Mastering The Future – Investing In Technology And Innovation With Dr. Eddie Sanchez, Part 1

 

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Welcome to another episode of The 7 in 7 Show with Zack Ellison, which features full length interviews with the world’s leading investors in innovation.

The show this week features part B of the interview with Dr. Eddie Sanchez, who has over 25 years of experience as a hedge fund portfolio manager and securities analyst. He managed long/short Technology and Telecommunications portfolios at Citigroup Investments, First New York Securities, The Galleon Group, Credit Suisse, and the Blackthorn Group.

Dr. Sanchez is currently a Clinical Assistant Professor at Warrington College of Business at the University of Florida. Previously, he was an Assistant Professor of Instruction and the Director of the Bloomberg Lab at the University of South Florida, Mumma College of Business. Dr. Sanchez’s research interests are in Municipal Bonds, Hedge Funds, Mutual Funds, Capital Markets, and Financial Institutions. He has taught Executive and On-line MBA courses in financial statement analysis and corporate financial planning, as well as undergraduate courses in principles of investments, advanced investment analysis and management, and financial markets and institutions. He received a Doctorate in Business Administration with a concentration in Finance from the University of Florida.

In this episode, Zack Ellison and Dr. Eddie Sanchez discuss:

1. Evaluating Tech Innovations
2. Tech Company Valuations
3. AI’s Financial Impact
4. Tech Stock Analysis
5. Venture Debt Insights
6. Equity vs. Debt Financing
7. Future Cash Flow Importance

Mastering The Future – Investing In Technology And Innovation With Dr. Eddie Sanchez, Part 1

I have with me Dr. Eddie Sanchez from the University of Florida. Eddie, thanks for joining.

Thanks for having me, Zack.

Introduction To Dr. Eddie Sanchez’s Background

Eddie’s got an incredible background in tech investing that goes back several years with some large institutions and hedge funds. Eddie, tell us how you started out and how you got to the University of Florida.

To give you a little history of my background, it’s a bit unique because I was a computer science major back in the ‘80s. They did have many microcomputers and mainframes but I got my hands wet when I was an undergraduate student at Quinnipiac college. I was working at a hospital in Hartford, Connecticut, and I got a chance to understand midframe, mainframe, operating systems, networking, storage, and semiconductors.

I got a lay of the land because I was a computer operator when I was at school. I was a computer science major when I was at Quinnipiac. On weekends, I would work at a hospital. I got a chance to get hands-on on understanding different types of hardware, software, networking, and operating systems on the machines. As I was going through school, I gained not only practical experience by getting my hands dirty, but I also got the theory and understanding. Whether it was programming, system analysis, and things of that nature in the courses I took. Database was with another course.

 

 

I remember all relate to learning BI, which stands for Business Intelligence. I’ll try to triangulate a little business intelligence for artificial intelligence, the word being intelligence. Anyhow, when I graduated, I went to work at EDS as a systems engineer. I quickly found out that I didn’t want to move to Houston for my second rotation, so I joined the Travelers Group.

I got into what’s called an accelerated entry into management. It’s a five-year program where they moved you around the company. This company was Travelers Insurance at Hartford. I was in different roles as an IT person. I got a chance to do programming, system analysis, and work on databases. Those were the types of jobs I had.

In my last rotation, I did want in corporate finance. What I was looking at in corporate finance was all the IT systems that produced information for the CFO, so the CFO could deliver their earnings. At that point, Travelers had five different businesses. A couple that I remember were healthcare, property casualty, life insurance and auto. These were the types of businesses Travelers had, and I needed to bring all the systems together so they could feed into corporate finance then into the area where the numbers were tallied so they could deliver their earnings for Travelers.

The beauty of that job was that I got a chance to rotate around many of the businesses at Travelers. I got to experience different types of either database, software, and hardware and doing different types of analysis. I had what I would classify as a strong foundation, not only from academia and college but working while I was in college and now doing it at the next level.

