Mastering The Future – Investing In Technology And Innovation With Dr. Eddie Sanchez, Part 2

 

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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 2

Understanding Market Efficiency

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.

You just hit on another important theme, which is to develop an edge. Figure out what you’re good at as an investor and then go all in on that. That’s how smart money operates. They find people in institutions that have an edge in a certain area and allocate to them so they can make money off of that edge. That’s another key theme.

 

 

If we’re to summarize some of these key themes, look for inefficient markets, and informational advantages, play to your strengths, figure out what you’re good at on a relative basis, and think very hard about price and value. What are you paying for what you’re getting? Think very hard about relative value, which is related to price value, but that’s incredibly important.

You don’t need to always run with the crowd. You can be a contrarian. You don’t need to be a contrarian just to be a contrarian. You have to understand that when you’re running with the crowd, it only takes one to decide, “I want to get out.” Everybody else starts to get out, and you could be left behind. Understand why you’re there, and if you’re going to run with the crowd, you have to understand.

We could all sit back and say, “We wish we would have run with the crowd if we had owned NVIDIA this year when they basically doubled their market cap.” There’s things like that. It’s a big point that you make, understand if you’re a growth guy. Are you a value guy? Are you a GARP, growth at a reasonable price?

Understand who you are. You could just say, “I’m a momentum. I chase growth, and I understand that I could have risk there.” That’s okay too. You don’t have to put your entire portfolio in one company. If one works and goes up 100%, and the others all go down 10%, you’ll still making money.

I’ll add to that. I think being forward-looking, as much as that seems obvious, most of the market is backward-looking. Truly look ahead and think about what’s changing and where there are going to be inflection points. Where are the catalysts that are going to change the price or value of the securities that you’re investing in? That’s huge. People miss it all the time, even though it should be very obvious that you need to be forward-looking. People don’t invest like that in practice.

I hear it all the time, “Why is this company down?” As a good example, Google is down. The numbers weren’t that bad. No one cares about what happened. They’re trying to decide what’s going to happen with Google. If AI and Cloud’s numbers weren’t as strong as people were expecting, that’s a disappointment. That doesn’t tell me anything. It tells me about what investors are looking for in their future cashflow.

Pricing Future Cash Flows

This is what I always tell my students, everybody always talks about stock prices. I don’t care about the stock price. What I care about are the future cashflows of that company to determine what the value of a business. I give them a great example, you’re going to buy a rental property. The gentleman or the woman who wants to sell you the property is charging you $10 million, and the income on the $10 million is going to be a 5% return.

You’re thinking, “That could be a pretty decent return,” until you figure out that you could have just put your money in the bond market given it to the government, and slept at night with no risk in principle or interest. That’s understanding where your capability is at. Maybe you are an investor in real estate, and also understanding what those future cashflows, what are the risks of those future cashflows, and how do I tie that back to what I pay for that company. It’s very hard to do.

I’ll make one more point. It’s very hard to dig through the filings, A’s, and Q’s, and the minutiae that goes on in there, but those are the details that are going to allow you to become a better investor at understanding. What could be the little details that could change the valuation of a company? I’ll leave it with an example. Everyone’s hyping Tesla to the standpoint of this growth unit.

It’s fabulous, but if they continue to lower their prices, they should be able to grow the units, correct? The question becomes, is it profitable growth? When your gross margins were 26%, and you’re at 17% now. That’s not good because that’s going to affect your net income. Net income margins are 7.5%. Instead of looking at Tesla as a software growth company, why has the valuation come down? It’s because it may be a car company.

To tie that into what I’m doing in the private markets with startups, a lot of VCs will value companies at a very high level without having justification for that. You have to do that, don’t get me wrong, because these companies are early-stage. Some of them are pre-revenue, and some of the companies have low revenue.

Folks are extrapolating into the future, looking ahead, which is a good thing, but they oftentimes wind up overpaying quite a bit. What’s different about what we do at ARI is we lend money to companies that are early-stage, but they’re already generating revenue. Many of them will oftentimes be at profitability or close to it. We can value the company and get a sense of what’s the intrinsic value of this company.

