights and cost them half a billion dollars over an eight day period. But, um, yeah, the, the, the barring those black swan events. The, like the basic thesis made sense where a lot of those get bit up, but then you look at like Delta airlines, uh, all of the [00:43:00] airlines and the cruise ship operators.

Those stocks were going bonkers in 2020. And especially the cruise lines are like, we might not be sailing for a year, you know, and they were spending hundreds of million dollars a month to just to stay to just to stay in like, for like their minimum operating costs to keep their fleets functional, but investors were acting like they were going to double their capacity and open for business in a month.

So a really good example of like, you know, being wrong and still making money. 

Jeff Santoro: So let's pivot to what to do when this happens. Right. So, I guess the question is, Should, should we, should investors reconsider a stock holding a position in our portfolio when we see it shoot up for reasons that are maybe detached from the fundamentals?

Jason Hall: I think, I think you have to, uh, you know, if you're a business focused investor, and I think any longterm investor, you have to [00:44:00] be business focused because again, What is the, what is the driver of returns over the longterm? It's earnings growth, right? Earnings per share growth. And if you need, you need to think about your, your thesis for the business.

If it's the stock's going up for reasons other than what your thesis were is the same as if the stock is going down for reasons other than your thesis. If your thesis is not playing out, you have to revisit it. You do. And you adjust accordingly. And maybe that adjustment is, wow, this really isn't working.

But this other thing happened that's working great. And all the evidence is that that's going to continue to working great. I'm going to remain long this thought. But you might also realize, wow, I've just gotten lucky and I've made money, but the reasons I invested aren't proving true. There's some good multiple expansion that's happened here and it's created an opportunity for [00:45:00] me, for me to move on.

You know, you do that just as much as your analysis of a stock that's not doing well, is the thesis is broken and you don't see a way forward, you sell and move on. I think you have to. 

Jeff Santoro: All right. I'm going to push back a little bit. I don't know that you have to sell and move on. I think it's okay. I'm 

Jason Hall: saying if you're, if you were, if you were going, you, you go ahead.

I was just 

Jeff Santoro: gonna say, I think it's okay in a lot of, in a lot of cases. All right, let me back up. I think if your, if your vibe is, or your way of investing is, I have a very defined reason for owning this company. And if it goes up or goes down for reasons other than that, I'm out. No, I don't, 

Jason Hall: I don't think you should do that.

Okay. But 

Jeff Santoro: I'm saying I don't necessarily think that that's a bad thing. If that is the way you, you have to, if that's the way you are as an investor, right? We talk a lot about you're 

Jason Hall: too rigid and you need to buy index funds. 

Jeff Santoro: But I think what I would do is in both cases, and I think this is where I end up when I ask myself this question.

Like I said earlier, like when I look at the stuff that has done well, and I'm like, [00:46:00] but not for any real reason. I'm much more of a wait and see kind of a person because I'm also, I challenge the idea that I don't think theses break as much as some people say they do. I think people who are like, Oh, I sold because the thesis was broken.

I think for a lot of people, That's not the reason they sold 

Jason Hall: money and they don't know what to do. 

Jeff Santoro: I think that's the reason they say they sold. And if, and the reason I think that is because you never, ever, ever hear someone say, Oh, that stock was up 80 percent in the last three months, but my thesis is broken and I sold.

Jason Hall: Yeah. 

Jeff Santoro: So I think if people were really thesis driven investors, you'd hear about it. On both ends. And some people do that. I'm not saying, but, um, the vast majority of people I think don't. So I think when a thesis changes I do think it's appropriate to kind of wait and see. You know, we've given examples, right?

Like, so I don't know what it would have been like to be an Amazon shareholder and then learning that they're investing money in AWS. I don't know [00:47:00] what it was like to be a Netflix shareholder and have them be like, Hey, you know, this really great, DVD mailing business we have, well, we're going to now stream like, 

Jason Hall: I've heard of the internet. 

Jeff Santoro: Right?

I might've at that time been like, well, that's, that's stupid. Why would you do that? Like, you know, and then I might've 

Jason Hall: entry, the big studios are going to blow you out of the water. Yeah. Like, absolutely. No, I agree. I agree. And we've talked 

Jeff Santoro: and we've talked, we've debated this a little bit too, with Boston, Omaha, a company where completely understand why some people think the thesis is broken and sold.