In my last rotation, I was also working on my masters in economics at Trinity College. I wanted to transition from doing system analysis and programming to the world of finance. I made this big jump where I moved into, what I would classify as myself, as probably the short-term bond trader. I was hired out of the program by a gentleman named Marc Weill. He’s Sandy Weill son who was the CEO of Travelers. Marc was the Chief Investment Officer at Travelers.

First Foray Into Investment And Bond Markets

He gave me a job. I wanted to be a portfolio manager, and he placed me on the short-term money market debt. That was a fun job because I got my first taste of understanding an organization like Travelers and its risk spectrum. The risk spectrum from short-term money markets to short-term bonds and short-term debt that we could invest in like commercial paper, overnight treasury, one week treasury, and longer-term treasury in the standpoint we were all buying. Treasury bills 6 or 9 months. I was managing the working capital of a company like Travelers.

I had a very big portfolio. This was my first foray into the world of investment and understanding a balance sheet of a company. I didn’t look at the income statement. All I was doing was managing the cash at the Travelers and putting that cash to work in investing in short-term maturities, trying to get or receive some interest on that short-term money, the working capital of Travelers.

I did that for about two years and got an understanding of the bond markets. I got to understand how the bond markets work from the short term all the way up to 30 and above. I got the lay of the land of understanding interest rates and how it the effect of investments. Now, I’ll talk about that, then I got the opportunity of a lifetime.

There was a gentleman who was running a small-cap portfolio and was looking to hire a technology analyst and I had no background. I have a computer science degree, this corporate finance work, and I have a masters. Now, I was making this jump trying to become a tech analyst for a billion-dollar small-cap fund. I’ll never forget some of the stock pitches I made back then. I picked Cisco and Whole Foods.

These were companies that had very expensive earnings, and my boss was a value guy. He’s always looking for very low P/E names or catalysts for a change in the asset structure that could change the business model where their value could be created. That was what I was heading into. I’ll never forget I started working for Harvey in 1997. I was trying to pitch him all these high-growth names, and he wanted no part of it. I quickly figured out that if I looked at some of these beaten-up names and figure out if I could look at the balance sheet to find some value there then I could get him to put some of my recommendations into the portfolio.

Fast forward a little bit, Harvey left and my co-worker, Jack and I were able to make a pitch to Marc while we started a technology fund with the Travelers. We started the fund in 1998. For those young people who haven’t been around, 1998 was a though year in the markets because of long-term capital. The fund with some of the most intelligent, Nobel-worthy investors at this hedge funds collapsed. Jack and I started the fund in January. My capabilities came through with understanding technology, and we’ll get a chance to talk about what that means as an investment.

In an efficient market, profits are zero. To outperform, find the value where others don’t see it. Share on X

I’ll never forget Peter Lynch always saying, “Understand the company you are buying.” Peter Lynch was a great manager at Fidelity. If you want to have ownership in Coca-Cola, understand that they are selling soft drinks. Walmart or Amazon, understand them. I had a great understanding of the technology landscape. I knew about software, hardware, and storage. This gave me what I would classify as a competitive advantage over some of my colleagues who were investors on Wall Street because I understood technology.

Technology can get people to pay extraordinary because they were buying more into the hype and less of what the technology was doing and how that technology transformed a company. Selling technology, how were they able to turn that into a business model? It’s generating future cashflows for the equity holders of a company. I did that. I was an analyst who became a portfolio manager. Jack and I had a great year. I remember we were up 20% in a year when the market was down in 1998.

1999 was a tremendous year because of the internet. You had all these companies and all these stocks. It’s a little different now because you’ve got large caps but investors was trying to figure out these internet companies. We had this build-out in telecoms. I remember we had companies doing what they’re doing now, outsourcing the hardware and bringing people on. Companies provide the service.