The idea here is that these companies are growing very quickly anywhere from 50% to 100% annually or sometimes more. That value is going to expand. At least that’s our underlying assumption, but there’s enough evidence and enough traction in terms of the revenue and the cashflow to say, “I know what this company is worth even if they don’t reach their full potential.” Even if they stagnate or slow-down in terms of growth, they’re still going to be worth X. That is enough for us to then lend to them.

They’re going to generate enough revenue and cash flow to support the interest payments on the loan. What I’m getting at here is that whether you’re in the public markets or in the private markets, whether you’re looking at mega-cap or late-stage companies like Apple or Google, or a seed-stage or Series A or B company, it’s still fundamentally the exact same thing that you’re doing.

That’s a great point, Zack. You talk a little bit about edge. I call it capability. You bring capabilities. If I were to say, “Zack, you’ve been selling used cars for the last twenty years. You’ve been buying them from these dealers and you’ve been doing that.” What you’ve been able to gather, and this goes even into the mom-and-pop world. I would always ask them questions, “Why are you selling the business?” “My son or my daughter don’t understand pricing so they can’t take over the business.”

Being forward-looking is key. Most markets are backward-looking, but true investors think ahead and spot the catalysts that will drive future value. Share on X

There’s a lot to be said about understanding a business model and understanding pricing. In essence, you’ve got a tough job because as an analyst, I look at myself as a bottoms-up. I look at the details in the bottom, and I don’t have to worry about the macro as much, even though I’m aware of it. I also keep inflation in mind. That’s more of a macro thing, but I have to stay aware of it. Where you have to understand how those things play because you have these companies that haven’t experienced anything just yet.

I can go back in history and look at, “How does Apple do in a downturn? What happens to the business model? What happens to the margins?” You have to build from that based on experience. What have you seen? The more you see, the more different types of business models you see, the more you can assess pricing. Pricing basically mitigates the risk. If you can become better at assessing the risk, you can become better at assessing valuation.

If you can become better at assessing valuation, you do better than anybody else. You mitigate the risk. If you can mitigate the risk, then your upside is much greater than your downside if you can get it right. We all think we can make the greatest investments, and that’s all we talk about. We never go into the bar and say, “I want to tell you about all my bad investments. I want to tell you how Microsoft’s up today. I bought Microsoft last night.” These are the things we’re looking at, but if we’re true to ourselves, it’s understanding the risk.

I also attribute that when the wealth manager is calling you up to invest in a stock. He’s never telling you about the stocks you should sell in your portfolio, so to speak. He’s telling you about all the stocks that you should buy. There is a bias. The one thing you talk about when you talk about edge or capability is, you see many of these companies over and over again. You could see some of them when this happens. When you’re valuing it, that’s only when you inject that into the cost of risk.

Eddie, you bring up a point that is important. It’s this idea of pattern recognition that enables one to then handicap probabilities. Some people will say to me, “You’re pretty new to venture debt. Why should I invest in you?” The response and the truth is, “I’ve seen more than probably anybody in this space because I’ve either traded or executed over 50 billion in debt deals.”

Nobody in the space even comes close. I’ve seen more business models, more successes, failures and worn risk 24/7 for more years than almost anybody in this space. People sometimes have a hard time comprehending that because they’ll say, “Did you do this deal or that deal?” It’s like, who cares about a deal? I’ve done thousands of transactions. I’ve analyzed thousands of companies and talked to thousands of business leaders that are CEOs, CFOs, hedge fund managers, portfolio managers, and institutional allocators.

What that gives me, to your point, is this ability to basically compare and contrast. It gives you a sense for where things are going, even if you don’t know a lot about that particular company or it’s an industry that’s nascent and nobody knows where it’s going to go. What do you have to do? You have to take everything in your mind all the things that you’ve seen in the past. Develop a story for where you think this is going, and then be able to handicap that and pick probabilities for where things can wind up.