Well, I think they're 

Jason Hall: wrong and nobody made money except for the insiders. 

Jeff Santoro: I think the thesis has changed. 

Jason Hall: It has, but the original thesis is broken. And my, my point was, this is what I want to show, it is broken. I don't. Yes. Let me, let me, let me explain why. Let me explain why. Because I think 

Jeff Santoro: a, I, hold on, hold on.

I will let you explain, but let me say this. I think a thesis you could have had is broken. I don't know that it's everyone's thesis. [00:48:00] Go ahead. 

Jason Hall: If it wasn't then they're lying. They're absolutely lying because now hear me out. Hear me out I'm gonna 

Jeff Santoro: say I'm not lying because I I don't think my thesis for owning the company is broken But go ahead you go and then I'll tell you how you 

Jason Hall: didn't have a thesis when you bought the stock then so no But I developed 

Jeff Santoro: one 

Jason Hall: There you go.

Mission creep. Ladies and gentlemen, this is called mission, mission creep. So this is the most important thing. I think I can say about it when it comes to having a thesis I think most people spend way too much time trying to confirm their thesis when we should all be spending more time trying to disprove the thesis.

We should always be constantly looking for evidence of why we're wrong, why things aren't working, more than reasons why that we're right. And the reason why is because the stock can be performing poorly because the business is not doing well. But we're still convinced about our thesis. This is going to happen.

This is going to happen. This is going to happen, right? Confirmation bias is, is the key here. So if you [00:49:00] spend more time constantly trying to poke holes in the business and the thesis that you built, you're going to arrive at a better place. And this is important because objectively, when you realize that the thesis that you developed was incorrect, it allows you the chance to either move, move Either evolve your thesis based on the reality of the business that you're learning about, um, or move on.

If you determine that there's just nothing valid there that supports. You continuing to own the business. And that's what I wanted to get to is that, and I think the thesis has to evolve for most businesses over time because business models change, opportunities, change, competitive environments, change, uh, technology changes, right?

Like all of those things kind of come into play. So I definitely agree with you that, that for most people, the last action should be selling or buying more. It should mostly be learning and [00:50:00] evolving. Your understanding of the business and your understanding of the business is going to inform your thesis.

So that's the biggest thing that I wanted to stress. 

Jeff Santoro: And I agree with everything you just said. Here's where I want to give an example 

Jason Hall: in Omaha. 

Jeff Santoro: Well, I do, but I want to do it not necessarily to defend myself because. You're right, I bought it because it was, I bought it because I was the ticker guide on the Motley Fool discussion boards for it, and I was interested, and I was like, this is cool, I'm doing this, I'm going to buy something, like, that's why I bought it, and then I learned about it.

But here's, I'm going to use it as an example of where, A, not everyone owns something for the same reason, and B, I do think, One person's busted thesis can be another person's changed thesis. So my basic, 

Jason Hall: 100 percent of 

Jeff Santoro: right, well, that's what I'm, that's what I'm getting at, right? So I'll use, I'll use Matt Frankel as an example because he has written and spoken about Boston Omaha very publicly on Motley Fool podcasts, on articles he's written on his own YouTube channel.

We've talked to him about it in person when we've seen him at events for [00:51:00] him that the thesis or the thing he was most excited about was. the thing that has changed, which was the, the asset management part of the business. That was his, like, I think this is going to be the driver for the future. So when that went away, I don't think he has sold.

If he did, I'd understand it because for him, that was the reason to own the company. I was always more interested in, I guess, the optionality provided by cash generating businesses. Right. So for me, it was about if broadband. And billboards and insurance can be cash generating profitable businesses. They can then use the proceeds to do X.

And I didn't necessarily care what X was. So if X was investing in, in DreamFinder homes and then cashing out after they IPO'd, Cool. Which is what they did. If X was sponsoring a SPAC, that became Sky Harbor, which is what they did, cool. If X was starting an asset management business, which they wound down, not great, [00:52:00] but okay.

Cause for me, it was never about the asset management business. It was about X. So that's why for me, the thesis has changed and is not broken. And I want to see now what they do, right? So now if, if a year from now, It's the same bullshit and nothing has really changed and they've done, they haven't done any X.