All this money was not only invested in some infrastructure for the internet. It was also being invested in some companies that would never, ever make a dime. The one thing I always go back to I’ll never forget, an analysts pitching and recommending companies to investors where all the company would do was shoot web pages up to people. How does that translate into the business model of that company making money?

I was an analyst not only in the portfolio but I was a portfolio manager. Jack and I ran the portfolio for about three years. The returns were astronomical. We were up 120 something that year. Even in 2000, the market collapsed with the internet, we still were up another 20% or 30%. I attribute all that to my capabilities in understanding business models and the technology that’s associated in finding great companies.

That’s my background at Citi. I later started a hedge fund. I found it very difficult coming from Citi and being able to manage money without having the Citigroup. I did that for a couple of years. I was successful in doing it, but I decided I wanted to go to a larger hedge fund. I went to one of the biggest technology hedge funds but not the biggest on Wall Street, the Galleon Group.

I did a lot of software investing at Galleon as an analyst, and I also was a PM. I did that for about a year. Off and on, I’ve also run out of money. I ran money for a private company in New York. The best thing about that was the payoffs was good in making money. I was pretty successful only because I had a strong background in technology and understanding the better technology plays versus the companies that I thought would never make it because of their business.

Fast forward a few years, I moved because of family reasons. I met my wife when I moved to the Midwest. I still managed money for some New York-based companies. I did that off and on. When I was in the Midwest, in Kansas, I was asked to speak to some portfolio management classes at the University of Kansas. The reason I’m telling this story because this is my foray into academia. I was also working on a masters and an MBA because I had an economics degree but I wanted to get a finance degree, so I got a masters in Finance because I thought I needed it to teach finance courses at a college.

I didn’t really need them but I did it anyway. Not only did I have this, I would call it a strong background in investing as an analyst, portfolio manager, and hedge fund manager where you buy long securities and you go short. I did that but I was also building up my skills on the academic side then I made a decision to go to the University of Florida and get my Doctorate in Business Administration.

That was probably one of the hardest things. My wife said to me when I joined and started my work there. She’s like, “You want to go from the frying pan to the fire.” It’s interesting. I’ll never forget my dissertation chair saying, “Eddie, why did you want to do your doctorate?” I said, “It’s because I wanted to do a better dive on research.” Wall Street produces research. I would say, in some cases, it’s good and in some cases, very bad. Maybe that’s the same classification in academia, but I felt I wanted to strengthen my skill there.

I completed my doctorate at the University of Florida. I went down to the University of South Florida. I taught there for years. I won Professor of the Year. Students probably loved me because I did a great job. What I bring to the classroom is I can bridge the theory and what takes place and what you read in a book with my practical experience on Wall Street.

My practical experience stems from credit, looking at bonds into equity. I have seen a pretty good spectrum of different types of securities. I’m a Clinical Professor at the University of Florida. I’m doing two things. I’m teaching a valuation class and also working with very bright students. We are trying to build one of the few, if not one or two, long-short equity funds. That’s where I am.

 

Before you dig into all that, let’s talk a little bit about the University of Florida’s program. That’s how we met. I’m in the program as well, and I’m about 75% done with the classes. We now have a lot of professors in common that we’ve both learned from. Now you’ve got an office right next to them. It’s great how that’s worked out for you. I’m going to wind up doing my dissertation with Michael Vanguard, who sits in the office next to yours. What’s great is Michael did his PhD at the University of Chicago in the ‘80s. I’m pretty sure he did his work under Eugene Fama if I’m not mistaken. I’ll have to double-check that.

George French, too. He had a strong dissertation committee.

I’m trying to keep that lineage going because we’ve got the University of Chicago connection where I did my MBA. Now we’ll have the University of Florida connection. You had some great advisors too. You had Andy Naranjo, if I’m not mistaken.