That’s a good point. You’re tying everything. All that capability, and it could be qualitative. As I tell my students, “It’s great to tell a qualitative story. How do I take all that capability and drill it down to, this is what this company is worth at the end of the day?” The numbers, as I said, cashflows don’t lie, and that’s what you do best.

What you’re taking is your capabilities, and you have a lot. You have a strong pedigree and strong work environment based on what you experience. You’re bringing those two together to do make an assessment. You walk into a doctor who’s operated on 50 arms or 1,000 shoulders. Been there and done that. I have seen it. I can assess the risk first and foremost, and then I can do this procedure to make it better, and this is your upside. No difference in a business.

Pricing Risk And Market Mistakes

Two things you brought up there that is important. One is, think about risk first, and be trained in risk. Not just say, “I think this might happen.” What’s your process for assessing the risk? The second step, which is equally important is how do you price it? The reality is, my job for many years was pricing risk all day long, every day. All types of risk. I’ve priced corporate bonds, leveraged loans, bank loans, preferred stock, and hybrids.

What that means is within any asset class that I’m looking at, within any product, I’m thinking about how to price the risk factors that I’ve assessed. You first assess the risk factors, and then you figure out how to price them. You’re nodding your head. For folks that are reading, this is the key, how do you price the risk?

I’ll give you a great example. When folks were underwriting venture loans in 2021, I love venture debt. I’m probably the biggest advocate for this product in the country, but they were pricing them wrong. Venture loans from 2021 that were priced at the prime rate from Silicon Valley Bank is garbage. You might as well flush that. It’s a terrible investment because the prime rate was at three and a quarter percent. Some of these loans were priced subprime. They were literally at 3% or two and three eights. It’s terrible. You were not getting paid for the risk you were taking.

Now, the markets change. You get paid for that risk. It’s funny, I was at this venture debt conference in March in New York. This was right after SVB had collapsed. SVB collapsed on March 10th and this conference was on March 31st in New York City. People were like, “We don’t know where pricing’s going to go.” I’m like, “You don’t because you’ve never traded a multi-billion-dollar book. I know where pricing’s going to go. It’s going higher.”

A lot of people that stepped into that market after SVB collapsed also are going to get the short end of the stick because they stepped in way too early. They stepped in when they thought they were going to go take market share. What they got was adverse selection. They got the companies that needed cash that were no longer able to get it from SVB at 3%, then going to the next dummy in line to get it at a little bit of a higher rate. Ultimately, those guys are going to have a lot of trouble.

 

In some cases, some people haven’t even experienced risk. Some people didn’t experience 2008. Those who experienced can see what a stock. Amazon went below $5. It’s just things like that, that unless you see and experience it, and almost feel a little bit of the pain. You don’t get away from always trying to understand, what is my downside first before I can figure my upside? The thing you and I can do every single day is, we can give our money to the government and sleep at night knowing we’re going to have protection of principal and interest.

The question now is, what about the government market and this is what I tell my students. Every day you wake up, the day you get married, what is the yield curve telling you? I’m going to be able to price risk off that yield curve and ask myself, “Am I being compensated for the incremental return that I’m receiving on any type of investment?” Even in your world of venture debt.

Eddie, it’s funny. Most of the folks that have only been in the market for fifteen years never saw the credit crisis, the GFC. When people say, “I have a great ten-year track record.” My first thought is, “Who cares?” If you didn’t, you should go jump off a bridge because everybody in the last 13 or 15 years had a great track record. Anybody post-2010. The market only went up into the right for 10 or 15 years.

Look at the S&P in the public markets. When you get rates going to zero, what do you do? You buy growth. It’s not that hard. The math will tell you that, risk premiums. That’s where you buy and chase. It’s times like this that we could possibly be going into where things are different. Why? The cost of capital and what’s higher.

Let’s get into investment mistakes that you’ve seen others make. I touched on one, which is mispricing risk. You could have a great product or a great company, but you buy it at a price that’s too high or you lend to it at a rate that’s too low. What are some other mistakes that you see, especially in innovation and technology?