It's just here at what, here's what these three businesses are doing. I might be out because I'm not seeing that part of what I, so I guess that's my, that's my main point. Like it's not necessarily about Boston, Omaha. So I think 

Jason Hall: this is, this is kind of a matter of maybe defining the difference between a change thesis and a broken thesis, 

Jeff Santoro: but that nuance I think is important.

Jason Hall: No, I agree. I absolutely agree. So my, my definition. Is a broken thesis. Is there something about your original reasoning for investing in a business that has so fundamentally changed? If you will intend to continue owning the business, your, [00:53:00] your new thesis is going to be fairly radically different. Then the one that it was before.

Now, where I think this is important for Boston, Omaha, is that sure. Optionality from the cash flows from their existing operations to be able to pursue ways to generate more return. You could say that about every business, whatever they do. I mean, you could use Amazon as it will go back to that one, because it's the one that we're talking about.

They invested, invested in like this, this what's now a cloud infrastructure. For themselves, like they built it for themselves to host. You know, amazon. com on. Right. And then, and they realized that, well, there's lots of value in a lot of this capacity that we're not always maximizing that we can sell.

Right. So that whole first best customer thing, they, they like, you can say optionality all you want about any business, but eventually at some point, the optionality thing, when it's wildly successful becomes more valuable [00:54:00] than like the original core thesis. And when I say it's broken for a company like, like, Boston, Omaha.

Is. The optionality is gone because the optionality before was to fund internal and external opportunities. That doesn't exist anymore. It is all about reinvesting in existing businesses, existing operations, which is literally what every other company that you would buy would do, whether it's Coca Cola, so that when I say it's broken, like it's, it's become altered that much that that optionality part doesn't exist in the same way anymore.

And for me, I still hold shares and to me it's broken because I've had to rebuild like really what is it now that it's just Adam Peterson and Alex Rozek is gone. It's just reinvesting our cash flows back into our existing businesses to make those more profitable and to grow them if we can. 

Jeff Santoro: All right. So let's, let's wrap up with a question about our portfolios. So what is a stock or some stocks [00:55:00] in your portfolio right now that you feel like The result of the stock price has benefited more from multiple expansion than from the actual results of the business.

Jason Hall: So I want to talk a little bit more about NVIDIA. And then I've got another one I want to talk about. So the reason I want to talk about NVIDIA is, 

Jeff Santoro: well, I do too. So we'll, we'll both talk about NVIDIA and then we can take it to go in the other direction. 

Jason Hall: So, and I don't, I don't know if it's more multiple expansion. Because you look at it's like historical price earning ratios and things like that. It's not really a whole lot more expensive. Like I think about that. That's 

Jeff Santoro: my take. Yeah. 

Jason Hall: So to a certain extent, it has certainly earned a lot of what we've seen, but the expectations are all still exceedingly high for what is in essence, still a cyclical cyclical business.

And eventually that cycle is going to turn. And also we. As much as like, and I've made videos about it, we've talked about it a lot. It's like, there's could be a ton of meat [00:56:00] left on the bone for, for AI, for capital spending before we even get to the, like the maintenance phase of, of CapEx for, for artificial intelligence focused semiconductor infrastructure.

I mean, we could be talking three to five years of build out, or we could also be talking in two years about, you guys remember the AI CapEx bubble. When everybody thought these companies were going to be spending all of this money and then none of them were making revenue and the wind kind of fell out of the sales.

The reason I want to talk about NVIDIA is reminds me of like GE back in 2000 now a lot of different things there that, that make it not a fair comparison.

I mean, we could use Microsoft. We use a lot of different like the stocks that, and actually let's use Microsoft because that's a company that like the business is a lot bigger now than it was back then. But like, I think you, you know, you know, somebody that made a small investment in video, call it 20 years ago and it's now it's worth like a million dollars and this is like a regular [00:57:00] person that works a regular job, right?

Um, so it's a substantial portion of that person's net wealth now and you. You have to start thinking about downside at some point with, with these massive, massive winners where multiple expansion has helped you because again, I'm thinking about multiple expansion here is this bet that the earnings growth that we've seen is going to remain static, right?