Dr. Andy was my mentor, and I never forget when I was looking at doctoral programs. Andy was involved in many things but he’s the director of the International Center. He has a Masters in International Business. He takes them on trips. He is on a trip to Brazil. I remember sending him an email saying, “I have got this weird background of a hedge fund manager. I’m thinking of doing my doctorate. What do you think?” He said, “You need to come here. We are doing a lot of research on hedge funds. You’d be a great asset to the department and some of the professors could use some of your private knowledge.”

What attracted you to the University of Florida’s program versus other schools?

What attracted me was the faculty. I had a faculty member who was my metrics professor. I spoke with her about what I was thinking for my second career. I said, “This is what I’m trying to do. I’m trying to build up my research skills.” She said, “Go out and do the due diligence like we do in companies, and go find schools that may have a program that’s attractive for you.”

I looked at some programs that seemed to be more like Executive MBAs, but they were doctorate business administration. Florida had everything. The more important thing that Florida has is being a great school and a large part comes in having great professors. If you look at the professors across the disciplines at Florida and in the business school, that would have been my professor.

The background is very strong. I need Andy Naranjo for my grind guard. I have a great relationship with Dr. Dave, which they call Mr. IPO. He has done a lot of research on IPOs, and he’s on CNBC all the time talking about IPOs. You’ve got Mark Flannery and Mick Ford James, both great in the bank sectors. A lot of firepower, and brainpower around different areas of finance. I wanted to be part of that in some form or fashion.

When I was doing my DBA, it was more of a weekend program but I turned it into a PhD where I spent a lot of time with many of the professors with seminars, plantations, and understanding the research. I put in the groundwork to get myself to where I am and getting myself to become a professor in the Department of Finance. They have a great department with great professors, and I would say to myself, “I did a good job getting into that.”

I agree with you. It’s the best program of its kind in the country, and I did a ton of research before choosing the University of Florida. One thing I will mention is my education was at some very good schools, but they were all division three athletic schools. I started in college in 2000 at Swarthmore College, which at the time was the number one liberal arts college in the country according to the US News and World Report. I didn’t know what it was in high school. They wanted me to play basketball there, and I looked it up. I thought, “This is a great opportunity because they are number one. Why don’t I go there?”

That’s how I started at Swarthmore. Later, I did the MBA at the University of Chicago, which is a division three with a terrible sports program, generally speaking. They have great academics and they’ve been ranked number one in business school and in finance pretty much unequivocally. I did another masters while working full-time at NYU and an MS in Risk Management at Stern.

Those are great schools. I thought the professors and classmates were tremendous at each school. I wanted to find something that was equivalent or stronger. That’s pretty hard to do when you’ve been through three of the best schools in the world. What I like about Florida, to your point, the professors are incredibly strong, and the institution itself is the flagship of the entire State of Florida. In my opinion, it is the best school in the Southeast United States.

In tech investing, it's about more than hype. Look at how technology translates into a business model with future cash flow. Share on X

One thing that you are mentioning as you talked about the professors. The students in the class are tremendous. There’s a vast background of different experiences where you see consulting or being CFO at these companies. It’s not only the professor, but it’s also your classmates who are excellent.

That was my biggest surprise to the upside was how great my classmates were. I expected them to be talented, but the bond that we have in our class is very strong. I have never been in a more helpful group of people probably in my entire life. There are about 25 of us, and we are from all over the country. The average age is mid-40s. We have people as old as in their mid-60s, and the youngest is in her late twenties. Everybody is just phenomenal. That’s been a huge bonus. The alumni network also is incredibly powerful.

There are 500,000 plus alumni from the University of Florida and 300,000 live in the State of Florida. A few people have said, “Why are you doing a doctorate? Why do you need that?” I said, “I don’t need it. I’m already successful. I’m doing it because I want to be the best. If I want to be the best in what I’m doing in venture debt, I need to have access to the Southeast market of the United States,” which is the best growth region going forward. The best place to connect with folks is the University of Florida. I can get a meeting with anybody in the Southeast United States by saying, “Go Gators.” “I can make you money,” and I get in the room. That ultimately is tremendous.