I think one of the biggest mistakes from the public markets and that’s all I can speak to. This is one thing I see all the time. When the analysts on Wall Street start to model the company, they’re very quick at modeling it up like a hockey stick because they’re trying to get investors attracted. They’re very slow to take numbers down when things go bad. One of the worst things that you can do is not understanding how bad things can get when they really get bad.

I always think that in any investment, you always have to do a bull and bear case. You have to do some sensitivity analysis. Understanding when it gets bad, how bad can this get? I’m going to give you a great example. There was a company called Tableau. Investors could go back and look at this company. They lost 50% of their value in the aftermarket. A real software company making money, why? It’s because what people don’t understand with a software company is they have very high gross margins, and very high operating margins.

When the numbers go South, guess what happens? Those margins help you when things are good. Only they look ugly when things get ugly because those margins start to drop and they drop like crazy. One of the biggest mistakes that we will do is get too caught up in, it’s just up and to the right all the time because we haven’t seen a bad market and how the models can change. That’s number one.

Another big mistake that investors will always do is they don’t know when to get out of a company and sell because they get too infatuated with what the market is telling them. This is what I always say about investment, you’re chasing price action and every day, we can see it. It makes us feel good when Amazon or Apple, for instance. Apple goes 90 to 110 to 120. You’re not assessing the risk of the company or what the cashflows are telling you. You’re letting the price tell you to go up “This thing could go to 200.” Why? It’s because it keeps going up. That’s a big mistake.

Every single day, a portfolio manager or a hedge fund manager should always evaluate, what are my opportunity costs? Where can I get a better investment than Apple? If Apple is the best investment because you own that, then you keep it in the portfolio. You keep it in the portfolio because there aren’t other better returns maybe in that asset class that can give you a higher return with less risk.

If you only associate it with price, you’re going to keep owning that. Tesla kept going up. We all think that Wall Street analysts are really smart. Weeks ago, an analyst at Morgan Stanley puts a strong buy recommendation on it. Stock gets up to 270 and trading at 213. Why? Again, pricing is coming down, and margins are coming down and the prospects are worse. You’ll hear analysts talking about Elon Musk was negative on the conference call.

If Elon Musk was negative and they had blown out the numbers and the margins were going the other way. No one would have cared. Ultimately, stocks reflect what their fundamentals are telling them. What the fundamentals are telling you about Tesla is they’re getting worse, not better. Those are, I would say, from my public standpoint on companies. That’s where I see big changes.

If one thing you touched on there that’s incredibly important is exit strategy. It’s different in the public and private markets because of differences in liquidity, but ultimately, a lot of folks get into an investment. It might be a great investment at that time and might perform very well, but when do you exit? I think about folks that were in crypto. They bought in before the peak, and it peaked at close to 70,000, Bitcoin a couple of years ago. When do you know when it’s time to sell? That’s the question. How do you think about exit?

Growth is very hard. You’re always assessing the prospects. If I get a small company like Tableau into the business intelligence space, I try to assess what is the market opportunity? Realistically, what is the opportunity of that company within that? At the end of the day, when you’re a small company, I would say there are great opportunities where, in many cases and even in your case, you could fly underneath the radar. You start to become bigger, and the bigger guys start to focus. They start to say either, “We acquire you.” It could be an exit strategy, or we try to make it difficult and hurt your business prospects and your growth.

As I said, you’re always looking at the opportunity of what is the opportunity of that company? Has it achieved what I think could be the best it can do in an environment with valuation and the business model? Do I stay there, or do I decide, “I’m going to sell because I think its?” Here’s my thing and this is what I tell my students, you always have to have a price target. When it gets to that price target, here’s what Wall Street will do, they’ll just take it higher.

Don't get caught up in the hype. Always translate hype into numbers and ask: are those numbers reasonable? Share on X

They will just move it.