And even continue to grow from here. And that's, that's a big bet to make when you're talking about. Something that can be such a large portion of your net worth. And you, somebody has made a ton of money for reasons that they weren't necessarily predicting what happened. You can lose a lot of money for reasons you weren't necessarily predicting happening, uh, that happens a lot more often if we're, if we're honest, right?

So you have to be thinking about execution risk, the cycle turning, all of those sorts of things happening that costs you more in losses that you really shouldn't [00:58:00] incur. Because you were trying to capture a little bit more that you didn't necessarily need. 

Jeff Santoro: Yeah, I want to put numbers on NVIDIA really quick.

Just, this is not perfect, but I think it's directionally informative, right? Yep. Over the last year And this is all trailing 12 month numbers, okay? NVIDIA's revenue is up 78%, free cash flow is up 125%, net income up 126%. PE ratio has grown 15%. Right. So that's why I feel like it's equal parts business, equal parts multiple expansion.

Alright, so let me give you the one in my, Portfolio that I think is the opposite and then I'll see if you have one I haven't mentioned it earlier But I think it's a really good example. Let's use Broadcom. So Semiconductor and other things company basically if you've used electronic device You've likely had a Broadcom product in it, especially if it was a mobile phone Trailing 12 month revenue up 19 percent free cash flow up [00:59:00] 5 percent net income down 27 percent PE ratio up a hundred and forty one percent now, right This could end up being correct if the projected growth and excitement around how AI will impact their business actually pans out.

But right now I would have to say that has risen to the top of my portfolio because of non fundamental reasons, right? More because of multiple expansion, less because of business results. Would you agree with that? 

Jason Hall: Yeah. No, absolutely. Using the NVIDIA example again, their, their cash flows have gone up in the past two years, 5X.

Right. Trades for 65 times operating cash flow traded for a lot higher multiple than that over part of the past few years. Part of the way I think about it too, and I think this is really valuable is that you should pay a higher multiple for. smaller, still growing companies, [01:00:00] right? You growth, growth businesses are in a higher multiple, right?

As companies growth stabilizes and slows and they're not growing earnings per share of cash flows per share is quickly that multiple should come down over over time. So that's, that's another thing that you really have to be cognizant about when you think about multiples. 

Jeff Santoro: All right. What about you?

Do you have one in your portfolio that you feel like has benefited more from them? Multiple expansion than from business results. 

Jason Hall: Oh yeah. In phase and phase is a good example. It's another cyclical. And it's interesting because the, their, their core businesses tied to residential distributed solar rooftop, solar.

And that business has gone through the first downturn, uh, in probably six or seven years, maybe longer, maybe close to a decade where there's a, just a massive, massive down, like their revenues from the peak were down like 60, 70%. And you look at the past eight or nine months the stock has gone up a lot.

Um, even as the results have deteriorated. So a little [01:01:00] bit, it's like an extreme example of, of, uh, Texas instruments, like it's even worse. And there are until the earnings, they just reported a couple, yeah, I don't know, maybe a week and a half ago, there were very little indication that we had hit the bottom of the cycle.

And now it looks like maybe we've hit the bottom of the cycle, but thinking about getting back to like the prior peak of demand, I mean, we're talking years and years. So stock price is still well down from the, from, from the high, unlike Texas sentiments where the stocks still pretty close to all time highs.

But it's a lot of the same thing, um, because the market is always forward looking, right? The market is looking for signs that the industry is going to bounce back and investors want to get in as early as they can to win that cycle does turn.

 Okay, friends. Thank you so much for listening. Go out there and give us a rating. Want to get out there to please give us ratings. We want more ratings, only the five stars though. You can [01:02:00] keep the other ones. Yeah, no, I'm kidding. They should give us those ratings too. okay, friends, thank you so much for giving us another listen this week. Just a reminder we're doing our live stream. The Friday after you hear this, this episode comes out. So first Friday's a few months in a row. It's been the second Friday 4 p. m. Eastern on our YouTube channel.

Be sure to tune in for that. If you're able to, we'll of course put it in the podcast stream as well. So it'll show up there. If you're not able to attend it live, as always, these are our answers to these questions. It is up to you is up to you to find your own answers to these hard questions about investing.

You can do it friends. I believe in you. All right, Jeff. We'll see you next time.

Jeff Santoro: See you next time. 

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