It speaks a lot for Florida. You’ll be able to go into either a family office or talk to investors with your pedigree and your background. You’ll be able to say, “I have done it on the academic side, but I have also done it in the world.”

I’m learning a lot from you and the path that you traveled because you did quite well on Wall Street for many years and then decided you didn’t need to work anymore. You do this because you enjoy it, want to give back, you love learning, and you love the community. That’s ultimately what I want to do one day as well. I probably have another 10 or 15 years left in me before I reach that stage at least. I love what I do, so I might do this until I’m 85 years old. Who knows?

The great thing about being a teacher not having to manage money is I don’t have days like now.

It is nice. As former traders, we both know what it’s like to wear risk even on the weekends because the market’s going to change. You’re going to come in Monday morning and oftentimes, you’re going to have a firestorm to put out. I want to dig into this investment program that you are building at the University of Florida because it’s an amazing program. I want to learn more about it and have people learn more about it.

Building A Student Investment Program At University Of Florida

Florida has a couple of funds that students can participate in. As undergraduates, there’s a Founder’s Fund where they take students who want to learn the skills of being an analyst and becoming a portfolio manager. What they do is make pitches on companies and pitch them as bond. To give you an example in the Founder’s fund, they don’t manage any money but they have a project people where they say, “I want to pitch Coca-Cola or Amazon as a long in the portfolio.”

What they do is they’re acquiring the skills of analysts on Wall Street. We’ll talk about that in a second what those skills are. You’ve got the Gator Student Investment Fund which is a fund for students. Most of the students of that fund are working to get their masters. It’s a four-year program in Florida, and many of them are working to get their masters. It’s a different level student, number one, and they do have $1 million capital that they’re investing in. What they’re investing in, there are thirteen sectors in the S&P. They have sector analysts within those sectors. They got managers who are pitching stocks, putting them in. They have hands-on live money where they can put that.

What I’m trying to do is take my capabilities and my background, and maybe build on that, maybe a little more from the standpoint of, I wouldn’t say risk but from a standpoint of actual work as an analyst. It’s riskier because I’m looking at doing a long-short equity fund. As an example, let’s say, over a hedge fund, I want to go long Pepsi and short Coca-Cola. First and foremost, what is shorting? You believe that the company fundamentals are going to deteriorate. I can go onto the market to sell the stock. You borrow and sell it with the hopes that if I sold the stock at $100, it would go down to $50, and I would make the difference between $100 and $50 because I was short on stock.

Why would a stock go from $100 to $50? Maybe because the company is going through a business cycle transition or its fundamentals are getting worse due to the economy. There are many reasons why we’re short on stocks. Number two, we could also hedge your portfolio. Why would you want to hedge them? We don’t want to take any market risk.

Apple is a great company, but does that make it a great stock? Always question the fundamentals and valuation. Share on X

To give you an example, Zack. I’m long Pepsi because I like the business prospects and their future cashflows. I can buy that stock and I can short Coca-Cola and put those two in my portfolio as a hedge. If the market goes up and down, I don’t care. What I care about is when the stock appreciates, I want Pepsi to appreciate more value. When the stock goes down, or the market goes down, I want Coca-Cola to go down.

I want to dive into that for folks reading. Oftentimes, that’s called a pair trade. What you’re thinking about is the relative value or relative performance between those two companies.

That’s what we are looking at. What we’re trying to do is take the risk right out of the market. That, to me, is good analytical work. I’m not betting on a stock because the market’s going to take it higher. I’m betting on the stock because of the true fundamentals. How do you come up with the intrinsic value of a company? You look at the future cashflow.

What you’re betting, if you’re going to make a bet outside of just investing in the S&P 500 is, you think that the intrinsic value of the company should be worth more than what the market is saying it is. If not, you just buy the market. You would be doing that and then you’d be hedging it or a pair trade with a stock that you thought had deteriorating fundamentals. In this case, we’d be looking at two companies that look very similar.