They don’t have any money at work. What you have to do is ask yourself at that point in time. Only because that stock is green, does it make it a great stock or great valuation. Is there a better opportunity? In that sector, that’s where you want to have your money. If not, then hold on to your investment. Don’t be lazy and say, “I don’t know. I’m going to ride this horse.” I never do that. I’m always looking for what is the opportunity. If I’m going to sell NVIDIA, where am I going to put my money?

If I don’t have that place to do it and I have to be invested there, I’m going to stick with my horse, so to speak, and I’m going to maybe let it ride from a standpoint of valuation. Even though I think it’s a little bit expensive, because I’m always looking for other opportunities. My exit strategy is always having a target price. Target price comes from some view on what I think the growth prospects are and how do I back.

In the private markets in VC, it’s a little bit easier in a sense because most folks are just going to buy and hold until there’s an exit or an acquisition. Either they go public, or get bought. That becomes the obvious exit point. For a lender like ARI, it’s pretty easy too because we have loans that have discrete timeframes.

We’ll say, “We made a three-year loan.” At the end of three years, we don’t have to continue to have anything to do with this company once they’ve repaid the loan. If we choose to, we can reassess at that time and maybe continue to lend to them. It’s a little bit easier for us. You have it much harder in the public markets.

You’ve got a finite term, right?

Yes.

Look at it as having a finite term. I’m always looking at what are my opportunity costs, and do I stick with what my investments are, or do I find other investments that provide greater value? The greater value means I’m always looking at the cashflow. Is this company doing better than this company? Are they the same? I’m going to common-size them. I’m going to make them look the same. Why do I want this one company at this level or this valuation and by this company, because I think they’re future prospects or better cashflow?

Segueing a bit in terms of technology companies and how they fund themselves, how do you think about debt as a piece of the financing puzzle, especially for earlier-stage tech companies?

I think it’s interesting because the traditional way I look at a company is you go IPO, raise money in the capital markets on the equity side, and put people as owners of the business that you’re selling. Slowly, as you become a more mature company where you could service the debt, you start to add debt to the balance because it’s lower cost of capital.

When it comes to your space, it becomes a little harder because when I’m going to lend money and you’re my buddy. If I lend you $100, maybe I’ll say, “What’s the collateral here? You don’t pay me back after you go drink.” A $100 is probably not a big number, but think about lending $2 million, $3 million, or $4 million. You’re looking at, what is the collateral? Where do I offset my risk?

Again, it’s not equity. You’re not getting ownership. You’re paying me some lower rate than I would get if I were an equity shareholder or owner in the business. I would be looking at, where can I mitigate my risk on some collateral? Whether it’s I get some of your accounts receivables, or a portion of your revenues. I’m looking at other ways to mitigate that risk because the pricing is not going to be like that.

Why do you make these great returns on a venture deal when you take equity because there’s a good possibility you’re going to zero. There’s probably a greater possibility in a venture deal that you’re going to zero than you are becoming the next Google, the next Amazon, or the next Microsoft. Those are the things that I would be looking at, where’s my collateral? How much do I think I can get to offset the investment?

That’s a great point. I think part of the reason why venture lenders have traditionally done very well in terms of very low losses is that they typically are keeping the loan-to-enterprise value very low. The average in the industry amongst the better lenders is 10% to 20% range. Even if the company doesn’t reach its full potential, there’s still so much collateral and cushion essentially, that still protects the lender quite well. That’s one thing to consider.

You know there’s another round coming if they’re going to put more capital into the company. That could be something to mitigate offset the risk because you’ve got terms of 2 or 3 years.

 

Equity Vs. Debt Financing Decisions

From a founder’s perspective, so if you’re the tech company founder, how do you think about the decision between financing with equity and debt? Assuming you’re later stage, you’re generating revenue, and you’re profitable. How do you think about that decision?

I hate giving away ownership of my company. I hate giving away that upside. That’s very hard. I would hear stories of how people will give up 30% to 60%. I always hate giving up upside because I’m the founder. It’s my hard time and sweat and rolling up my sleeves and getting into my business to build this.

I hate giving that up. If I can find other ways of trying to get cheaper capital, if that’s the word. I would try to do that first before giving up ownership because think about it, for investments. When you’re giving up ownership, you’re giving up claims to the future cashflow. If I own 100% of the business and I made a million dollars, I get to keep a million dollars. If I own 20% and I gave away 80%. I only keep 20% and I’m giving away 80% and all my hard-earned sweat and everything I’m putting in to give somebody of the profits going forward. That’s hard and. In some cases, that could be demotivating.

You nailed the biggest theme with founders, which is that they want to keep the companies that they’ve built. I’ve read some academic research. I think it was Stanford, or some professors from Stanford that did this research. It basically showed that for companies that IPO that were venture-backed, the ownership percentage that belongs to the original management team is something like 3% to 7%.

You’d be amazed at how much of their equity they need to sell to get to that stage. That’s why I think venture is catching on a lot because folks are starting to realize, “There are alternatives to equity financing.” It’s not right for every company. Oftentimes, people will call me and they’re way too early for debt. Once you’ve reached a stage where you’ve got sufficient revenue and cashflow to service the debt, it makes a lot of sense to have some debt in your capital structure because, to your point, it’s cheaper.

It’s a much lower cost of capital. It’s about a third to 50% of what you’d pay on the equity side for capital. It’s also much less dilutive. The lenders typically do get equity warrants, so there’s a little bit of dilution to the founders, but not a lot. You’re going to own a lot more of that company if you use debt along the way. Your payout at the end is going to be significantly higher. That’s what appeals to the founders, I think.

Companies are in different cycles, and you talked about it. Maybe they’re a little bit more mature, where you can see how they can service the debt. It could be in a period of where they are in the business cycle or where the economy is. There are so many things to look at. You may have a good company, and as long as you can service the debt.

Very quickly, I’m going to tie that to the capital market. Students ask me, “Why does Apple have so much debt?” I shouldn’t say so much. It’s a big number. It’s $132 billion. They generate all this cash. Why? There are so many reasons why Apple has debt on the balance sheet. I tell them, when you generate a return on equity of 170%, and you can borrow money at 3%. There’s a good reason you should be borrowing money to fund purposes of your company.

Why would Apple bring money back from Europe or from China if the money is there? If they bring it back and they repatriate, they have to pay taxes. If they want to pay a dividend and buy back stock, why not borrow it? Someone’s going to give you money at 3%, and you think the returns are better in the capital eradication of not bringing that money back. Borrowing the money to do those two things is not a bad idea.

Apple spent $15 billion in dividends. They bought back $89 billion worth of stock. Part of that’s financed. If I can borrow at 3%, it’s not a bad idea. Again, always trying to think of ways and how to leverage your capital structure in the proper place. That’s not bad. It’s not. If you’re over-levered, it could be a problem. If you’re using capital that is not giving up ownership and going into the debt markets where it’s cheaper. I know I’m using a great company, but that may be the way to go.

Eddie, you nailed it. Funny enough, when I was at Deutsche Bank as a bond trader, we led the biggest bond deal in history at the time, which was Apple’s deal. The TMT trader that sat next to me was the lead trader on that deal. It was great because the entire trading floor just paused. Everybody, rates traders, and structure products froze and was watching him trade these bonds on the break as they say at the end of the day. The reason they did that big deal, you already mentioned it. It was that they didn’t want to repatriate a bunch of the cash that they had overseas. It was so cheap for them to go in issue debt that they figured they would do it.

Again, it’s smart and proper use of your capital structure. I talk to students about Apple’s portfolio. They say, “Apple owns mortgages? Apple owns treasuries?” They’re using their allocation or the capital structure and their cash. If they’re spending on average about $10 billion in CapEx, what do you do with the excess cash? I got to put it to work. If I don’t want to put it to work because I can’t put it to work in the company because I don’t have any opportunities. Where is the next best place to manage my risk? It’s even an incremental return above and beyond just having it in a money market account.

We’ve only got about five minutes left and I wanted to ask you a big-picture question. If you had to give advice to an institutional investor on how to invest in innovation and technology over the next 3 to 5 years, what advice would you give them?