Eddie, how do you think about the intrinsic value versus the perception of that company, which leads to a price? In other words, when prices don’t match up with the intrinsic value because they are either too high in a very bullish market or maybe too low in a bearish market. There’s that risk when you’re short that market sentiment could be very strong and take a company with mediocre fundamentals and still push the price higher.

That’s a great question. This is the thing I’m teaching. At the end of the day, the only way I get value a company is by looking at its prospects on future cashflows. I can’t come in every day and judge sentiment. I can try to understand it and what’s taking place in the market. I can’t make my investment decisions based on what the market is doing. I’ve got to make my investment decisions on what the business model suggests these cashflows look like and what is the probability of those cashflow.

If I have strong probabilities that those cashflows are going to be very strong and the company is going to super grow. That’s not being reflected in the stock price of a company, I’m going to try to take advantage of that but that comes from understanding the company and its products and assessing the probabilities of those future cashflows.

How do I determine value? If I’m going to grow the cashflows going forward, what is the probability of, let’s say for example, Apple growing by 50%? Probably not a very high probability, but the market may be pricey. My job is to figure out that the market may be wrong there. If we go, why is it wrong or where my analysis is wrong in those future cashflow? To also properly discount, those cashflow have some risk. For instance, rates are rising now.

There’s greater risk in future cashflows. Why? As rates rise, the cost of capital rises for companies, and that ultimately will probably cause a slowdown in the company’s business prospects. Tying this back to the student management investment fund, these are the skills that I’m trying to build for my students. Help them build those types of skills where they get away from the company and these rising stock prices. They get more to understanding what is the value because in the long term, stocks will reflect what their cashflows going forward at that point in time.

During the internet boom of 1999, very many companies weren’t making any money. The entire prospect was on these growing sales but how do those sales turn into something profitable and in return, for who? The shareholders, the investors who gave them the money. I try to get away from, and I always have gotten away from, the hype in the market when the market’s going up. I don’t get too down when the market’s going down as well like in 2008.

I’m always looking for opportunity. What I try to do is develop the processes, and my process always comes back to the business fundamentals. There’s one saying that you will hear many analysts say, either, “Come back to talk to me.” One common saying Eddie used to always hear is, “The cashflow is going up.” I am always looking for strong cashflow at a company. I’m also looking for a return on investment that’s greater than the weighted average cost of that capital because that will bring value of the company.

The Importance Of Understanding Business Models

I like this quote from Ben Graham where he says, “In the short run, the market is a voting machine. In the long run, the market is a weighing machine.” To your point, what he means is that over the long term, fundamentals will dictate value and price. In the short term, they don’t necessarily. One question I have before we dig into some more fundamental investment principles and processes. When you have an irrational market as we had in 2021 and still to this day because sometimes it happens in certain pockets. Do you avoid certain companies or sectors that have a lot of hype behind them because they are not tied to fundamentals in the short term?

 

Amazon has been classified as an expensive stock for probably the last twenty years. Here’s to understanding the interesting dynamics of the Amazon stock and its valuation. Amazon is a great company. The question is, is it a great stock? It has been, but it’s been expensive. I was speaking to a large-cap portfolio manager at JP Morgan, and this was his line to me.

He said, “Eddie, I know that Amazon is very expensive to the cash. I have to own that company in my portfolio because if other portfolio managers who are large-cap managers own that, and that stock continues to rise and I don’t own it. What’s going to happen is, I’m going to basic the poor performance relative to those other portfolio managers who are owning that large cap stack.”

As you can see over time, there are very few companies that can be that large and grow that fast. This is a good example too. It’s expensive, but you get these large-cap growth managers that are looking for these companies that grow very fast. They’re willing to pay prices that don’t make any sense because these companies could never grow into those valuations.

Another thing for the older portfolio managers, I used to hear this. They used to always say, “I don’t want to get Walmart-ed.” I go, “What does that mean?” “We all missed Walmart because we never believed in it or Home Depot. Those became great companies.” There are a couple of dynamics there, but how do you capture that in a factor or something? It’s very smart.

What I try to do is stay away from the heavily shorted stocks. There are plenty of stocks out there with good business models. Models that may be coming through a peak and into a trough, or maybe coming out of a trough and into a peak. There’s plenty. Even in technology. It’s interesting because I’ve even told students, “You can find value even in technology, i.e., Meta or Facebook.” Trading at $76 because they were spending too much money in capEx. The company changes its capEx, business model, and then it goes from $76 to $300.

There are opportunities in there. What I try to do is figure out where the location is in great companies. Sometimes, there is some of that and also not-so-great companies, but good companies. I will also say another thing that investors have to understand. If I’m a portfolio manager at a fund, and I own a sector. I decide that I want to reduce my waiting of that sector, I could be selling some names that are very cheap as a multiple to cashflows, to earnings, and sales.

Those names are just being sold because the manager wants to take that money from those names and put them into another sector. You could have some very good companies that get this location in price relative to their intrinsic value that you say to yourself, “There’s an opportunity here.” Always focus on, as I tell my students, what is the future cashflows? What are the probabilities? What is the risk? That’s the way I do it.

Eddie, I want to emphasize one of the key points you made, which is that a great company does not always make a great investment. A lot of people get this confused, even professionals. I have been on teams. I have worked for three different institutions that manage over a trillion in assets. Even at those institutions, working with the analyst teams, people can continue to make that mistake.

When I was a trader, one of my fundamental analysts might say, “I like this company.” I’m like, “It’s a great company. That’s why it’s investing great. That’s why it’s an A-rated company.” There’s value there. That’s something to keep in mind that a lot of professionals and certainly younger folks get wrong.

They think because a company has got great fundamentals like Coca-Cola for instance, that you brought up a couple of times. That it makes a good investment. Oftentimes, it doesn’t. Conversely, you can find companies that don’t have good fundamentals, that are deteriorating or poorly run companies. You can make a lot of money on them if you either short them or you buy them at the right price, where it’s low enough such that there’s a lot of price appreciation left in them.

That’s a great point, Zack. I talked about Apple, and I say I never have to tell students in my classroom. I teach evaluation classes or in the fund, “Short this company and buy this company. I talk about what the numbers are telling me, and I always allow them to decide. I always say Apple is a ridiculous company. Pull their numbers. A company that can generate a 180% return on equity and can borrow at 3%. They can take their margins from 38% to 43% and take their revenues in that same time frame from $280 billion to almost $200 billion. That’s a great company, but I say to them, it does not always make it a great stock.

Another thing I tell them is look at the price-to-earnings. Apple can be and is a cyclical company, even though they have gotten into the services business, which has been represented in their business model. It’s a more secure type of business but Apple always traded at a discount in multiple to the S&P 500. What is the S&P 500, Zack? All these five hundred companies generate future cashflows. At the end of the day, why was Apple paying a local lower?

When interest rates rise, so does the cost of capital. It’s crucial to understand how this impacts a company’s future cash flow. Share on X

The average of the last 100 years, the multiple earnings for the S&P 500 companies on average is seventeen times? Why was Apple traded? It’s because investors hear that sick fatality in the iPhones that would hurt the earnings but they have bounced out the business model. In some regards, they showed investors, “Not only are we getting away from some of the sick fatality, but when times are not so good, we can still maintain 43% to 44% gross margins when they were 38%. We are doing it at a margin. Even though our numbers are sold.”

You know this and I know this, Zack. The bigger you get, the harder it is to grow 10% and 20%. When you are doing $400 billion and you’re generating $110 billion a year cashflow like Apple is. You cannot acquire the entire market. That’s very important. It’s very important that you know. That’s to understand great companies don’t necessarily make great stocks.