Let’s take AI, for instance. I was looking at some IDC numbers, the compound growth. You look at hardware at $37 billion going to $650 billion and software going from $1.5 billion to $150 billion from now and over the next ten years. My biggest advice first and foremost, I think everyone should understand this, do the detailed work. Don’t get caught up in the hype.

The hype needs to translate into the numbers. We’ve got a great example that we didn’t have back in 2000. NVIDIA showed you what a company can do with its cashflow. Its cashflows go from below $10 billion to probably $36 billion to $40 billion over the next two years. That’s not hype. That’s real. Try to always turn the hype into numbers.

In both public and private markets, the fundamentals are the same. It’s all about assessing the value of a company’s future cash flows. Share on X

Final Thoughts On Investing In Innovation

For you, and even for those investors, some of it may be difficult. You may not want to put all your eggs in one basket because you may want to look at multiple companies in multiple places. Stay away from the hype and get into understanding, what is the market? What are the so-called strategists telling you about the market? What are the growth guides telling you about it? Try to always ask yourself, are those reasonable numbers? AI is going to be very big. Business intelligence is very big. Even then, there are a lot of pitfalls. You’ve got to understand also like an investor, what’s the upside? What’s the downside?

A lot easier said than done. You’re going to miss a lot of great companies, but just because you missed great companies, i.e., “I missed Walmart.” “I missed Home Depot.” “I didn’t buy them.” It doesn’t mean that you’re going to go out and try to find them in the sense that I got to throw money at everything and hope that they’re going to become the next Walmart or Home Depot. Very great.

Great points. Anything else you want to add before we go?

I will say this, I think AI is going to be very big. What people need to understand is, and I associate this with any investment. If we think about what AI is, it’s intelligence, Zack. Who has the data to create intelligence? Big corporations. They’re just going to allow that data to go out there and be out there for free. It’s going to be very hard.

AI is going to be phenomenal. Is there some kind of cap? Let’s not get too crazy about it. I said this in business intelligence, there are so many disparate areas of data. Bringing that together is very time-consuming, hard, and costs a lot of money. Microsoft is talking about the chip that they have to buy from NVIDIA. It’s expensive. Understand that there’s a cost to everything. Make sure that the return is greater than the cost of any investment.

I agree with you. I think the way to play pure AI is to stick with the big incumbents that have the data and have basically infinite resources. The Microsofts of the world, for instance. You can’t beat them in terms of what they’re doing. Find a different game to play. What I’m looking for are companies that are utilizing what folks like Microsoft are building to then be better at their business within a different segment.

In other words, take AI and use that to make your existing business in a different segment better, and better than your competitors, faster, and more cost-efficient. That, to me, is where there are going to be real opportunities. Folks that can recognize how AI is going to be applied and who can apply it most successfully to their existing business models to put them on steroids, so to speak, put them on the rocket ship. That’s where there are going to be winners. Folks that are investing in pure AI plays are going to lose most of their money.

Zack, it’s a great point. Listen to what companies are telling you. It’s expensive. The nice thing about Microsoft, Google and Amazon, they can make a lot of mistakes that we’ll never know about. Smaller companies can’t make these mistakes. That’s why it’s really imperative to understand what your capabilities are versus your competitors’ and to expound and push on that, and invest, so that you can hopefully come out ahead.

Eddie, thanks so much for joining. It’s been awesome having you.

Always a pleasure. Hopefully, you’ll continue your hard work in the DBA program. I’m sure you’re looking forward to getting into your dissertation and finishing it up. Someday, we’ll call you Dr. Zack.

I don’t know if I’m going to be Dr. Ellison or Dr. Z or what I’m going to be. We’ll see.

I like that.

Anyway, it’s great having you. I always learn a lot talking to you. I love what you’re doing at the University of Florida. I’ll see you in Gainesville soon.

Great. I appreciate it. Thanks, Zack.

Thanks, Eddie. Go Gators.

Go Gators.

 

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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.