There are so many good points you made and I want to make sure we dig into these. One is, when it comes to larger companies, you also have trouble as an investor gaining an information advantage. Whatever you and I know about Apple, there are probably a thousand other smart analysts know as well. There are probably things they know that we don’t even know. It’s very hard to make money, in my opinion, as a large-cap investor, because you are competing in a market where you don’t have any information asymmetry or information advantage.

That’s one of the reasons why I transitioned my career out of the public bond markets and public fixed-income markets into venture debt because I have information advantages here. I know things that nobody else on the planet knows and as do other people in the private markets. Being able to leverage that private information allows you to generate alpha and outperformance for prolonged periods. That’s one thing I want to mention.

Market Efficiency And Investment Opportunities

That’s an interesting point because what you are saying is you’re using the capabilities to figure out where there’s value and is that value represented in the value of the company, i.e., Apple now trades at 28 times. It’s probably well-represented. The information like I tell my students, “Every day you wake up, there are hundreds of people looking at Apple stock and looking at the valuation.” By the way, there’s a guy in Omaha, who’s one of the largest shareholders of Apple stock.

Trust me, I tell you he’s looking at it. Even at 28 times, he’s probably saying to himself, it’s pretty expensive relative to the earnings process. Why do I say that? I’m paying this multiple that’s 10X greater than what you would pay for a normal S&P 500 for a company that’s got slowing growth. On the top line, you can see the numbers. We’ll have slowing net income, but still a great company. That’s very interesting.

What you are saying is your marginal product is not your capability in buying a large-cap, where it is much greater in venture capital and areas where the markets not as focused. In some cases, you could make an argument that it helps you and hurts you because you got smarter investors maybe in your market than the traditional retail investor that may not know enough about what you know where they could be funding money into Apple, Nvidia, or Tesla, where that’s more of a speculative plate on their part, versus what you are doing and financing companies that are at different stages in their business cycle.

In a way, what we are talking about here is market efficiency. It’s easier to make money in less efficient markets, and that’s something you learn on the first day of business school or investment classes. You want to go where other people aren’t because if you do what everybody else is doing, by definition, you are going to get an average return.

You get an average return if you extend that in a perfectly competitive market. What are the profits? They are zero. It’s same way. If there’s no money to be made, there’s no arbitrage. The arbitrage for you could be the information you know. That’s a great point. I will always say this, remember how I started my conversation with you? What are my capabilities? My capabilities are technology.

I felt like I had that upper edge against others when I was evaluating a technology company because I could make a distinction of why I thought this company was better than that company and where I thought the numbers were incorrectly being priced. All those cashflows will be priced by the market because, at the end of the day, when Apple opens up, it’s trading at, let’s call it 170.

The market’s telling you what they think about Apple’s future cashflow. The question you have as an investor is, do I buy that stock now or do I put my money somewhere else? You have to bring that capability. Probably less capabilities than what Apple and their $410 billion in sales have versus you looking at venture company startup at different cycles up the stage of a startup trying to develop into a company like that.

 

Important Link

• Zack Ellison on LinkedIn
• Applied Real Intelligence (A.R.I.)
• 7 in 7 Show with Zack Ellison on Apple
• 7 in 7 Show with Zack Ellison on Spotify
• 7 in 7 Show with Zack Ellison on YouTube
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• Dr. Eddie Sanchez on LinkedIn
• University of Florida, Warrington College of Business
• Travelers Insurance
• 7 in 7 Show Disclaimer

 

About Eddie Sanchez

Experienced Portfolio Manager and analyst with a demonstrated history of working in the investment management industry. Skilled in Equity Research, Budgeting, Analytical Skills, Banking, and Credit Analysis.

Strong finance professional with a DBA focused in Business Administration, Finance from University of Florida – Warrington College of Business.